Direct Tax Alert

BACKGROUND

Business restructurings have emerged as one of the most preferred tools for corporates in India, enabling segregation of distinct undertakings, ensuring focused management, availing business synergies, achieving strategic realignment and unlocking long-term value. Section 2(19AA) of the Income-tax Act, 1961 (‘the Act’) provides a tax-neutral framework for the transfer of one or more business undertakings from a demerged company to a resulting company. Further, provisions of section 72A of the Act allow carry forward of accumulated losses related to the demerged undertaking to a resulting company. One of the conditions for a demerger to qualify as a tax-neutral demerger is that the resulting entity is required to issue the shares to the shareholders of the demerged company.

In this regard, recently¹ the Mumbai Income Tax Appellant Tribunal (‘ITAT’) had an occasion to analyse the scope of the term ‘resulting company’ and whether a court-approved demerger can fail tax neutrality in the absence of strict compliance with the statutory mechanism prescribed under the Act.

We, at BDO in India, have analysed and summarised the key aspects of this judgement and provided our comments on its impact hereunder.

FACTS OF THE CASE

• The taxpayer company, Thomas Cook Insurance Services (India) Limited, is engaged in selling vacation homes and leisure hospitality services.

• Pursuant to the scheme of arrangement sanctioned by the Bombay High Court, ‘Resorts and time-share undertaking’ of Sterling Holiday Resorts India Ltd. (‘SHRIL’ or ‘demerged company’) was demerged into Thomas Cook Insurance Services (India) Limited (‘TCISL’ or ‘resulting company’ or ‘the taxpayer’) on a going-concern basis. Further, TCISL is a wholly owned subsidiary (‘WOS’) of Thomas Cook (India) Limited (‘TCIL’), a listed holding company of the taxpayer.

• The residual business of the SHRIL was merged into TCIL or the ‘transferee company’.

• As a consideration for the demerger, TCIL issued shares to shareholders of the demerged company instead of issuance of shares by the resulting company.

• The above transaction of demerger is depicted as under:

• The resulting company, while filing the return of income, claimed carry forward of accumulated business losses and unabsorbed depreciation aggregating to INR 2.40 bn approximately, under section 72A of the Act.

• During the course of assessment proceedings, the tax officer disallowed the claim of carry forward and set off of losses on the ground that the demerger failed to satisfy one of the statutory conditions specified in section 2(19AA) of the Act, i.e., the shares were allotted by TCIL and not the resulting company.

• Aggrieved by the same, the taxpayer filed an appeal before the First Appellate Authority, wherein the findings of the tax officer and the disallowance were confirmed.

• Aggrieved by the order of the First Appellate Authority, the taxpayer preferred an appeal before the Mumbai ITAT.

MUMBAI TAX TRIBUNAL RULING

The Mumbai ITAT upheld the disallowance, holding that the conditions of the definition of ‘demerger’ and ‘resulting company’ were not complied with, and while coming to this conclusion, the following observations were laid down:

• Section 2(19AA) of the Act provides that the transfer of an undertaking from one company to another as part of a genuine restructuring process is not considered a taxable event on satisfaction of the conditions laid therein. One of the conditions requires the resulting company to issue its shares to the shareholders of the demerged company on a proportionate basis.

• As per section 2(41A) of the Act, ‘resulting company’ means one or more companies (including a wholly owned subsidiary) to which the undertaking is transferred.

• Further, the demerger must be in accordance with additional conditions as specified under section 72A(5) of the Act. Only upon satisfaction of all the conditions will it be considered a demerger for purposes of the Act.

• Reliance is placed on several rulings²pronounced by the Supreme Court wherein following principles have been laid out with regard to interpretation of tax statutes –

• Taxation statutes need to be interpreted strictly, going by their literal meaning;

• There is no place for searching intendment or making a presumption;

• Further, when the language of a statute is clear and unambiguous, the courts are to interpret the same in its literal sense and not to give a meaning which would cause violence to the provisions of the statute.

• Considering the provisions of the Act, the resulting company was required to issue shares to the shareholders of the demerged company. However, in the given case, the holding company of the taxpayer has issued shares pursuant to a demerger, resulting in non-fulfilment of the condition specified in section 2(19AA) of the Act.

• Further, it is to be noted that there is a substantial difference between a Holding company and a subsidiary company. They both have their own independent legal existence. Accordingly, a holding company cannot issue shares on behalf of the subsidiary, and its obligations are restricted to its own legal liabilities and obligations under the law.

• Since one of the conditions to qualify as a demerger is not satisfied, the business losses and accumulated unabsorbed depreciation cannot be carried forward under section 72A of the Act.

BDO INDIA COMMENTS

This decision would have significant practical implications for a scheme of arrangement with an identical structure where the holding company issues shares to the shareholders of the demerged company while the subsidiary company receives the demerged undertaking. This ruling opens an important debate on the interpretation of the bracketed phrase ‘(including a wholly owned subsidiary)’ as used under section 2(41A) of the Act and its implications on corporate restructuring involving demergers.

Despite the commercial rationale to consolidate value in the listed parent, the legislature does not contemplate structures where provisions of the law are not strictly complied with. Further, the Mumbai ITAT has reiterated the principles laid down by the Apex Court that while interpreting the statutes which are clear and unambiguous, there is no place for presumption.

---

1. Sterling Holiday Resorts Limited vs. DCIT in ITA No. 843 & 941/MUM/2024 (Mumbai Tax Tribunal)
2. Comm. of Customs vs. Dilip Kumar & Co [AIR 2018 SC 3606]; Britania Industries Ltd vs. CIT [(2005) 178 ITR 546-547 (SC)]; Union of India vs. Dharmendra Textiles Processors and Others (2008) 306 ITR 277 (SC); CIT vs. Rajasthan Financial Corporation (2007) 295 ITR 195 (Raj); Ajmera Housing Corporation and Another vs. CIT (2010) 326 ITR 642 (SC)