by Amrit Behera
This paper mainly focuses on the concept on merger and Demerger. This paper focuses on the development of the demerger and also discusses about the current state. And most importantly it analyses the concept and focuses on the provisions and aftermath of the concept. This paper also discusses about the use of this concept and hoe is it implemented in the Budget.
A “demerger” is a company’s split or division into a larger number of businesses. The transferees, or new firms, do not have to be subsidiaries of the parent corporations that have split or divided.[i] The term “demerger” is defined by the New Oxford Dictionary as “the division of a bigger corporation into two or more smaller firms.”[ii]
The Finance Minister, in her maiden Budget speech for the Financial Year 2019-2020, Finance Minister Nirmala Sitharaman made policy announcements and proposed amendments to existing economic policies, infrastructure development program, and the taxation regime in order to facilitate economic growth and make India a five trillion dollar economy in the next five years. Existing tax laws were also clarified in order to avoid ambiguity and litigation.
One such clarification in the taxes regime is the revision of the concept of “demerger” to remove uncertainty and challenges for corporations that must adhere to Indian Accounting Standards (Ind-AS).
Provisions and aftermath
Currently, the provisions of section 2(19AA) of the Income-tax Act, 1961 (Act) define “demerger” in relation to companies as a means of transfer undertaken pursuant to a Scheme of Arrangement under sections 230 to 232 of the Companies Act, 2013, whereby one or more undertakings of the demerged company (transferor company) are transferred to the resulting company (transferee company) after attaining the required level of success. If certain conditions are met, such transfers are deemed to be exempt transfers (i.e., not taxable under the Act).
Transfer of all assets and liabilities of the undertaking by the demerged company to the resulting company, issue of shares as consideration by the resulting company to the shareholders of the demerged company, transfer of the undertaking on a going concern basis, and so on are some of the conditions for a tax neutral demerger under section 2(19AA) of the Act. Section 2(19AA)(iii) of the Act further stipulates that the demerged company must transfer the undertaking’s assets and liabilities as they appear in the books of accounts immediately before the demerger, implying that the transfer must be done at book value.[iii]
Companies followed the accounting rules under the Indian Generally Accepted Accounting Principles until Ind-AS was introduced (Indian GAAP). However, because there was no special accounting standard for demergers in Indian GAAP, firms transferred the assets and liabilities of undertakings at book value to conform with the Act’s definition of “demerger.” As a result, the demerged firm used book value to transfer assets and liabilities, and the successor company utilised book value to record assets and liabilities.
Ind-AS was created in India to match with International Financial Reporting Standards (IFRS) by adapting the IFRS to the Indian economy’s needs. The Ind-AS regime introduced the idea of “business combinations,” which included mergers, demergers, slump sales, and other transactions. The accounting standard for company combinations, Ind-AS 103, gives guidelines on the accounting rules to be followed for business combinations, stating that acquisitions involving unrelated parties should be recorded at their acquisition-date fair values.
Many Ind-AS corporations had difficulties while executing demerger activities since the accounting standard required the new company to record assets and liabilities at a fair value that differed from the demerged company’s book value. This created the ambiguity that if section 2(19AA) of the Act was implemented, the provisions of Ind-AS were not being followed, which could result in the audit report being qualified by auditors. If the assets and liabilities were recorded at their fair values in accordance with Ind-AS, there was a possibility that the demerger would be interpreted as non-tax neutral, and hence tax would be imposed. The inconsistency between tax and Ind-AS provisions caused confusion for companies legally required to follow Ind-AS, and raised concerns about whether the anomaly between fair value accounting under Ind-AS and book value accounting under section 2(19AA) of the Act could jeopardise the tax neutrality of demergers.[iv]
There were multiple interpretations of the tax and Ind-AS provisions of the statute, one of which was that a demerger is not tax neutral since the provisions of section 2(19AA) of the Act are not followed. Another viewpoint was that such a fair valuation is required from the acquirer’s standpoint to comply with Ind-AS, whereas the requirement of transfer at book value is for the demerged firm from a tax perspective. There was a risk of lawsuit as a result of these viewpoints, as well as differences in the positions of different authorities in different forums.
As a result, the Finance Minister has proposed to amend section 2(19AA) of the Act to allow the resulting company to record the value of assets and liabilities of the demerged undertaking at a value other than book value in accordance with Ind-AS and still be considered a tax neutral demerger in the Finance Bill, 2019.
The proposed change would take effect on April 1, 2020, and would apply to Assessment Year 2020-2021 and subsequent years.
Although this is welcome news for Ind-AS companies considering demergers in the future, what happens to those that have already done so or are in the process of doing so? The 2019 Finance Bill is silent on this crucial clarification.
The government has proposed a number of reforms and initiatives to reduce the cost of litigation, and the proposed easing of the definition of “demerger” is one of them.
This suggested alignment of tax neutrality of demergers with Ind-AS accounting norms is a good improvement that would help India’s M&A market grow. However, because the proposed amendment is prospective, further information is needed to determine if the benefit would be available to past demergers as well.
[i] J. C. (Jagdish Chandra) Verma et al., Bharat’s corporate mergers, amalgamations & takeovers : concept, practice & procedure, 1631 (2008)
[ii] demerger noun – Definition, pictures, pronunciation and usage notes | Oxford Advanced Learner’s Dictionary at OxfordLearnersDictionaries.com, https://www.oxfordlearnersdictionaries.com/definition/english/demerger (last visited Jul 28, 2021)
[iii] Demerger: Alignment of tax neutrality with Ind-AS requirements, https://taxguru.in/income-tax/demerger-alignment-tax-neutrality-ind-as-requirements.html (last visited Jul 28, 2021)
[iv] Demerger under Company Law, http://www.legalservicesindia.com/article/420/Demerger-under-Company-Law.html (last visited Jul 28, 2021)
[v] Picture: India Filing