Meaning of demerger Ι Demerger under Income Tax Act
Meaning of demerger
The term ‘Demerger’ has not been defined in the Companies Act, 1956. However, according to Sub-section (19AA) of Section 2 of the Income Tax Act, ‘demerger’ in relation to companies means a transfer, pursuant to a scheme of arrangement under Sections 391 to 394 of the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company in such a manner that all the property and liabilities of the undertaking being transferred by the demerged company, immediately before the demerger, become the property and liabilities of the resulting company by virtue of the demerger.
Tax implications of demergers
India’s changing business and economic environment have enhanced the need for rationalisation of laws relating to business reorganisation, with the view to enable the Indian Industry to reinvent itself and become globally competitive.
Amendments to Income Tax Act were introduced by the Finance Act, 1999 (effective from 01-04-2000) to enable corporate enterprises to be assured that:
- Demergers will be tax-neutral and not attract any additional liability to tax.
- Tax benefits and concessions available to the demerged undertaking will be available to the resulting company after the demerger.
Demerger under Income Tax Act
The Income Tax Act stipulates the following conditions for a transaction to be recognised as a demerger:
- All the assets and the liabilities of the undertaking are transferred from the demerged company to the resulting company.
- The transfer is on a ‘going concern basis and at book value.
- Shareholders holding not less than 75 per cent in value of the shares in the demerged company become shareholders of the resulting company or companies by virtue of the demerger.
- In consideration of the demerger, the resulting company issues its shares to the shareholders of the demerged company on a proportionate basis.
The following tax benefits and concessions are available:
- Accumulated losses and unabsorbed depreciation can be carried forward from the demerged company to the resulting company.
- Neither the companies nor the shareholders are subject to capital gains tax.
- Expenses incurred wholly for the purpose of demerger are allowed as a deduction in five annual instalments of 20 per cent each.
Characteristics of demerger
Given below are the key characteristics of a demerger:
1. Demerger is basically a scheme of arrangement under Sections 391 to 394 of the Companies Act which requires:
- Approval by the majority of shareholders holding shares that represent three-fourths value in a meeting convened for the purpose
- Sanction of the High Court.
2. Demerger results in ‘transfer’ of one or more ‘undertakings’.
3. The transfer of ‘undertakings’ is done by the demerged company, otherwise known as ‘Transferor Company’. The company to which the undertaking is being transferred is known as the resulting company, otherwise known as ‘Transferee Company’.