Issuance of shares by holding company may not satisfy conditions for tax-neutral demerger – Mumbai bench of the Tribunal

In brief

The Mumbai bench of the Income-tax Appellate Tribunal (Tribunal), in a recently1 , examined whether a demerger will qualify as a tax-neutral demerger where the undertaking is transferred to a resulting company, whereas the shares are issued to the shareholders of the demerged company by the holding company of such resulting company. 

The principal issue before the Tribunal was whether, for the purposes of section 2(41A) of the Income-tax Act, 1961 (the Act), both the holding company and its wholly owned subsidiary could together be regarded as the ‘resulting company’, thereby permitting issuance of shares by the holding company

In the present case, an undertaking was demerged into the resulting company (being a wholly owned subsidiary of the holding company), and the holding company of the wholly owned subsidiary company issued shares to the shareholders of the demerged company.

The Tribunal concluded that the conditions prescribed under section 2(19AA) read with section 2(41A) of the Act were not satisfied, as the resulting company into which the undertaking was transferred did not issue shares to the shareholders of the demerged company. Accordingly, the Tribunal denied the benefit of carry forward and set-off of accumulated business losses and unabsorbed depreciation under section 72A(4) of the Act in the hands of the resulting company.