RESTRUCTURING OF BUSINESS ORGANISATIONS

By H Padamchand Khincha
BCom, LLB, FCA
Chartered Accountant
Bangalore

INTRODUCTION:

In this era of liberalisation, re-organisation of business has assumed paramount

importance. The process of globalisation has increasingly made business re-organisations

inevitable for developing a globally competitive edge. A good legislative support gives such

effort the requisite impetus. Re-organisations must be encouraged where they are in

consonance with the objective of economic development and not where they are merely

devices engineered to secure a tax advantage.

Increasing size of operations, need for sharpening of technological edge, obtaining

benefits of economy of scale, limiting risks, etc. are some of the reasons that compel business

organisations to convert themselves into companies.

Progressive companies embark upon expansion activities and there comes a stage

when some of the units of such companies grow to such a size of their own, that they can

function as independent companies. Also, companies expanding their activities, after some

time, realise that such diversified business and the volumes therein are unmanageable. The

various departments or units lose synergy in such a set-up. Companies are also increasingly

realising the need to restrict their activities to areas of `core-competency'. Such a situation

may therefore call for a need to restructure the business, involving inter-alia spin-off of some

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of the divisions into separate companies. The objectives is to run the separate units more

efficiently, smoothly, professionally and profitably.

The topic to be covered is very wide in its ambit. To cover the topic as allotted in its

entire gamut would be a very difficult task indeed. An attempt has been made hereunder to

cover certain recent developments especially on the taxation front of conversions into

corporate entity and demergers. It is only then, in our opinion that the deliberations could

become meaningful.

Part-I of this write up deals with the Company Law & Income tax aspects of the

conversion of a proprietorship or partnership business into a Company. Part-II deals with the

Company Law & Income Tax aspects of, spin-off of a unit into a separate Company.

PART -1:

1.0 CONVERSION INTO A COMPANY UNDER PART-IX OF THE COMPANIES

ACT:

PROVISIONS OF COMPANIES ACT:

1.1 Any company consisting of 7 or more members can register as –

 Company limited by shares;

 unlimited Company;

 Company limited by guarantee (Sec. 565).

1.2 A resolution passed by a majority of the persons present in person or by proxy is a

pre-condition for registration.

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1.3 For the purpose of Part-IX a joint stock company means a company having:

i) permanent paid up or nominal share capital of fixed amount;

ii) divided partly or fully into shares of fixed amount or held and transferable, as

stock;

iii) the members being the holders of such shares or stock (section 566).

1.4 The requirements for registration as a joint stock company are:

 List of members of the Company with shareholding

 Deed of partnership

 A statement showing:

- Nominal capital with its division

- Number of shares taken and the amount paid thereon

- Name of the company.

1.5 A copy of the statement showing the names, addresses and occupation of directors,

and deed of partnership will have to be filed with the Registrar of Companies.

1.6 On completion of the formalities, the Registrar would issue a certificate. The

property would vest in the Company automatically on registration. It was held by the

Andhra Pradesh High Court that on registration the firm's property is automatically

transferred to the company without any further act or conveyance. Vali P Rao Vs Sri

Ramanujan Ginning & Rice Factory (P) Ltd 60 Company cases 568 (AP). This

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 judgement followed the ratio of the Calcutta High Court in the case of Rama Sundari

Ray Vs Syamendra Lal Ray (1939) ILR (Cal) 1.

1.7 Once the entity is registered under Part-IX, all the provisions of the Act would apply

as if the Company was formed under the Companies Act. The exceptions to this are

that Table-A in Schedule-I would not apply unless and except in so far as it is adopted

by a special resolution. Further, provisions relating to numbering of shares would not

apply to a Company whose shares are not registered.

1.8 On registration under Part-IX it shall be deemed that the provisions of the constitution

of erstwhile firm were contained in a Memorandum of Association and Articles of

Association. These provisions may then be altered in the same way as a

Memorandum or Articles of Association.

1.9 Section 579 provides for the mode of altering the form of its constitution by

substituting a memorandum and articles for a deed of settlement. This could be done

by passing a special resolution

2.1 It is important to note that the Memorandum and Articles of Association are not to be

registered, but merely the partnership deed. Further, partnerships cannot register as

companies limited by shares unless they fit into the definition of a joint stock

company provided in section 566. If it does not so fit, the answer would be to

register as an unlimited company and later go through the process of converting it

into a company limited by shares under section 32 of the Companies Act, 1956.

2.2 The basic requirements for being treated as a joint stock company are:

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  the firm should have a permanent paid-up or nominal share capital;

 such capital should be held as shares of fixed amount or held and transferable,

as stock or partly shares or partly stock, and only the holders of the shares or

stock should be members.

2.3 There is no need for a partnership to fall within the definition of a joint stock

company. It could be registered initially as an unlimited company with the help of its

existing partnership deed without any modifications whatsoever. Section 32 of the

Act specifically provides the manner to re-register an unlimited company as a limited

company. This section clearly shows that the provisions are meant for use by

associations such as partnerships which have registered as unlimited companies.

2.4 Since registration of firms under the Companies Act had been long forgotten, existing

commentaries on Company Law in India have little to provide on the scope and need

for section 32.

The procedure for such re-registration is not only simple but also far easier

than approaching the Company Law Board in order to substitute a Memorandum and

Articles of Association for a "deed of co-partnery" and for making all provisions

of the Companies Act applicable. Till such time as the Memorandum and Articles

of Association substitute the partnership deed, the limitations of section 578 will

operate (this being separately discussed under "effect of registration").

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2.5 Sub-section (4) of section 578 makes it clear that while the partnership

deed/constitution over-rides the provisions of the Act, in respect of some matters the

provisions of the Companies Act are paramount.

2.6 If the company wishes to be governed only by the Companies Act, it would have to

apply to the Company Law Board in terms of section 579 to substitute its constitution

with a Memorandum and Articles of Association. The section makes it clear that the

power of substitution is only subsequent to its registration and also at the option of the

Company. This can only be done by means of a special resolution and the provisions

of section 17 to 19 of the Act are applicable. Consequently, the substitution takes

effect only on confirmation by the Company Law Board.

3.0 GENERAL EFFECTS OF REGISTRATION:

3.1 Some doubts have been expressed as to whether upon registration; a new company is

created which is distinct and separate from the earlier association. An understanding

of the exact status would be very important from the taxation view point also. It is

implicit from a reading of Part-IX of the Act that registration does not result in a new

association or company. Registration merely provides certain additional rights and

obligations to an existing association. This can be better appreciated in the light of

the following:

3.2.1 Section 566(1) defines a joint stock company as an `association’ (in place of the term

company loosely used) complying with certain requirements. Section 566(2) states

that "such a company (or association), when registered with limited liability under this

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 Act, shall be deemed to be a company limited by shares". This clearly shows that the

company or association continues and is, in addition deemed to be a company limited

by shares. This is only a deeming provision in relation to an existing company. Had

a new company been created upon registration, there was no need to deem it to be a

company limited by shares. The need to 'deem' arises as the company so registered

continues to be governed by its own laws and regulations under section 578 but is, in

addition, given the status of having the liability of its members limited. In V P Rao Vs

Sri Ramanujam Ginning and Rice Factory (supra) it was stated that "if the

constitution of the partnership firm is changed …………. there is no need of a

separate conveyance of the property the firm".

3.2.2 Section 572 empowers the firm, where the Central Government is of the opinion that

the existing name is undesirable, to `change its name with effect from the date of

registration under this part'. If the firm upon registration became a new company,

there was no question of its changing the name with effect from the date of its

registration.

3.2.3 Section 573, refers to the addition of the word `limited' or the words `private limited'

as the last words of its name. This again shows that the Act contemplates the

continuance of the association with the addition of `limited' or `private limited' after

its registration.

3.2.4 Section 574 refers to the issue of certificate of registration to existing companies.

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3.2.5 Throughout Part IX, the firm is referred to as `the company’ prior to and after its

registration. Nowhere has the association subsequent to its registration been referred

to as a different `company'.

3.2.6 Even the vesting of property on registration under section 575 is clarificatory and

such vesting of property is `for the estate and interest of the company therein'.

3.2.7 Section 577 provides for the continuation of all pending legal proceedings as though

there was no change at all.

3.2.8 Palmer has opined that there is no breach in the continuity of the concern and this has

never been questioned in the past.

4.0 Doubts have been raised that section 578 of the Act is both contradictory and

unworkable. Sub-section (2) states that all provisions contained in the Act of

Parliament or instrument constituting or regulating the association, etc would be

applicable. Sub-section (3) states that all provisions of the Companies Act subject to

the exceptions specified are applicable. What is the position when the requirements

of the two laws on the same issue are different? On a plain reading of the whole

section 578 of the Act it is clear that there is no contradiction and the following

emerge:

4.1.1 The Act of Parliament or partnership deed, etc regulate the working of the company

even after its registration (sub-section 2).

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4.1.2 The provisions of the Companies Act, to the extent that they are not precluded by the

Act of Parliament, partnership deed, etc., and, subject to the exceptions provided,

would apply to the Company (sub-section 3).

4.1.3 The wordings in sub-section 4 make it clear that the provisions of the Act of

Parliament, etc (in this case, the partnership deed) apply notwithstanding anything

contained in the Companies Act. It is only with respect of the three items referred to

in sub-section 4 that the reverse hold good.

4.1.4 Sub-section (5) and (6) further cement the fact that the provisions in the Act of

Parliament, Partnership deed, etc will apply. Further, the powers provided by the

Companies Act are curtailed in situations where they can be used to alter any

provisions or objects of the company embodied in the Act of Parliament, other Indian

Law, Act of Parliament of the U K Royal Charter of Letters Patent [578(3)(c)(d) &

(e)].

5.0 TAX IMPLICATIONS:

5.1 The tax implications arising out of registration under Part-IX of the Companies Act

can be discussed under the following heads:

 Whether the transaction amounts to a transfer

 Stamp Duty

 Sales Tax

 Status under the Income-tax Act

 Capital Gains Tax

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  Acquisition under Chapter XXC of the Income-tax Act

 Gift Tax

 Depreciation

5.1.1 Whether amounts to transfer?

While dealing with general effects of registration earlier, it had been shown

that registration does not give rise to a new organisation. It merely provides certain

additional rights and obligations to the organisation already in existence. If this view

is accepted, there could be no transfer within the meaning of section 2(47) of the

Income Tax Act, 1961. It may be noted that there is no sale, exchange,

extinguishment etc. involved, in order to fit into the definition of transfer provided in

section 2(47).

5.1.2 Stamp Duty:

Section 575 of the Act makes it clear that there is an automatic vesting of

property - both moveable and immovable - upon registration under Part IX. Since

such vesting is under statute, no separate conveyancing is necessary. It has been held

in Rama Sundari Ray Vs Syamendra Lal Ray (1939) ILR (Cal) 1, that `the section is

mandatory and does not require the statutory transfer provided thereby to be

accompanied by a registered instrument'. This topic is again separately discussed

later.

5.1.3 Sales Tax:

When there is no transfer between two separate entities, the question of

payment of sales tax does not arise. Many state sales tax laws also provide exemption

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 on the sale of a business as a going concern from sales tax. Further, the sale of an

industrial concern would not constitute goods and, if this logic is accepted, there

would be no liability even if the scheme were to be considered as a transfer.

5.1.4 Status under the IT Act:

Section 2(31) provides an inclusive definition of a `person' which includes,

inter-alia, a company and a firm. We have seen, while dealing with general effects of

registration, that no new organisation comes into existence. The firm continues but

with certain additional rights and obligations. If this were so, the firm, even after

registration, would have to be treated as a `firm’ under the Income Tax Act till it re-

registers itself under section 32 of the Companies Act, 1956. The other possible

alternative is that the firm gets treated as a company upon registration. However, for

this to happen, the firm should fit into the definition of Indian Company provided in

sections 2(17) and 2(26) of the Income Tax Act, 1961. Section 2(26), inter-alia,

defines an Indian Company as `a company formed and registered' under the

Companies Act, 1956. It is apparent that while the firm is registered, it was not

formed under the Companies Act. Section 578(5) of the Act of 1956, while dealing

with alterations in the provisions contained in the partnership deed (instrument

constituting the Company) clearly indicates that the Company has not originally been

formed under the Companies Act. Retaining the status of a firm may be also

advantageous in contending that there has been no transfer for the purposes of capital

gains tax, an aspect which is discussed next.

5.1.5 Capital Gains Tax:

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 When a firm gets registered as a company there is a statutory vesting of

properties and no transfer takes place between one distinct person and another -

Ramasundari Ray Vs Syamendra Lal Ray & V P Rao Vs Ramanuja Ginning and Rice

Factory (P) Ltd. In the absence of such a transfer, the question of capital gains does

not arise. The position would be the same even if the firm were to revalue its assets

prior to registration.

Another question is whether registration results in the dissolution of the firm

and whether the provisions of section 45(4) of the Income Tax Act would apply.

When no new organisation comes into existence and the firm continues, section 45(4)

cannot apply. In any case there is only a statutory vesting of property and no

distribution of capital assets consequent to dissolution.

5.1.6 Acquisition under Chapter-XXC:

Once it is accepted that on the registration of the firm as a company no new

entity comes into being, the question of applicability of Chapter XXC of the Income

Tax Act, 1961 which deals with purchase of properties by the Central Government

does not arise.

5.1.7 Gift Tax Act:

The applicability of Gift tax would also not arise since there is no transfer

from one distinct person to another. With the Gift Tax Act being made in-applicable

in respect of transactions after 01-10-1998 this issue remains of academic interest

only.

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5.1.8 Depreciation:

Once we accept that registration does not result in the creation of a new entity,

depreciation would be available only on the written down value of the assets even if

the assets have been revalued.

6.0 CONVERSION OF PROPRIETARY CONCERNS AND PARTNERSHIP FIRMS

INTO COMPANIES - THROUGH THE PROVISION OF SECTIONS 47 (xiii) &

(xiv):

Implications under Income Tax Act.

6.1 Finance (No.2) Act 1998 has introduced provisions granting exemption where a firm

or a proprietary concern is converted into a Company. This amendment was brought

about as a result of the recommendations of the Expert Group constituted to

rationalise and simplify the Income Tax Act.

6.2 Due to tax and other considerations some of such concerns were hitherto forced to

consider "questionable" devices and register themselves in terms of Chapter-IX of the

Companies Act.

6.3 The provisions as introduced by the Finance (No.2) Act 1998 are effective from

Assessment Year 1999-2000. These provisions could be discussed under the

following broad headings:

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 i) capital Gains on succession;

ii) carry forward of business loss and un-absorbed depreciation;

iii) depreciation in the hands of the transferee Company;

iv) other provisions.

6.3.1 Capital Gains:

The new provisions in section 47 have been introduced as sub-clause (xiii)

relating to partnership firms and sub-clause (xiv) relating to proprietorship business.

6.3.2 The ingredients of the new provisions could be summed-up as under:

 Existence of a partnership or proprietorship business

 Succession by a Company

 Sale or otherwise transfer of any capital asset or intangible asset.

6.3.3 Conditions to be complied:

 Transfer of all assets and liabilities relating to business

 allotment of shares in the Company

 partners or proprietor not to get any other benefit

 holding of 50% voting power for a period of 5 years.

6.4.0 Succession by a Company:

6.4.1 Not only Indian Companies but also Companies incorporated out-side India could

succeed to business. For a company to succeed to the business, one of object clauses

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 of the company should have the nature of business succeeded to. If a Company is

being incorporated to succeed the business it is advisable that one of the objects

specifically states the fact of succession. Considering the condition of holding 50% of

the voting rights by partners or proprietors, it is advisable to incorporate a new

company to succeed the business.

6.4.2 Taking into account the condition of holding 50% of the voting rights by partners or

proprietors, in practical terms, it may be difficult for two firms merging into a

single Company.

6.5.0 Existence of business:

6.5.1 The partnership or proprietorship, going in for a business re-organisation, should

have an existing business. It is immaterial under what head its income or loss is

being computed.

6.6.0 Sale or otherwise transfer:

6.6.1 The transfer could be by any mode coming within the definition clause in section

2(47) of the Income Tax Act. Transfer of immovable properties will have to be

effected by a registered document, properly stamped.

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6.7.0 Capital asset or intangible asset:

6.7.1 The word `Capital asset' is defined in section 2(14) of the Income Tax Act. However,

the word `Intangible asset’ has not been defined in the Act for the purpose of levy of

capital gains tax. This word has been defined for the limited purposes for claiming

depreciation.

6.8.0 Conditions to be complied:

6.8.1 Assets and Liabilities to be transferred:

All business assets and liabilities have to be transferred in its entirety without

a single asset, whether large or small, tangible or intangible being left behind.

6.8.2 What is expected to be transferred to the Company are all business assets and business

liabilities. Thus all non-business assets and liabilities may have to be left behind.

This may turn out to be a contentious issue.

6.8.3 The crucial point of time is the moment of succession. If any business asset or

liability is desired not to be transferred to the Company, it may be disposed before the

succession is effected.

6.9.0 Allotment of Shares:

6.9.1 All the partners should become the shareholders of the Company. The shareholding

has to be in proportion to the respective capital accounts in the books of the firm on

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 the date of succession. If the capital account of any partner or the proprietor is

negative, then the condition of being a shareholder in proportion to the capital account

may become difficult to achieve. This condition could push lot of business re-

organisations either to cold storage or into adopting questionable devices. The shares

to be allotted could be either equity shares or preference shares. Through a proper

planning, allotment of either type of shares could help in determining and establishing

the controlling interest.

6.10.0 No other Benefit or Consideration:

6.10.1 None of the partners, should get either directly or indirectly any other consideration or

benefit, other than by way of allotment of shares in the Company. This could raise an

issue about the manner in which the partner’s current/loan account is to be treated

subsequent to the succession.

The partner/s or proprietor may receive remuneration for services that he/they

may render. The same should not be regarded as a violation of the requirements of

the exemption section.

6.11.0 Voting Power:

6.11.1 The partners/proprietor should continue to hold 50% of the total voting power of the

Company, for a period of five years from the date of the succession. Inter adjustment

or share transfers among the partners may be permissible. This could further mean

that the partners could transfer their shares to the other partners and cease to be share-

holders as long as at least one person among the partners continues to hold 50% of the

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 voting power. Death of a partner or proprietor and consequently the shares devolving

on legal heirs could lead to a contentious issue of the benefit already granted being

withdrawn on the ground that the erstwhile partner/proprietor have ceased to hold

the minimum voting power for the required duration.

6.12.0 Withdrawal of the benefit:

6.12.1 If any of the conditions are not complied with, then the amount of capital gains

exempted by virtue of section 47 would be withdrawn and shall be treated as an

income of the Company in the year in which the conditions are not complied with. It

is to be noted that the provisions of section 47A(3) could be acted upon only if the

condition regarding holding of voting power for 5 years fails. All the other

conditions are only relevant at the time of succession.

6.12.2 Though the exemption was originally availed by the firm, on the violation of the

conditions, subject to which the exemption was granted, it would be the transferee ie

the Company that would be liable to pay tax.

6.13.0 Carry forward of business loss and un-absorbed depreciation:

6.13.1 By the virtue of newly introduced section 72A(4), the successor company would be

entitled to set off the losses and un-absorbed depreciation of the erstwhile

partnership and proprietorship. Such loss or depreciation shall be deemed to be the

loss or depreciation of the year of succession. Thus, the limitation period of carry

forward of loss or depreciation, envisaged under section 72(3) and under section 32(2)

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 shall be counted from the year of succession irrespective of the period that had

elapsed in the hands of the proprietor or predecessor firm.

In the event any of the conditions specified in section 47(xiii) or 47(xiv) are

not complied with, then the amount set-off in accordance with the provisions of

section 72A(4) shall be deemed to be income of the year in which such conditions

are not complied with.

6.14.0 Depreciation:

6.14.1 During the year of succession, the actual cost to the company shall be the value at

which the assets have been taken over. However, while calculating depreciation in

the year of succession, the sum total of depreciation allowable in the hands of the

successor company and succeeded business, shall not exceed the depreciation

allowable on such assets, as if the succession had not taken place. The division of

depreciation between the two entities shall be on the basis of the number of days for

which the assets were used by each of them.

6.14.2 As the law stands today, the revaluation of assets before succession could be a good

planning tool. The cost of the assets to the company would be the value at which the

assets are taken over. Though the depreciation pertaining to the year of succession is

restricted due to the limitations specified in the proviso (v) to section 32(1)(iii),

from the subsequent year the depreciation would be allowed on the cost to the

company as reduced by the depreciation allowed in the first year.

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6.14.3 Though the exemption is granted to the profits arising from the transfer of assets to

the company, there is no condition that the company should continue to hold the

assets for any minimum duration. The succeeding company may therefore sell the

assets without fear of violation of any of the conditions subject to which the

exemption had been availed.

6.14.4 In relation to amalgamation of companies, section 47 specifically provides for

exemption to shareholders also when they give up their shares in the amalgamating

company in exchange of shares of the amalgamated company. When a firm is

converted into a company, the shares are allotted to the partners. There is no specific

clause conferring an exemption to the partners when they get assets or shares in

excess of the balance standing to their capital account. However looking at the

various other conditionalities in section 47(xiii), it is arguable that the consideration in

the first instance is received by the firm and then distributed to the partners. It could

therefore be further contended that there was no need to provide for a specific clause

exempting the benefit derived by the partners on surrendering their shares in the

partnership firm in exchange of the shares of the company. Even otherwise, it is

arguable on the basis of the Supreme Court judgement in Mohanbhai Pamabhai's

case 165 ITR 166, that what the partner receives is in satisfaction of his pre-existing

rights and therefore not a transfer at all.

14.0 CONCLUSION:

14.1 An attempt has been made hereinabove to outline the Company Law and taxation

aspects governing corporatisation of business or a spin-off. The strategic or business

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reasons for such conversions have not been dealt with. So also labour legislations,

rent legislations, accounting guidelines sales tax laws, excise duty implications have

not been covered. Being a topic with a very vast ambit, the attempt has been only to

highlight briefly the various issues involved under the topics covered. A multi-

disciplinary approach would be expected of Chartered Accountants to provide "value

innovation" in such transactions.

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PART-II:

SPIN OFF/HIVE OFF/DEMERGERS:

7.0 COMPANIES ACT PROVISIONS:

7.1 For the sale of an undertaking, a public company or a private company which is a

subsidiary of a public company would have to obtain the permission of the share-

holders in a general meeting ( section 293(1)(a) ). This condition does not apply to a

private limited company which is not a subsidiary of a public limited company.

7.2 If a company sells its undertaking without obtaining the sanction aforesaid, the

purchaser's title would not be affected if it is shown that the transaction was

entered into in good faith, exercising care and caution.

7.3 That a company may have several undertakings is recognised by section 349(5)(d).

7.4 In the case of an arrangement or a compromise between the company and its creditors

or the company and its members, an application would have to be made to the

jurisdictional High Court to sanction the scheme (sec.391). A spin-off is also in

pursuance of a scheme. It could be achieved only after the sanction of the High Court

is secured.

7.5 On an application being made, the High Court would call for a meeting and also direct

the conduct of the proceedings. The Court would sanction the scheme after approval

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 by the creditors and members. After such sanction, the scheme would be binding on

all the parties. The Court would sanction the scheme only if there is a support of a

majority in number and 3/4th in value of those present and voting at the meeting.

7.6 If the members approve the scheme and sanction of the Court is also obtained, the

fact that through such a scheme the property was transferred at a nominal value

thereby avoiding capital gains, stamp duty or court fees would not be a ground to

reject the validity of the scheme. A W Figgis & Co (P) Ltd in Re (1980) 50 Company

Cases 95 (Cal).

7.7 The scheme so approved is not binding on the workers. The transferor company is

not bound to transfer their services to the transferee. If the employees disagree, the

transferor is bound to make suitable or separate arrangement for them. The scheme,

if bonafide, would not suffer merely because the workers disagree. [Larson &

Toubro Ltd 63 Company cases 381 (Bom)].

7.8 In sanctioning the scheme, the Court has an inquisitorial and supervisory role to play

to form an independent and informal judgement.

The order of the Court becomes effective only after a certified copy of the

order is filed with the Registrar of Companies.

The Court’s sanction only binds the parties under the arrangement. It is

essential therefore that a comprehensive and complete settlement is effected.

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7.9 The property would vest in the transferee company by virtue of the order of the High

Court.

7.10 In relation to the scheme, the powers of the High Court would be:

 to enforce the compromise or arrangement

 to supervise carrying out of the compromise or arrangement

 to give directions for the compromise or arrangement

 to modify the compromise or arrangement (section 392).

The Court thus has the power of superintendence. It cannot however

determine or adjudicate any right or interest claimed by a company against persons

who are not parties to the scheme.

7.11 Where an application is made to a Court for sanctioning a scheme where under the

whole or part of the undertaking, property or liabilities are to be transferred, the Court

may provide for:

 transfer of undertaking/property/assets

 allotment by transferee company of shares, debentures etc

 continuation of legal proceedings by or against transferee company

 provision to be made for persons who dissent

 incidental, consequential or supplemental matters (sec-394)

Within 30 days of the order of the Court, a certified copy is to be filed with the

Registrar of Companies.

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7.12 For section 394, to apply, the transferee company should only be a company as

understood under the Companies Act. The transferor company includes any body

corporate whether a company within the Companies Act or not. Section 394 also

defines the terms `property' and `liabilities'.

8.0 DEMERGER – INCOME TAX PROVISIONS:

8.1 Provisions relating to amalgamation have existed in the Income Tax Act for a long

time. However, there were no specific provisions in the Act dealing with demergers.

Economic, strategic and business compulsions have in many a case necessitated a

spin-off of or hive-off of an existing undertaking into a separate company. The tax

implications of such spin-off till recently were not very clear. Attempts were made to

understand these implications by reading the provisions relating to amalgamation. In

this scenario, corporate India began clamouring for specific provisions relating to

demerger. The Finance Minister while presenting the budget last year had assured the

setting-up of a Committee, to study and suggest how the tax laws could be amended

to incorporate provisions relating to demerger. The existence or otherwise of such a

Committee has not been publicised. Nevertheless, the Finance Bill 1999 has

introduced comprehensive provisions relating to demerger.

8.2 DEMERGER – PRELIMINARY:

The Company which spins-off or transfers any undertaking to another

Company is called the Demerged Company. A Demerged Company is defined in

section 2(19)(AAA). The Company to whom the assets are transferred is known as

the Resulting Company. The term “Resulting Company” is defined in section 2(41A).

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 The provisions of demerger are applicable only to companies. Demergers of

undertaking belonging to other types of assessees has not been covered. The word

company for this purpose will have to be understood in the light of the definition of

the term in section 2(17) of the Income Tax Act. The term undertaking which is the

subject matter of transfer is defined separately under explanation-1 to section

2(19)(AA).

A demerger postulates a scheme of arrangement under section 391 to 394 of

the Companies Act.

8.3 DEFINITION OF DEMERGER:

8.3.1 The term “demerger” is defined in section 2(19)(AA). Apart from seven conditions

being prescribed the definition clause also has four explanations. Being a definition

covering a wide range of situations and conditions the same is being discussed

pointwise hereunder. Thus a `demerger' would occur, if the following are fulfilled:

(a) All the properties of the undertaking being transferred by the Demerged

Company immediately before the demerger become the property of the

Resulting Company by virtue of the demerger.

(b) The term “property” is not defined. The term would therefore have to be

understood in accordance with its ordinary scope and ambit. The Supreme

Court in the case of Ahmed G H Ariff Vs CIT 76 ITR 471 held that property

would connote every conceivable right or interest which a man can hold and

enjoy.

(c) The words "property being transferred" would suggest that all the assets of the

undertaking need not compulsorily be transferred. What is required to be

26
 transferred is a group of assets of such magnitude so as to constitute a business

activity. This view could further be reinforced by referring to the definition

of the term “undertaking” in explanation-1.

(d) The undertaking being transferred may be a part of a larger set-up owned by

the Company. In this large set-up there could be various assets which are

jointly owned and shared by different

units or divisions of the Company. Example: Canteens, Workers Quarters,

Toilets etc. Transfer of such assets to the Resulting Company could cause

difficulties.

(e) The definition mandates that properties immediately before the demerger

should become the properties of a Resulting Company. The time frame of the

underlined word is not very clear. It should in our opinion mean those assets

which were existing at the time the shareholders approved the scheme of

demerger and are continuing to exist in the same form or otherwise when the

High Court put its seal of approval to the scheme.

(f) The Resulting Company should become the owner of the asset by virtue of the

demerger. In other words, demerger should be the `causa causans' for the

transfer to and ownership of assets by the Resulting Company.

8.3.2 (a) All the liabilities relatable to the undertaking become the liabilities of the

Resulting Company the virtue of the demerger.

(b) The term “liabilities” for this purpose is explained in explanation-2.

(c) Explanation-2 covers the following liabilities:

(i) Liabilities which arise out of the activities or operations of the

undertaking. This would refer for eg to trade creditors for raw

27
 materials purchased, amounts payable to employees, statutory

liabilities like sales tax, excise duty etc which directly spring from

the activities of the undertaking.

(ii) Specific loans and borrowing including debentures raised for the

activities or operations of the undertaking. However, this clause states

that such loans should have been raised, incurred and utilised solely for

the activities or operations for the undertaking. In other words, if the

loans have been utilised for creation of assets not exclusively

belonging to undertaking this clause strictly speaking should not be

attracted. This could cause difficulties, as such loans would then not

also be covered by either links (i) or (iii) presently under discussion.

(iii) In all other case where there are general and multi-purpose

borrowings the liability to be transferred to the Resulting Company

would be in the same proportion which the value of assets transferred

in a demerger, bears to the total value of the assets of the Demerged

Company immediately before the demerger. The term “value” here

could cause difficulties as it is unclear whether the term “value” refers

to book value, market value or any other value.

8.3.3 (a) Properties and liabilities are to be transferred at values appearing in the

books of accounts immediately before the demerger.

(b) Explanation-3 would mandate that revaluations made shall be ignored for this

purpose. This explanation is of far reaching effect as it would cover

revaluation of assets at any point in time and for whatever purpose.

(c) Compulsion of transferring assets at book value could cause genuine

difficulties eg: A foreign partner may want to participate in any venture of an

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 Indian Company and for this purpose may insist that a separate joint venture

company be formed. If the existing business activity and assets relatable

thereto are transferred to the new joint venture company at book values, then

the Indian Company would stand to lose.

(d) The assets appearing in books of accounts have to be transferred. What is

meant by the books of accounts is not known. Whether it includes the

statutory records or registers of the Company? Whether it includes the

comments in the notes to the financial statements? Whether it includes the

remarks of Auditors in the statutory reports?

(e) In today’s world, value of assets not recorded in books of accounts could be

more substantial than properties reflected in books of accounts. For example,

man power, goodwill, trade marks, brands, patents, copy rights, licenses etc.

If the demerger has to be done at book values and only of assets appearing in

books of accounts for a consideration equal to the net worth as per the books

of accounts, the same could be a dampening effect on genuine demergers.

(f) Keeping into account the concept of materiality companies write-off

individual assets below a particular figure as an expenditure in the year of

acquisition. Such assets may then not appear in the books of accounts. These

assets may not be able to command any consideration despite being

transferred.

(g) Though the section stipulates that the assets have to be transferred at books

values, there are no compulsions that the consideration should also be equal to

net value of assets as per books of accounts. The question therefore is whether

the consideration could be higher than the net book value of assets? It is only

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 then, there could be some meaning attached to the amendment to section 47

which regards a demerger as not a transfer.

8.3.4 (a) The Resulting Company in consideration of the demerger, issues shares to the

shareholders of the Demerged Company. Such shares are to be issued on a

proportionate basis.

(b) As to how the proportion is to be arrived at, is not clarified in the section. The

term proportionate probably refers to the net consideration being divided

rateably amongst all the shareholders.

(c) For a demerger however, only 75% of the shareholders of the Demerged

Company need become the shareholders of the Resulting Company. This

conditions seems to be at variance with the condition that the consideration

should be divided proportionately amongst all the shareholders of the

demerged company.

(d) The term “shareholders” for this purpose should mean the registered and not

beneficial shareholders.

(e) This condition has been incorporated in a manner akin to the condition of an

amalgamation without appreciating the significant difference between the two.

In an amalgamation the amalgamating company is liquidated after the

amalgamation. The Company ceases to exist. Therefore the shares of the

amalgamated company are issued directly to the shareholders of amalgamating

company. However in a demerger the Demerged Company may continue to

exist. This is because only one of its various undertakings may be transferred.

The consideration should therefore normally be received by the Demerged

Company. The accounting entries which are required to be passed in this

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 connection would also support a contention that the consideration is in the first

instance received by the Demerged Company and thereafter given to the

shareholders therein.

8.3.5 (a) The shareholders holding not less than 3/4th in value of shares of the

Demerged Company become the shareholders of the Resulting Company by

virtue of the demerger.

(b) This condition has already been discussed above.

(c) The capital gains implications including cost of acquisition of shares in the

hands of the dissenting shareholders may have interesting implications.

8.3.6 (a) The transfer of the undertaking should be on a going concern basis. The

exact significance of "going concern basis" has not been delineated. However

if one were to look to the accounting standards, the term “going concern”

means an entity which has neither the need nor the necessity to liquidate or

materially curtail the scope of its operations. This is probably the meaning

that should be attached to a demerger also. This is more so because the

demerger should be for commercial reasons and not solely to take advantage

of a tax shelter. Under section 72A also a continued existence of the business

after the demerger is essential. Further the Central Government may

prescribe conditions under section 72A(5) which have to be fulfilled.

Keeping in view the objectives of demerger highlighted by the Finance

Minister in the course of his Budget speech, the continuance of business in

reasonably the same manner is likely to be prescribed.

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8.3.7 (a) The demerger is in accordance with the conditions if any notified under

section 72A(5) by the Central Government in this behalf.

(b) Section 72A(5) deals with the conditions to be complied with in order to

enable a Resulting Company to carry forward the loss or un-absorbed

depreciation of the Demerged Company. The inclusion of these conditions in

the definition clause itself would mean that the prescribed conditions under

section 72A(5) will have to be fulfilled whether or not the Resulting

Company is seeking the benefit of carry forward of loss of the Demerged

Company. In other words, these conditions would apply even to a profit

making Demerged Company.

8.3.8 (a) The term “undertaking” is defined in Explanation-1. It includes an

undertaking, a part thereof, a unit, a division or a business activity taken as a

whole. A part of the undertaking therefore could also independently be

regarded as an undertaking. A part of a whole would thus be a whole itself.

(b) This definition would cement the argument that an undertaking by itself would

be a capital asset.

8.3.9 As a result of this definition it is arguable that a business activity may be a smaller

part of an undertaking, which may itself be a smaller part of an assessee. This

differentiation is important. It helps us in understanding the logic of the computation

provisions which have to be applied independently to each source of income.

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8.3.10 It is interesting to note that though the term undertaking is defined hereunder, the

amendment to section 47 by the incorporation of sub-clause cib thereunder not

regarding demerger as transfer refers to a Capital Asset only.

9.0 DEPRECIATION, ACTUAL COST AND WRITTEN DOWN VALUE (WDV):

9.1.1 In the case of a demerger, the depreciation would be calculated as though the

demerger had not taken place. Such depreciation quantum would then be allocated

between the Demerged Company and the Resulting Company on the basis of the

number of days for which the respective companies used the asset. The allocation of

depreciation is on the basis of the number of days the asset had been used (& not

owned) by respective companies of the asset. The ownership of an asset would pass

only after the High Court's sanction of the scheme of demerger.

9.1.2 There could be interesting implications where an asset for eg is acquired by the

Demerged Company in the first part of the year, but is transferred to the Resulting

Company prior to the completion 180 days of its user. In such a situation, in the

first stage depreciation shall be calculated and apportioned between the two

companies depending on the date of demerger. Then, applying the second provision

to section 32(1), the admissible depreciation in the hands of the Demerged Company

would again be reduced to half as the asset has not been used by it for more than 180

days.

9.2.0 WRITTEN DOWN VALUE (WDV):

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9.2.1 Explanation-2A and 2B have been added to the definition of the term “written down

value” in section 43(6).

9.2.2 Explanation-2A refers to the adjustment to be made to the WDV of the Demerged

Company.

9.2.3 In view of the compulsion in section 2(19AA) that the transfer of the assets have to

be at book value, Explanation-2A states that the WDV of the block should be

reduced by the book value of the assets transferred.

9.2.4 In view of the concept of the block of asset whereby the individual assets loose their

identity, it may be very difficult to find out the value of individual assets from out of a

block of assets.

9.2.5 Explanation-2A states that where a demerger takes place, then the WDV of the block

for the immediately preceding previous year shall be adjusted. In other words, the

adjustments contemplate a shift to the WDV of an earlier year. This could also cause

complications particularly when there are acquisition and disposal of assets in the

previous year in which the demerger takes place.

9.2.6 Explanation-2B deals with the adjustments to be made to the block of assets in the

Resulting Company. The explanation is very peculiarly worded.

9.2.7 In the Resulting Company WDV of the block shall be the value of assets appearing in

the books of accounts of the Demerged Company immediately before the demerger.

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 This is in accord with the fundamental condition that the demerger and

consequential transfer of assets have to be effected at book values only.

9.2.8 This explanation would mandate that the block of assets comprising of assets

received from the Demerged Company would have to be separately maintained and

not get merged (at least for the year of demerger) with the other assets already

existing with the Resulting Company.

9.2.9 The fact the such block of assets is to be separately maintained is reinforced by the

argument that otherwise the ENTIRE block of assets will have to be compulsorily

adopt at the book value of the Demerged Company, despite the fact that such assets

were acquired by the Resulting Company independently.

9.2.10 The proviso to Explanation-2B says that however if the book value of the asset is

greater than WDV as per the Income-tax rules, then such excess of the book value

over the Income-tax WDV shall be ignored. In other words, the lower of the book

value or the Income-tax WDV shall be the value of the assets in the hands of the

Resulting Company for the purpose of claiming depreciation.

9.2.11 The explanation is peculiarly worded. The explanation probably covers situation

where the book value is more than the WDV. In such situations, the difference

between the book value and WDV is not chargeable to tax because of the exemption

under section 47. Logically therefore it should only be the WDV which should be

the starting point for the purpose of allowing depreciation in the hands of the

Resulting Company.

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10.0 CAPITAL GAINS:

10.1 Transfer of a capital asset by a Demerged Company as a result of the demerger

would not give rise to any capital gains implications. This is because clause (vib) to

section 47 proposes to treat such transactions as not a transfer at all provided the

transferee company is an Indian Company.

10.2 Similarly clause (vid) to section 47 proposes that the transfer or the issue of shares

by the Resulting Company to the shareholders of the demerged company, shall be

regarded as a transfer provided such shares are issued in consideration of the

demerger of the undertaking. For such exemption the transferee company ie the

issuing company need not be an Indian Company.

10.3 When the shares of the Resulting Company received pursuant to the demerger are

sold, the period of holding shall include the period for which the shareholder held

shares in the Demerged Company. This would apply only where the Resulting

Company is an Indian Company.

10.4 Sub-section 2C is proposed to be inserted in section 49 to provide that the cost of

acquisition of the shares of the Resulting Company shall be the amount which bears to

the cost of acquisition of shares held by the assessee in the same proportion as the

net book value of the assets transferred in a demerger bears to the net worth of the

demerged company immediately before such demerger.

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10.5 The explanation to the section provides that the term "net worth" shall mean the

aggregate of the paid-up share capital and general reserves as appearing in the books

of the demerged company immediately before the demerger.

10.6 The word “general reserve” is not defined even in the Companies Act including

Schedule-VI thereto. This term could also thus cause difficulties, particularly in

determining whether particular items would constitute a part of general reserves or

not. For eg: Share premium, balance in profit & loss account, investment allowance

reserve etc.

10.7 When the assets are being transferred at book values, adopting the net-worth basis

for arriving at the cost of acquisition of shares is going to complicate things. It would

have been more appropriate had a comparison of a like item be made with a like ie

proportionate net book value of assets transferred to the net book value of assets

before such transfer.

10.8 Complications could also arise if the net worth of the demerged undertaking is a

negative figure. The provisions would become unworkable. Possibly, the law

relating to demerger in its conception, contemplated situations where both the overall

net worth of the demerged company as also of the undertaking being transferred

were positive figures.

10.9 Sub-section (2D) to section 49 proposes that the cost of acquisition of the original

shares held in the demerged company shall be deemed to have been reduced by the

amount arrived at under section 2C.

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11.0 SET-OFF AND CARRY FORWARD OF LOSS:

11.1 Section 72A is being overhauled. Sub-section (4) thereof provides for the loss or un-

absorbed depreciation of the Demerged Company being carried forward in the

hands of the Resulting Company.

11.2 Where the loss or depreciation is directly relatable to the undertakings transferred, the

entire loss or un-absorbed depreciation would be allowed to be carried forward and

set-off by the Resulting Company. Even if a part of the undertaking only is

transferred, the section mandates the shifting of the entire loss or un-absorbed

depreciation to be carried forward by the Resulting Company. This effect appears

un-intended.

11.3 Where the loss or depreciation is not directly relatable to the undertakings transferred

the amount of loss or depreciation shall be apportioned between the demerged and

the Resulting Company. This would be on the ratio of the assets transferred and

retained by the demerged company. Whether the ratio would be worked out on

the basis of book value or market value of assets is not clarified in the section.

11.4 It is also not clear whether the carry forward and set-off shall be for a fresh period of

8 years, although comparing the language of sub-section (4) with other sub-

sections, it would appear reasonable to argue for a carry forward only for the

balance of the eligible period.

38
11.5 Section 72A(4) refers to loss, without distinguishing between business loss and other

losses. Thus all types of losses would, either in part or in whole enure to the benefit

of the Resulting Company.

11.6 The section does not require the continuation of business or the retention of the

assets for any minimum duration by the Resulting Company.

11.7 In view of the over-riding effect of sub-section (4), over all the other provisions of

the Act, section 79 also should be held inapplicable to situations of demerger

satisfying all the conditions of the Act.

12.0 CERTAIN OTHRE SPECIFIC PROVISIONS:

12.1 The benefit granted to a shipping company under section 33AC in respect of reserve

created by it will not be withdrawn due to demerger.

12.2 The benefit of amortisation of expenses available to the undertaking under the

following sections will be allowed for the balance of unavailed period to the

Resulting Company.

(a) Section 35A – Patents and Copy rights

(b) Section 35AB – Expenditure of know-how

(c) Section 35D – Preliminary expenses

(d) Section 35E – Expenses on prospecting of Minerals.

39
12.3 Benefit of section under section 80IA/80-IB in respect of new industrial undertaking

will continue in the hands of resulting company after demerger.

12.4 Benefit of section 35ABB for allowance of capital expenditure for obtaining license

to operate telecommunication services will be available to resulting company after

demerger.

12.5 Section 41(1) treating any benefit or remission of trading liability etc. will apply in

the case of resulting company after demerger as this will be treated as successor

company.

12.6 Section 42(2) giving benefit to certain companies engaged in prospecting of mineral

oil will apply to resulting company after demerger.

12.7 When the reserves of demerged company are reduced due to demerger, the same

will not be considered as dividend under section 2(22) in the hands of shareholders.

12.8 Under section 2(42A) the period during which shares in demerged company are

held by the shareholders will be considered for the purpose of determining whether

the shares in resulting company constitute long-term or short-term capital asset.

12.9 Under section 115AC the benefit available to Non-Resident for shares purchased in

foreign currency will be available in respect of shares in resulting company received

under the scheme of demerger.

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12.10 Section 35DD is proposed to be inserted to provide that any expenditure incurred on

or after 1-4-1999 for the purpose of demerger of an undertaking shall be allowed to

be amortised in equal proportion in five years beginning from the year in which the

demerger takes place. There is no ceiling on such expenditure. It appears that all

legal charges and other incidental expenses including stamp duty for transfer of

undertaking, will be allowed to be spread over the period of five years under this

section. The section applies to expenses incurred by the demerged company as well

as resulting company under the scheme of demerger.

13.0 CERTAIN OTHER ISSUES:

13.1 Where the business undertaking is transferred, the transferee company may also

pay a non-compete fee. On the basis of the under mentioned judgements it could be

argued that such non-compete fee should be a capital receipt:

(i) Gilanders Arbuthnot & Co Ltd Vs CIT 53 ITR 283 (SC);

(ii) CIT Vs Best & Co (P) Ltd 60 ITR 11 (SC);

(iii) CIT Vs P K Das 34 ITR 729 (Cal).

(iv) Beak, Inspector of Taxes Vs Robson 25 IC 33 (HL).

13.2 Section 10B(4) provides that the written down value of the assets of the 100% E.O.U.

would be computed as if the assessee had claimed and been allowed the deduction

in respect of depreciation for each of the relevant assessment years. If at the end of

the tax holiday period, the unit is sold to a new undertaking, the above referred

section may not be applicable. This is because the section will have meaning only

when the assessee is the same company in the tax holiday period and in the 9th year

41
 also. Explanations to 43(6) would now govern the determination of the written down

value of the assets for the purpose of claiming depreciation in the hands of transferee

company.

13.3 The CBDT vide its clarification F No 15/5/63-IT(AT) dated 13-12-1963 has stated

that the benefit of section 84 (predecessor to the current section 80IA) should

continue to be available to the transferee company for the balance of the eligible

period. This was because, in the opinion of the Board, the benefit of the deduction

attaches the undertaking and not the assessee. On the basis of the logic of the

clarification, it would be arguable that the deduction under the section 80 IA as also

exemptions under 10A & 10B should continue to be available to the transferee

company for the balance portion of the tax holiday period.

13.4 Under Section 72 of the Income Tax Act, brought forward business loss can be set-

off against the current year business income, the pre-condition being that the

business in which the loss was incurred is continued to be carried on. It is possible

that one business may have two or more undertakings within it. On the basis of the

judgement of the Supreme Court in the under-mentioned cases, the fact of

interlacing, interdependence would determine whether two or more undertakings are

one.

(i) B R Ltd Vs V P Gupta (1978) 113 ITR 647;

(ii) CIT Vs Prithvi Insurance Co Ltd (1967) 63 ITR 632;

(iii) L M Chabda & Sons Vs CIT (1967) 65 ITR 638.

42
 In such a scenario where the undertakings form part of one business, the loss

of the transferred unit could be set off against the profits of the continuing business.

Similarly, the un-absorbed depreciation may also be setoff. To this extent the benefit

of the Bombay High Court judgement in the case Hindustan Petroleum Limited,

reported in 187 ITR 1 wherein the un-absorbed depreciation was deemed to be a part

of actual cost would not enure to the benefit of the transferee company.

13.5 Section 170 would govern the manner of assessment in the case of succession to a

business. By virtue of this section the predecessor is to be assessed on the income

upto the date of the succession and the successor is to be assessed on the income after

the date of succession.

13.6 Bad debts written off by the transferee company may be claimed as a deduction even

though the original debt and the income thereon arose in the hands of the transferor

company. For this proposition reference can be made to judgement of the Supreme

Court in CIT Vs T Veerabhadra Rao K Koteshwar Rao & Co 155 ITR 152. The

observations of the Supreme Court which are very illuminating are reproduced

hereunder:

“If the same assessee was carrying on a business and he wrote off a debt

relating to the business as irrecoverable, he would without doubt be entitled to a

corresponding deduction under clause (vii) of sub-section (1) of section 36 subject to

the fulfillment of the conditions set forth in sub-section (2) of section 36. If a

business, alongwith its assets and liabilities is transferred by one owner to another,

we see no reason why a debt so transferred should not be entitled to the same

treatment in the hands of the successor. The recovery of the debt is a right

43
 transferred alongwith the numerous other rights comprising the subject of the

transfer. If the law permits the transferor to treat the whole or part of the debt as

irrecoverable and to claim a deduction on that account, it seems difficult to accept

that the same right should not be recognised in the transferee. It is merely an

incident flowing from the transfer of the business together with its assets and li-

abilities from the previous owner to the transferee. It is a right which should, on a

proper appreciation of all that is implied in the transfer of a business, be regarded as

belonging to the new owner. Unless the language of the statute plainly and clearly

compels a construction to the contrary the normal rule of the law should be given

its proper play.

It seems to us that even if the debt had been taken into account in

calculating the income of the predecessor firm only and had subsequently been

written off as irrecoverable in the accounts of the assessee, the assessee would still

have been entitled to a deduction of the amount written off as a bad debt".

13.7 In relation to items governed by section 43B remaining unpaid by the transferor

company, the transferee could claim deduction for the payments made. Reference

could be made in this connection to the ratio of the judgement in Harrisons

Malayalam Ltd Vs C Ag IT 233 ITR 273.

Reference could also be made to the rationale of the Supreme Court in the

case of CIT Vs Veerabhadra Rao K Koteshwara Rao & Co (1985) 155 ITR 152. The

Supreme Court in the case of CIT Vs Amalgamated Development Ltd (1967) 65 ITR

395, held expenditure incurred by the company relatable to the firm to which it had

44
 succeeded as allowable on grounds of commercial expediency. Other judgements

that may be referred to are:

(i) Emerald Paints & Colour Products Pvt Ltd Vs CIT (1986) 159 ITR

105 (Cal);

(ii) Iyengar Coffee & Tea Co Vs CIT (1970) 78 ITR 775 (Mad).

13.8 Applicability of Chapter-XXC:

In the case of a spin-off if may be arguable that the provisions of chapter

XXC not applicable if a lumpsum amount of consideration is paid for the

undertaking acquired. It is also arguable that the property would vest in the

transferee company only as a result of the order of the High Court. Such a vesting

would not be in pursuance of transaction covered by Chapter-XXC viz sale,

exchange or lease. Further chapter XXC applies only where there is a transfer of an

immovable property. Whether a business undertaking which in itself is a capital

asset is moveable or immovable property is debatable.

13.9 Tax liability under section 41(1):

Section 41(1) has been amended with effect from assessment year 1993-94.

The amended section provides that in case of succession to business (which would

include spin-off), the successor would be chargeable to tax even if the deduction

was allowed to the person succeeded to. The amendment to section 41(1) was

made to overcome the Supreme Court judgement in Saraswati Industrial Syndicate

Ltd Vs CIT (1990) 186 ITR 278.

13.10 Section 43C:

45
 Section 43C provides that where an asset is obtained by the transferee

Company and sold as stock-in-trade, the cost of such asset shall be the cost thereof in

the hands of the transferor Company. Section 43C is however applicable only in

cases of amalgamation. Consequently, it is arguable that the said section should be

inapplicable to cases of spin-off. Therefore, in the case of a spin-off, it is the actual

amount that is paid for the asset, that should be considered while computing the

business income.

13.11 Bad debts recovered by the transferee Company:

Applying the ratio of the decision of the Madras High Court in CIT Vs P K

Kaimal 123 ITR 755 and of the Supreme Court in Saraswathi Industrial Syndicate

(1990) 186 ITR 278, a transferee Company being a successor to the business of the

transferor Company cannot be taxed under section 41(4) for recoveries of bad debts

allowed as a deduction to the transferor Company.

14.0 CONCLUSION:

14.1 An attempt has been made hereinabove to outline the Company Law and taxation

aspects governing corporatisation of business or a spin-off. The strategic or business

reasons for such conversions have not been dealt with. So also labour legislations,

rent legislations, accounting guidelines sales tax laws, excise duty implications have

not been covered. Being a topic with a very vast ambit, the attempt has been only to

highlight briefly the various issues involved under the topics covered. A multi-

46
 disciplinary approach would be expected of Chartered Accountants to provide "value

innovation" in such transactions.

ACKNOWLEDGEMENTS:

The paper writer acknowledges the help of the following in the preparation of this

paper:

Sri D Devraj

Sri V Raghuraman

Sri Sanjay Dhariwal

Sri K R Sekar

Sri Unni Rajgopal

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