Demerger – Income Tax Provisions
In order to avail benefits
available to entities involved in demerge process, the demerger should satisfy
the conditions stipulated in section 2(19AA) of the Income Tax Act.
The conditions mentioned in
section 2(19AA) are broadly as under:-
a)
All properties of demerged undertaking become
the property of resulting company.
b)
All liabilities of demerged undertaking become
liabilities of resulting company.
c)
All assets and liabilities shall be transferred
at book value, ignoring any revaluation done earlier.
d)
Resulting company allot its shares to the shareholders
of demerged company in consideration of demerger.
e)
Shareholders holding not less than 3/4th
in the capital (equity + Preference) of demerged company, other than shares
held by resulting company, become the shareholders of resulting company.
1.
Capital Asset
a)
Taxation on transfer of Capital assets by Demerged Company to Resulting company
b)
Period of holding of capital asset in the hands
of Resulting Company
c)
Cost of acquisition of capital assets in the
hands of Resulting company
2.
Actual Cost of Capital Assets-
from depreciation angle
a)
Actual cost of capital asset in the hands of
Resulting company acquired from Demerged Company
3.
Written Down value (WDV) of
Block of assets
a)
WDV of block of assets in the hands of resulting Company
acquired from demerged company
b)
Reduction in WDV of asset in the hands of
demerged company transferred under demerger
4. Capital gain in the hands of Resulting Company.
5.
Shares allotted by resulting
company to shareholders of Demerged company
a)
Cost of shares allotted by resulting company
b)
Effect on existing cost of shares already held
by shareholders of Demerged company, pursuant to allotment of shares by
resulting company in demerger
c)
Period of holding of share allotted by resulting
company
6.
Depreciation
a)
Depreciation in the hands of Resulting company.
b)
Depreciation in the hands of Demerged Company.
7.
Bought Forward losses as per
Income Act
a)
Benefit of bought forward losses of demerged
company to resulting company.
8.
Benefit of bought forward losses
as per books for MAT
a)
Benefit of bought forward losses of demerged
company to resulting company.
9.
MAT Credit
a)
Benefit of MAT Credit of demerged company to
resulting company.
Capital Assets
a) Taxation on transfer of Capital assets by Demerged Company to Resulting company
Any
transfer of capital assets from demerged company to Indian Resulting Co in a scheme of demerger is exempt from capital gain u/s 47(vib).
b) Period of holding of capital asset in the
hands of Resulting Company.
1.
Income
Tax Act is silent on this aspect, as against the case where capital asset
is transferred in scheme of
amalgamation.
2.
In case of amalgamation, the period of holding
of capital assets in the hands of amalgamated company will include the period
for which capital asset was held by amalgamating company as per section 2(42A)
read with Section 49(1).
3. Thus in the absence of any beneficial
provision for demerger, period of holding of capital asset in the hands of
resulting co will start from day capital asset was acquired in demerger.
c) Cost of acquisition of capital assets in
the hands of Resulting company.
1.
Income
Tax Act is silent on this aspect, as against the case where capital asset
is transferred in scheme of amalgamation.
2.
In case of amalgamation, the cost of capital
assets in the hands of amalgamated company will be the cost for which capital
asset was acquired by amalgamating company as per section 49(1) read with
Section 47(vi).
3.
As per
Section 2(19AA) defining demerger, one of the condition is that assets and
liabilities be transferred at book value.
4.
Thus in
the absence of any specific provision for demerger, Cost of capital assets in
the hands of resulting company will be book value of capital assets in the
hands of demerged Co.
Actual Cost of Capital Assets-
from depreciation angle
a) Actual cost of capital asset in the hands
of Resulting company acquired from Demerged Company
1.
Actual
Cost of capital asset in the hands resulting co will be same as in the hands of
Demerged Co, provided it should not exceed the WDV, as per Explanation 7A to
section 43(1).
2.
This Provision appears to have relevance for
depreciable asset only.
3.
Despite using block of asset concept with
respect to depreciable asset, the Actual cost has relevance in some cases.
4.
One such case is slump sale. In case of slump
sale, reduction in the hands of seller in the WDV of assets forming part of
slump sale is computed as under as per Clause C of section 43(6):-
a)
Actual cost of asset transferred under slump
sale is taken into account.
b)
From Actual cost, depreciation is deducted on
such asset, as these assets were only assets in the block.
c)
The Resultant WDV is arrived at for assets
transferred under slump sale.
d)
The above said WDV of assets transferred under
slump sale is reduced from existing block of asset of seller company
5.
Explanation
7A has created some ambiguity in arriving at Actual cost of Capital asset in
the hands of resulting company as acquired from Demerged company on following
grounds:-
a)
Actual cost is taken as actual cost or WDV,
whichever is less
b)
Once asset in make a part of block of asset, it
loses its individual identity. There is no provision for working out the WDV of
Individual asset.
c)
Explanation 7A has not provided any mechanism of
how to arrive at WDV of Individual asset.
d)
To arrive at the WDV of Individual asset, it is
assumed to be work out on the basis that as individual asset is only asset in
the block.
Written Down value of Block of
assets
a) WDV of Block of assets in the hands of resulting Company
acquired from demerged company
1. Explanation
2B to section 43(6) – WDV of the block of asset in the hands of resulting
company shall be WDV of transferred assets of demerged company immediately before demerger.
2.
Explanation 2B is also silent as how to
calculate the WDV of transferred asset, which are part of other assets forming
block of asset.
3.
To view the explanation from practical
implementation perspective, WDV of transferred assets will be computed as if
they were the only assets in the relevant block.
b) Reduction in WDV of asset in the hands of
demerged company transferred under demerger
1.
Explanation 2A of section 43(6) – WDV of the
block of asset of demerged company shall be reduced by the WDV of the assets as
at the beginning of the year, transferred to resulting company pursuant to
demerger.
2.
Here also explanation 2A is silent about
computation of WDV of transferred asset.
Suppose Company PRQ Ltd has
two units: Unit X and Unit Y.
Computation of WDV in case of
demerger is illustrated as under:-
| Assets- 15% Depreciation | Unit X | Unit Y | TOTAL |
| Plant A & B | Plant C & D | ||
| Actual Cost Acquired on 1/4/2010 | 10,00,000 | 15,00,000 | 25,00,000 |
| Depreciation- FY 10-11 | 1,50,000 | 2,25,000 | 3,75,000 |
| WDV as at 1/4/2011 | 8,50,000 | 12,75,000 | 21,25,000 |
| Plant C sold | -13,00,000 | -13,00,000 | |
| WDV as at 31/3/2012 | 8,50,000 | 8,25,000 | |
| Depreciation- FY 11-12 | 1,27,500 | 1,23,750 | |
| WDV as at 1/4/2012 | 7,22,500 | 0 | 7,01,250 |
| Unit X is demerged | |||
| WDV of Unit X | 7,22,500 | ||
| WDV of Unit Y | 7,01,250 | ||
| Less: WDV of Transferred Assets | 7,22,500 | ||
| WDV of Unit Y | NIL |
There will not be short term capital loss
in the hands of PRQ Ltd u/s 50, since transfer of capital assets under demerger
is not treated as transfer for purpose of capital gains.
Capital gain in the hands of
Resulting Company.
1.
There is transaction of exchange in the hands of
resulting company, whereby resulting company is getting assets (demerged
undertaking) in exchange of issue of its own shares.
2.
As per section 2(47) exchange fall under
definition of transfer for the purpose of capital gains.
3.
Section 47(vid) exempt issue of shares, by
resulting company in a consideration of demerger from the from definition of
transfer, thus no capital gains in the
hands of resulting company on issue of shares in exchange of demerged
undertaking.
Shares allotted by resulting
company to shareholders of Demerged Company
a) Cost of shares allotted by resulting
company
1.
Section 49(2C)- The cost of acquisition of shares
of resulting company in the hands of shareholders of demerged company, will be
computed as under:-
Cost of
acquisition of original shares in Demerged Company x Net
Book value of asset transferred / Net Worth of Demerged Company immediately
before demerger
2.
Net worth- As per Explanation after Section
49(2E), net worth is aggregate of paid up share capital and general reserve as
appearing in books of accounts of demerged company before demerger. The point for consideration is whether
General Reserve is to be taken in strict sense, as GR appearing in balance
sheet or is it to be taken in liberal sense to represent all reserve belonging
to shareholders. The point is illustrated later on.
3.
Net Book of assets Transferred –It should be
mean assets net of liabilities of demerged company.
b)
Effect on existing cost of
shares already held by shareholders of Demerged company, pursuant to allotment
of shares by resulting company in demerger
1.
Section 49(2D) – Upon allotment of shares by
resulting company, the cost of shares of demerged company in the hands of
shareholders of Demerged company shall be adjusted as under:-
Revised
cost of shares in Demerged Company = Original Cost of shares in Demerged – Cost
of shares in resulting company as per section 49(2C).
c) Period of holding of share allotted by
resulting company
1.
Explanation 1(g) to section 2(42A) – For Share
of resulting company, acquired by shareholders of demerged company in demerger,
the holding period shall include the period for which shares of demerged
company were held by shareholders. For example, A purchase shares of X Ltd on
1/4/2000. On 1/4/2011, pursuant to demerger in X Ltd, A was allotted shares of
Y Ltd, resulting company. On 30/9/2011, A sold shares of Y ltd. The period of
holding of shares of Y Ltd will be counted from 1/4/2000.
This illustration is taken to
considered the meaning of General reserve in Net Worth definition
Balance sheet of A Ltd
| Liabilities | Amount | Assets | Amount | ||
| Unit X | Unit Y | Total | |||
| Share capital | 10,00,000 | Fixed Assets | 27,00,000 | 3,00,000 | 30,00,000 |
| Securities Premium | 20,00,000 | ||||
| TOTAL | 30,00,000 | 27,00,000 | 3,00,000 | 30,00,000 | |
Suppose Unit X is demerged
with B Ltd
If we goes by definition of
Net worth for calculating cost of shares of resulting company in strict sense,
then in the instant case, only share capital will be considered , since there
is no General reserve. In that case, cost of shares of B ltd in the hands of
shareholders of A ltd will be as under:
30,00,000 (Cost of Shares
in A Ltd) x 27,00,000 (Book value of assets transferred)
10,00,000 (Net worth of A Ltd)
= 54,00,000 (Cost of shares in
B Ltd)
This has resulted in absurd result, where cost of shares in B ltd
(resulting Co.) will exceed cost of shares in A Ltd. (Demerged Co.)
Thus the definition of General reserve should be taken in liberal
sense, considering all reserve and surplus belonging to shareholders
Depreciation
1.
As per 5 proviso to section 32(1), the depreciation
shall be apportioned between demerged and resulting company in the ratio of
number of days for which assets were used by them
Illustration
a)
Suppose D undertaking of X Ltd is demerged to Y
Ltd on 1/6/2012.
b)
Plant A of D undertaking has WDV of Rs. 10 lacs
on 1/4/2012 and depreciation rate is 15%
c)
Aggregate Depreciation on Plant A for FY 12-13
is Rs. 1,50,000
d)
Assets used by X Ltd & Y Ltd is for 91 days and 271 days
respectively.
e)
Depreciation deduction available on plant A to X
Ltd – Rs. 37,397 (1,50,000X 91/365)
f)
Depreciation deduction available on plant A to Y
Ltd – Rs. 1,12,603 (1,50,000 x 274/365)
g)
Reduction in WDV of Block of Assets (15%
Depreciation) in the hands of Demerged Company – Rs. 10,00,000 as per
explanation 2A to section 43(6)
h)
WDV in the hands of Y Ltd – Rs. 9,62,603
(10,00,000 – 37,397), being WDV of transferred assets immediately before
demerger as per explanation 2B to section 43(6)
Benefit of bought forward losses as per Income Tax
of demerged company to resulting company
1.
Bough forward business loss and unabsorbed
depreciation of demerged company will be allowed to be carried forward and set
off in the hands of resulting company in following manner as per section 72A(4):
a)
Where loss and unabsorbed depreciation is
directly relatable to demerged undertaking, entire loss and unabsorbed
depreciation shall be available to resulting company.
b)
Where loss and unabsorbed depreciation is NOT
directly relatable to demerged undertaking, such loss and unabsorbed
depreciation be apportioned between demerged company and resulting company proportioned
assets retained by demerged company and assets transferred to resulting
company.
2.
Loss under the head capital gains of demerged
company is not allowed to be carried forward and set-off by resulting company.
1.
There is no express provision in the Act to
allow the resulting company to carry forward and use book losses of Demerged
company for calculating its (resulting co.) MAT liability
1.
There is no express provision in the Act to
allow resulting company to carry forward and set off MAT credit of Demerged Company.
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