Section 43CA (Income Tax Act) vs Demerger

Section 43CA (Income Tax Act) vs Demerger

Herein attempt is made to understand, whether Section 43CA of Income Tax Act can be a dampener in Demerger Process?

Section 2(19AA) defines demerger, which is summarised as under:-

1.       Transfer, pursuant to scheme of arrangement u/s 391 to 394 of the Companies Act.

2.       Of Undertaking.

3.       From Demerged Company to Resulting company

4.       Properties and liabilities of the undertaking , being transferred, are transferred at values appearing in its books of accounts immediately before demerger

5.       Resulting company issues, in consideration, of the demerger, it shares to the shareholders of demerged company.

Undertaking is defined as combination of assets and liabilities constituting a business activity as a whole.

Now, the issue sought to discuss hereinafter is whether UNDERTAKING as such is capital asset or components of Undertaking should be treated as a capital asset or stock in trade as per the nature of respective components and corresponding provisions of Act will apply to Capital Asset and Stock in Trade respectively.

To further elucidate the issue, considered undertaking purport to be transferred under demerger has following constituents:-

1.       Plant & Machinery

2.       Land – held as stock in trade

3.       Net Current Assets

Before we proceed further, consider summary of provision of section 43CA inserted by Finance Act, 2013

1.       Where the consideration for transfer of assets (Other than a capital asset), being land or building or both.

2.       Is less than value adopted by stamp duty authority

3.       Then value, so assessed by stamp duty authority, shall be deemed to be full value of consideration for transfer of said asset.

Under section 47 (vib) transfers of Capital asset under demerger is not treated as transfer of capital assets for the purpose of computation of Capital Gains in the hands of Demerged Company.

Now Questions for consideration are as under:-

1.       Whether Undertaking in itself is capital asset, thus transfer of the same is exempt u/s 47(vib), irrespective of nature of its components.

2.       Whether components of undertaking is to be treated separately and only transfer of capital asset is exempt u/s 47(vib) and other components should be treated as per separate provisions of Act e.g section 43CA will be applicable on transfer of land, not being capital asset in above example.

                                                                                                                               

Arguments- Against treating undertaking as Capital Asset

1.       Section 50B-

a)       The said section serves the dual purpose  relating to slump sale- Charging Section and computation mechanism.

b)      Section 50B(1) provides profits and gains from slump sale shall be chargeable to Income tax as capital gains. Slump sale is defined u/s 2(42C) as a sale of one or more undertaking without being values assigned to individual assets and liabilities. The undertaking is defined as by giving reference to section 2(19AA), which defined undertaking for demerger.

c)       Had the undertaking being capital asset, there would not have been need for separate charging section for sale of undertaking under slump sale, section 45 would  have taken care of the same, implies that law does not treat undertaking in itself as separate capital asset within the meaning of section 2(14), defining capital asset.

2.       Non- availability of Computation mechanism

a)      Transfer of Capital asset u/s 47(vib) is exempt only, if conditions specified in section 2(19AA) are satisfied.

b)      If Conditions of section 2(19AA) are not satisfied, then transfer of Capital Asset is not exempt in the hands of Demerged company.

c)       If undertaking is treated as Capital asset, there is no explicit provision for computing Cost of acquisition of Undertaking in the hands of Demerged Company.

d)      Section 50B which is treating undertaking as capital asset has also prescribed the computation mechanism to work out the cost of acquisition of undertaking.

e)      Thus had the intention of legislature to treat undertaking as capital asset, it would have provided the computation provisions for computing its cost of acquisition.

3.       Others

a)      Explanation 2B to section 43(6) separately provides for the computation of WDV of block of asset in the hands of resulting company acquired by it from demerged company under demerger. Explicit provision for computation of cost/WDV of one of the constituent of undertaking gives the impression that law does not intend to treat undertaking as separate asset in itself.

b)      Provisions of section 72A(4) provides the computation mechanism  for unabsorbed business loss & Depreciation of demerged company to be carried forward by resulting company. Computation mechanism is worked out based on  assets transferred in demerger out of Total assets of Demerged company. Here also, the use of cost of undertaking was absent, to allocate the loss between resulting and demerged company.

Implications

1.       Section 47(vib) benefits will be available to capital asset comprise in the Undertaking.

2.       If there is land or building or both, being stock in trader and forming part of undertaking, then on its transfer pursuant to demerger, AO may invoke the Provisions of section 43CA.

3.       Since in case of demerger, consideration is being received by shareholders of Demerged Company, AO may take the stand that since demerged company has not received any consideration for transfer of land, its stamp duty value, shall be deemed consideration in the hands of Demerged Company and will be taxed accordingly.

Since Demerger provisions are beneficial ones, intended to facilitate restructuring of business, unintended consequence of section 43CA should be amended appropriately to facilitate smooth transition in Demerger process.