ASSIGNMENT OF CORPORATE TAX PLANNING

TOPIC- Tax Planning And Its Role In Mergers, Demergers And

Amalgamations

SUBMITTED TODR.DHIRAJ SHARMA

SUBMITTED BYSHAVETA ROLL NO-5489(C)

AN INTRODUCTION AMALGAMATION, MERGERS AND DEMERGERS: An amalgamation is the means of merging the assets and liabilities of two or more amalgamating companies, with one continuing as the amalgamated company, and the other or others being removed from the register. The Companies Act 1993 deals with these in two ways, depending on whether the amalgamating companies: 1. Are unrelated (there can be exceptions to this) sometimes referred to as long form amalgamations where compensation for the lost investment represented by cancelling the shares in the company or companies to be removed is the key feature, as covered by sections 219-221 Companies Act 1993; or 2. Are within a group or have common shareholding, directly or indirectly referred to as short form amalgamations, as covered by section 222(1) or (2) Companies Act 1993, as the case may be. These are short, as there is no shareholder participation, no notice to shareholders and no public notice.

DEMERGERWhen one company, say X Ltd. having 10 undertakings, transfers one or more of its undertakings to a new company, say Y Ltd., it is a case of demerger. X Ltd. is the demerged company and Y Ltd. is the resulting company. Reasons for demerger : It is difficult to list out the reasons which give effect to demerger because reasons may differ from time to time, company to company, country to country and even industry to industry within the country. However, researchers have specified some reasons for demerger as noted below : (1) Corporate attempt to adjust to changing economic and political environment of the country;

(2) Strategy to enable others to exploit opportunity effectively to optimise returns when the parent company is unable to do so; (3) To correct the previous investment decisions where the company moved into the operational field having no expertise or experience to run the show on a profitable basis; (4) To help finance an acquisition; (5) To realise capital gains from the assets acquired at the time when they were under performing and now no better performance, capital gain can be realised; (6) To make financial and managerial resources available for developing other more profitable opportunities; (7) Selling unwanted and surplus or unconnected parts in the business as a restructuring strategy to get rid of sick part of the company. The above list of reasons for sell out is not exhaustive or conclu-sive as more reasons could be added depending upon the numerous influences emanating from political, economic, social and international backgrounds. One thing remains crystal clear that the objective underlying divestitures or sell offs in the corporate world is to ensure resource mobility essential to effective operations of an enterprise and moving these resources from less-valued uses to higher-valued uses.

Effect of demerger :
(i) (ii)

Tax neutrality of the assets transferred to resulting company. To extend the benefit of carry forward of loss or depreciation relating to transferred undertaking to resulting company.

(iii) (iv) (v)

To extend the benefits like S. 80IA, S. 80IB, etc. to the split off unit. To allow the expenditure incurred for demerger. Tax neutrality of the demerger for the shareholders of demerged company.

Applicability :
(i) Companies incorporated under the Companies Act, 1956

(ii) Any authority or a body constituted or established under a Central, State or Provincial Act (iii) A local authority (iv) A public sector company (v) A foreign company (vi) Any institution, association or body assessed as company or declared by the CBDT as a company. Conditions of demerger (S. 19AA) : Conditions : (i) The transfer is pursuant to a scheme of arrangement u/s.391 to u/s.394 of the Companies Act, 1956. (ii) Transfer of all the assets/ liabilities of one or more undertakings by a demerged company to any resulting company at book value on going concern basis, otherwise than by way of acquisition. (iii) The resulting company issues shares to the shareholders of demerged company on proportionate basis. (iv) Shareholders holding at least 75% of the share capital become shareholders of resulting company. (v) In accordance with the conditions notified u/s.72A(5) by the Central govt.

(vi) Transfer should be with reference to transfer of a business activity and not any individual assets or liabilities or any combination thereof. (vii) Apart from specific liabilities relating to a business, general liabilities are to be apportioned in the ratio of assets relating to each business. (viii) Revaluation of assets will be ignored. (ix) Reconstruction of any body, authority.

(x)

In case the conditions are discontinued to be complied with, the set off of loss or depreciation made in any earlier years in the hands of the amalgamated company shall be deemed to be the income of the amalgamated company taxable for the year in which there is non-compliance.

(xi) In case of demerger, accumulated loss and unabsorbed depreciation of demerged company shall be allowed to be carried forward and set off in the hands of the resulting company to the extent of : (a) if such loss/depreciation is directly relatable to transferred undertaking 100% (b) if such loss/depreciation is not directly relatable to transferred undertaking, that proportion which the assets of the undertaking transferred bear to the total assets of the demerged company (xii) Where a firm or proprietary concern is succeeded by a company fulfilling the conditions of S. 47(xiii) or S. 47(xiv), the unabsorbed loss/depreciation shall be deemed to be the loss/ depreciation of the successor company for the year in which reorganisation is effected. In case any of the conditions are not continued to be fulfilled in any of the years after such reorganisation, the set off of loss or depreciation shall be in case of the year in which conditions are discontinued to be fulfilled. (xiii) Accumulated loss relates to the head 'Profits or gains of business or profession (other than speculation business)' only. Definition of demerged company (S. 19AAA) : Demerged company means a company whose undertaking is transferred pursuant to a demerger to a resulting company. Definition of resulting company (S. 2[41A]) : Resulting company means one or more companies to which the undertaking of the demerged company is transferred in consi-deration of issue of its shares to the shareholders of the demerged company. Taxation of shareholders in demerged company :

(i)

Dividend : S. 2(22) has been amended by inserting a new clause (v) to provide that no dividend income shall arise in the hands of shareholders of demerged company on demerger.

(ii) Capital gains : A new clause (vid) in S. 47 has been inserted to provide that no capital gains shall arise to shareholders of the demerged company on account of receipt of any shares from the resulting company. Tax benefits to resulting company : (i) Expenses incurred for the purpose of amalgamation or demerger shall be allowed @20% every year from the year in which the demerger takes place. (ii) Depreciation shall be apportioned between the demerged company and the resulting company in the ratio of number of days for which the assets were used by them. (iii) The accumulated losses and unabsorbed depreciation in a demerger shall be allowed to be carried forward by the resulting company. (iv) Benefits available for demerger are also extended to authorities or boards set up by Central or State Govt.

TAX CONSIDERATIONS IN DEMERGERS AND AMALGAMATION: Generally, the gains arising from a demerger are exempt from capital gains tax, while those arising from a slump sale are not. But, then, what exactly is a demerger for the purposes of the exemption from capital gains tax? Can a demerger ever be characterized as a slump sale? Several sections of the Income Tax Act, 1961 deal with these issues.

The statutory provisions in the Income Tax Act: A. Section 2(19AA) says that a demerger means a transfer pursuant to a scheme under Sections 391-394 of the Companies Act, 1956 (by a demerged company of its one or more undertakings to any resulting company) such that a list of seven conditions enumerated in separate clauses is fulfilled. Clause [iv] is particularly relevant for the present discussion. It says that the resulting company must issue, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis.

B. A slump sale is defined in Section 2(42C) to mean the transfer of one or more undertakings as a result of the sale for a lump-sum consideration without values being assigned to independent assets and liabilities.

C. According to Section 45, any profits or gains arising from the transfer of a capital asset are chargeable to capital gains tax.

D. Under Section 47(vii), the provisions of Section 45 do not apply to a transfer in a demerger of a capital asset by the demerged company to a resulting company if the resulting company is an Indian company.

E. Under Section 50-B, capital gains arising from slump sales are chargeable to tax. The capital

gains from such slum sales are to be calculated by subtracting the net worth of the undertaking that is transferred from the lump-sum consideration (as per Explanations 1 and 2 to the Section).

In short, if a transfer is a demerger under the Income Tax Act, capital gains liability would not arise. If it is a slump sale, such liability would arise. For the transfer to be a demerger, the conditions mentioned in Section 2(19AA) must be complied with. But what happens when one or more of the conditions are irrelevant to a particular transaction? How this may happen is exemplified by the facts of the complex case of Avaya Global Connect v. ACIT, ITA No.832/Mum/07 (the judgment is available on the website of the Mumbai ITAT Bar Association.

The Facts: The assessee A was a company having two divisions B and T. T was transferred by A to I, an Indian company. For this transfer, a scheme of arrangement filed before the Bombay High Court provided, T without any further act, instrument or deed shall stand vested in or deemed to be vested in I as a going concern Significantly, the scheme went on to say Upon the demerger of T into I, I would not pay consideration either to A or to the shareholders of A (Emphasis supplied.) The Bombay High Court sanctioned this scheme. The value of the assets taken over by I was less than the value of the liabilities; and A showed the difference in the capital reserve account in the balance sheet. A question arose as to whether the gains which accrued to the assessee (as it had transferred more liabilities than assets) would be chargeable to capital gains.

The claims:

The Department took the view that the scheme would not qualify as a demerger; on the basis that clause [iv] mentioned above was not satisfied. The assessee contended that clause [iv] was inapplicable to the case, as the clause would have effect only when there was some consideration for the transfer. In the case, the value of its liabilities exceeded its assets, leading to negative net worth. Therefore, there was no consideration for the transfer as a practical matter, it was impossible for there to be any consideration. As there was no consideration whatsoever, the

question of complying with clause [iv] would not arise. Without prejudice, it was argued by the assessee that the transfer could not have been a slump sale given that no lump-sum consideration was paid. Further, it was contended that there being no sale consideration received in respect of the transfer, no question of computing capital gains arose.

The AO and the CIT (Appeals) however rejected these contentions. It was held that the transaction was a slump sale. The assessee had not received consideration as such; yet it had transferred liabilities in excess of assets and had credited the difference to its capital reserve account. This was sufficient to constitute consideration received on account of the transfer; and the assessee was liable to pay capital gains tax.

The issues before the Tribunal:

Essentially, the Tribunal faced the following questions: A. Was the transfer to be characterized as a demerger for the purposes of the Income Tax Act, 1961?

B. If not, could it be referred to as a slump sale? If it was a slump sale, would there be any capital gain on facts (considering the negative net worth of the assessee and the fact that no actual consideration was received)?

C. What would be the position if the transfer was categorized as neither a demerger nor a slump sale?

The decision: A. The Tribunal agreed with the lower authorities that there was no demerger in the present case. It was held that the legislature must be presumed to have foreseen all practical possibilities while adding the conditions. The fact that there was no consideration whatsoever (as a matter of practical impossibility) would not be sufficient to hold that the condition was inapplicable.

B. The Tribunal then went on to hold that it is only a transfer as a result of a sale which can be considered as a slump sale. The presence of a money consideration is essential for a sale. Also, when a Court sanctions a scheme under the Companies Act, the transfer in pursuance of that scheme would be not be a result of sale, but would be a result of the operation of law.

C. Essentially, the capital asset which was transferred in the case was a going concern. It would not be possible to conceptualize the cost of acquisition of a going concern (or) the date of acquisition thereof As such, it was held that the computation provisions of the Act in Section 48 would fail in the given factual matrix. In such a scenario, no capital gains could be levied. Accordingly, the assessees appeal was allowed.

The significance: From the point of view of the corporate world, the judgment serves to highlight an important point. Merely because a transfer is carried out in accordance with a scheme for a demerger under the Companies Act sanctioned by the competent High Court, the transfer will not be characterized as a demerger for the purposes of taxation. At the same time, such a transfer will not be a slump sale; and liability to capital gains will depend on whether or not the provisions for computation of capital gains would be workable. The safer course, it appears, would be to ensure that the requirements for a demerger under tax laws are complied with in the first place.

Taxation Aspects of Demerger in India

TAXATION ASPECTS OF DEMERGER The Income-tax Act, 1961 provides the tax reliefs to the demerged company, the shareholders of the demerged company, who are issued and allotted shares in the resulting company in the exchange for the shares held by them in the demerged company and the resulting company which emerges as a result of a demerger. TAX BENEFITS TO DEMERGED COMPANY: 1. Capital Gain Tax not attracted: As per section 47 (vib) of the Income Tax Act, the transfer

of any capital asset by the demerged company to the resulting company will not be regarded as transfer for the purpose of capital gain. 2. Tax relief to Foreign Demerged Company: As per section 47 (vic), where a foreign company holds any shares in an Indian company and transfer the same to resulting company in the course of demerger, such transfer will not be regarded as Transfer for the purpose of capital gain, if following conditions are satisfied: 75% of the shareholders of demerged foreign company continue to remain shareholders of the resulting foreign company. Capital gains tax is not attracted on the demerged foreign company in the country of its incorporation and S. 391 to S. 394 of the Companies Act will not be applicable. TAX BENEFITS TO THE SHAREHOLDERS OF THE DEMERGED COMPANY: 1. Dividend: Section 2(22) has been amended by inserting a new clause (v) to provide that no dividend income shall arise in the hands of shareholders of demerged company on demerger.

2. Capital Gains: As per section 47 (vid), any transfer or issue of shares by the resulting company to the shareholders of the demerged company, in scheme of demerger, is not regarded as Transfer for the purpose of Capital Gains. In case, the shareholders transfer these shares subsequent to the demerger, the cost of such shares will be calculated as under: Cost of acquisition of Shares in resulting Company Net Worth of the demerged company immediately before demerger We can illustrate and substantiate the concept by means of an example of Reliance Industries Limited which is the Demerged Company and the new companies of which shares were issued are the Resulting Companies. In this case, Reliance Industries Ltd. (RIL) has transferred four of its businesses to four separate companies. The telecom leg has been transferred to Reliance Communication Ventures Ltd, the coal based energy system has been transferred to Reliance Energy Ventures Ltd, the financial services leg has been transferred to Reliance Capital Ventures Ltd. And lastly the gas based energy business has been transferred to Reliance Natural Resources Ltd. Consequence of the demerger: The existing shareholders of RIL got one share each in the Resulting Companies for every share that they held in RIL. Tax impact of the above: = Cost of acquisition of Shares held by assessee in the demerged company X

Net book value of assets transferred in demerger.

As per the Income Tax Act, a transaction of demerger, per se, has no tax implications on the shareholders. In other words, when the shareholders of RIL are allotted the new shares in each of the four companies, there would be absolutely no tax implication whatsoever. The tax implication will only arise when either the shares of RIL or the shares of the new Resulting Companies are sold. Tax implications when shares are sold: When the shares of any of the companies are sold, it would give rise to capital gains tax liability. The three issues that arise are: Whether the new shares (in the Resulting Companies) are long-term assets or short-term. Indexation of the capital gains. Cost of acquisition of the various shares after the demerger transaction a) To find out whether or not shares in the Resulting Companies are long-term or not, the holding period of the RIL shares will be included in the period of holding of the new shares. b) The indexation will start from the date of allotment of the new shares and not from the date of acquisition of RIL. Relevance of indexation is only for working out the capital gain amount if the same has to be set-off against capital loss. However, as explained further on, for most shareholders, there will be no need of this. c) To calculate capital gains when the shares are sold, a vital piece of information is the cost of acquisition. Your original cost of acquisition of RIL shares will change now on account of the demerger. Plus there will be a new cost accorded to the new shares of the Resulting Companies. The Income Tax Act specifies a complicated formula that takes into account the proportion of the net worth of RIL vis a vis the book value of the businesses transferred to arrive at the new costs of acquisition. The net results of the above calculations are summarized in the following table:

Name of Company Reliance Industries Limited Reliance Communication Ventures Limited Reliance Energy Ventures Limited Reliance Capital Ventures Limited Reliance Natural Resources Limited

% of Cost of Acquisition of RIL Shares 52.0% 38.7% 7.3% 1.3% 0.7% 100.0%

What the above table indicates is the proportion in which your original cost of acquisition of RIL shares will be apportioned to the new shares. It Can be understood by an example: e.g. Say, Rakesh had purchased 100 shares of RIL for Rs. 534 on January 10th 2005. Consequently, his total cost of acquisition would be Rs. 53,400. Now, post the demerger, his new costs would as in the table here. RIL (52% of Rs. 53,400) RCVL (38.7% of Rs. 53,400) REVL (7.3% of Rs. 53,400) RCVL (1.3% of Rs. 53,400) RNRL (0.7% of Rs. 53,400) Total Rs. 27,768 Rs. 20,666 Rs. 3,898 Rs. Rs. 694 374

Rs. 53,400

For the per share cost, the above values be divided by the number of shares. For example, Rakesh's new cost of acquisition of RIL post demerger would be Rs. 27,768 divided by 100 which work out to Rs. 277.68. Now lets say he sells the all the above shares on January 15th. As explained earlier, since he has bought the shares on Jan 10th last year, 12 months have elapsed and hence the RIL shares will be long-term capital assets. Similarly, for the new shares, the period of holding RIL will be taken into account, thereby making these too long-term assets.

Therefore, since long-term capital gains are tax-free, if any or all of the above shares are sold on a recognized stock exchange, there would be absolutely no tax payable by Rakesh in the entire process.

TAX BENEFITS TO RESULTING COMPANY: 1. Amortisation of expenditure in case of amalgamation or demerger (Sec. 35DD): Expenses by an Indian company incurred after 1-4-1999 for amalgamation or demerger of an undertaking, shall be amortized @ 20% each year starting from the year in which amalgamation or demerger takes place. 2. Depreciation shall be apportioned between the demerged company and the resulting company in the ratio of number of days for which the assets were used by them. 3. The accumulated losses and unabsorbed depreciation in a demerger shall be allowed to be carried forward by the resulting company 4. Benefits available for demerger are also extended to authorities or boards set up by Central or State Government.