Any arrangement for demerger of a business undertaking, prerequisites the condition of ‘an undertaking’ i.e. the assets and liabilities sought to be transferred must be part of the business activity, for it to be a tax neutral demerger under the provisions of the Income Tax Act, 1961 (‘the ITA’).
However, in case a demerger of investment undertaking, even if it is strategic investment undertaking, might not qualify for tax – neutral demerger. Such an arrangement may invite contemplations / interpretations as to applicability of tax provisions under the ITA.
Recently, National Company Law Tribunal, Mumbai Bench (‘Mumbai NCLT'[1], approved a Scheme of Arrangement, which sought to transfer investment business from the wholly owned subsidiary to its parent entity. The details of the Scheme of Arrangement is as under:
Facts of the Case:
Ensemble Holdings and Finance Limited (‘the Demerged Company’) is a public limited company incorporated in India under the provisions of the Companies Act, 1956. The Demerged Company is a non-banking financial company registered with the Reserve Bank of India. The Demerged Company is engaged in the 2 businesses, viz. (1) Investment Business; and (2) other NBFC business activities. The Investment Business activities includes dealing in listed and unlisted securities and holding 0.6% of Godrej Properties Limited as a strategic promoter holding.
Godrej Industries Limited (‘the Resulting Company’) is a public limited company incorporated in India under the provisions of the Companies Act, 1956. The equity shares of the Resulting Company are listed on the recognized stock exchanges in India. The Resulting Company holds entire share capital of the Demerged Company. The Resulting Company amongst its various business segments has a business segment of Investment and Finance. It also holds strategic stake in various Godrej Group companies and also has a treasury function of investment and finance.
Demerger :
The Scheme sought to demerge Investment Business undertaking of the Demerged Company into the Resulting Company (‘the Scheme’).
The said demerger aimed at achieving the following:
- consolidation of investment of the Demerged Company into the Resulting Company and
- providing flexibility to the Resulting Company to exit from the NBFC activities of the Demerged Company by way of transfer shares of the Demerged Company having NBFC License to another promoter group entity at fair value.
The Scheme was approved by all the stakeholders and authorities without any objection. Although the rationale of the Scheme provides for reasonable justification for entering into such a transactions, interpretation under the provisions of the ITA may result into tax litigation. It would be interesting to see if at all the case is selected for scrutiny and resultant order in regards to same.
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[1] Godrej Industries Limited [LSI-274-NCLT-2020(MUM)]
