Ahmedabad tribunal ruling on issue of tax-neutrality of a demerger

Background

In a recent ITAT ruling, the Ahmedabad Bench of the ITAT, in the case of Reckitt Benckiser Healthcare India Private Limited (‘Company’ or ‘assessee’), addressed the issue of tax neutrality of a demerger under Section 2(19AA) of the Income-tax Act, 1961 (‘IT Act’). The Tribunal held that the assessee, being non-compliant with Section 2(19AA)(ii), i.e., transfer of all liabilities of the undertaking, was liable for capital gains tax under Section 45 of the IT Act. The ruling emphasized that a tax-neutral demerger requires the transfer of both assets and liabilities, which was not met in this case.

Facts of the case

• The assessee demerged its treasury undertaking by transferring all assets to the Resultant Company, but no liabilities of the treasury undertaking were transferred.
• The assessee argued that the liabilities belonged to other business segments and were not part of the treasury undertaking.
• The Revenue contended that since only assets were transferred without corresponding liabilities, the demerger did not qualify under Section 2(19AA), making it taxable as a transfer of a capital asset under Section 45.

Key Issues

1. Does the transaction qualify as a ‘demerger’ under Section 2(19AA) of the IT Act?
   And does the treasury segment qualify as a business undertaking?
2. Does High Court approval of a corporate demerger automatically grant tax exemption?
3. Whether the transaction is liable to deemed dividend under Section 2(22)?

Key Takeaways

1. Demerger must include both assets and liabilities to be tax-neutral

• A valid demerger under Section 2(19AA) requires transfer of both assets and liabilities.
• If only assets are transferred, the demerger loses tax-neutral status and becomes taxable under Section 45.

2. Treasury segment was not a business undertaking

• The assessee classified its income as capital gains and dividend income, not business income, failing to demonstrate independent operations.
• Selective classification of assets weakened the claim: some investments were included in the Treasury Segment while others were omitted, indicating that it was not a distinct business unit but a curated pool of assets.

3. High Court approval does not grant automatic tax exemption

• Corporate restructuring approval by the High Court does not override tax laws.
• The income tax department can independently assess taxability and deny exemption if the requirements of Section 2(19AA) are not met.

4. Capital Gains tax applies if demerger is not tax-neutral

• Since Section 2(19AA) conditions were not satisfied, the ITAT held that the transaction should be taxed under Section 45 as a transfer.

5. Dividend Distribution Tax (DDT) may apply

• In this case, shareholders of the demerged company received consideration (shares of the resulting company), not the demerged company itself.
• Therefore, it can be regarded as deemed dividend under Section 2(22).

Conclusion

• The ITAT held that the demerger of the Treasury Undertaking was a non-qualifying demerger due to non-transfer of liabilities.
• The ruling reinforces the importance of fulfilling all statutory conditions for tax-neutral demergers.
• Since the conditions of Section 2(19AA) were not met, the transaction was reclassified as a taxable transfer, resulting in capital gains tax and deemed dividend tax.
• The judgment underscores that tax authorities retain the power to independently examine taxability despite corporate approvals under the Companies Act.