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The demerger of a company simply means splitting of company into two or more parts. Any compromise or arrangement is defined under the Companies Act 2013[1], however, the said act is silent on demerger. Hence, the general meaning of demerger of the company can be termed as a kind of corporate restructuring whereby the company decides to part with one of its business activities to operate it under a distinct entity. A demerger can also occur by transferring a business to a new business in lieu of which the existing shareholders are issued new shares.
The National company law tribunal approves the scheme of the demerger, wherein all the liabilities, assets, and shareholders are transferred to the transferee company. Hence, the scheme of the demerger is a transfer wherein there is a capital gain on the side of the transferee company and capital loss on the side of the Transferor Company. This capital gain and loss would attract tax implications, which the company shall adjudicate carefully. Henceforth, the present article will discuss in detail the tax implications on demerger of the company from both sides.
Table of Contents
Before understanding the tax implications on demerger of a company under the IT act, it is imperative to first understand the meaning of demerger and demerged company. The demerger is defined under Secretion 2(19AA) of the Incomes Tax Act 1961. It means a transfer of demerged company or its undertaking into a resulting company.
According to Section 2(19AAA), a “demerged Company” is a company whose undertaking is transferred to the resulting company under the demerger.
Moreover, the act states that the demerger shall be accorded as a transfer if it is performed in such a manner that:
The tax implications on demerger in the case of a demerged company are defined under section 47 of the Income tax act. It states that transactions not regarded as transfers will not attract any tax liabilities under the IT act. Henceforth, certain transfers are exempted from the tax under the scheme of demerger.
The tax implications for the resulting company are enumerated in a different section of the IT Act.
The demerger of the company is a type of corporate restructuring in which the company decides to divide its operations and form a new entity. From the above provisions, we can conclude that the tax implications on demerger are tax-free in the hands of the demerged company. However, there are some tax implications in the hands of the resulting company. Further, there will be no capital gains when there is the transfer of assets by the demerged company to the resulting company. On the other hand, the resulting company is allowed deductions and tax relief on transferred assets, expenditures and various expenses.
Read Our Article: Legal Analysis of Demerger in Corporate
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