Section 2(19AA) of the Income-tax Act which defines ‘demerger’ facilitates tax neutral hive off of business to another entity (resulting company) by issue of shares to shareholders of demerged company. The set of income tax provisions associated with ‘demerger’ under s.2(19AA) ensures that there is no tax implication on demerged company, resulting company and shareholders of demerged company due to such demerger. The Revenue’s interests are also protected by providing for cost substitution/allocation and holding period substitution such that the tax is levied on the shareholders on subsequent transfer of shares of the resulting company.
However, in many cases, businesses are housed in an operating subsidiary company for regulatory or commercial reasons. For instance, extant RBI or IRDA or SEBI guidelines do not permit banking, NBFC, insurance or AMC business to be undertaken along with any other business activity under the same legal entity. Any business group desiring to enter any such regulated business is required to set up a separate SPV/subsidiary to undertake such business. Similarly, in the infrastructure sector, separate SPVs are required to be set up for executing individual infrastructure projects due to mandate of tender conditions issued by NHAI. Even commercially, business groups find it more expedient to commence any new business within the fold of a new subsidiary for diverse reasons like protection of existing business from risks of new business, invite PE investors, ease of divestment, etc. In regulated businesses, it is difficult to transfer the business from one legal entity to another. Even the acquiring business group is required to house the business activity in a separate company. Hence, the transfer of shares of the operating subsidiary is a more efficient mode of hive off of business
Since the current definition of ‘demerger’ refers to ‘undertaking’, there is ambiguity whether it can cover hive off of business through divestment of shares of such operating subsidiary. If the definition of ‘undertaking’ is expressly clarified to include shares representing controlling interest in operating subsidiary, it will clear the ambiguity in the matter and enable business groups to undertake demerger of operating subsidiary in a tax efficient manner. There is no revenue loss to the Government since the resulting company and shareholders of demerged company inherit the same tax cost as demerged company in the same manner as conventional demerger of ‘undertaking’.
We request you to kindly consider our representation to amend the definition of ‘demerger’ to permit tax efficient hive off of business through transfer of shares of operating subsidiary. A detailed representation in this regard is attached herewith for your kind consideration.