CONSEQUENCES FOR MERGER AND DEMERGER – Sailesh Bhandari & Associates

Merger under income tax act:

The merged entity is considered to be the successor of all the merging entities. This means that the merged entity will inherit all of the assets, liabilities, and tax attributes of the merging entities.
The merged entity will be liable to pay tax on any capital gains that arise from the merger. However, there are certain exemptions available for capital gains arising from mergers, such as exemptions for mergers between companies within the same group or mergers that are undertaken for the purpose of rationalization.
The merged entity will be able to carry forward any losses that were incurred by the merging entities prior to the merger.
The merged entity will be able to claim depreciation on the assets that it inherits from the merging entities.
The merged entity will be able to claim tax credit for any taxes that were paid by the merging entities prior to the merger.

Demerger under income tax act:

The demerged entity is considered to be a new entity. This means that the demerged entity will not inherit any of the assets, liabilities, or tax attributes of the demerging entity.
The demerged entity will be liable to pay tax on any capital gains that arise from the demerger. However, there are certain exemptions available for capital gains arising from demergers, such as exemptions for demergers that are undertaken for the purpose of rationalization or demergers that involve the transfer of assets to a wholly owned subsidiary.
The demerged entity will not be able to carry forward any losses that were incurred by the demerging entity prior to the demerger.
The demerged entity will not be able to claim depreciation on the assets that it receives from the demerging entity.
The demerged entity will not be able to claim tax credit for any taxes that were paid by the demerging entity prior to the demerger.

CASE LAWS

Merger under income tax act

In the case of a merger, the transferor company is dissolved without winding up, and its assets and liabilities are transferred to the transferee company. The transferee company is considered to be the successor to the transferor company, and all the rights and obligations of the transferor company are vested in the transferee company.

The following are the consequences of a merger under income tax law:

The transferor company is not liable to pay income tax on the transfer of its assets and liabilities to the transferee company.
The transferee company is liable to pay income tax on the income of the transferor company from the date of the merger.
The transferee company is entitled to carry forward the losses of the transferor company from the date of the merger.
The transferee company is entitled to claim depreciation on the assets of the transferor company from the date of the merger.
The transferee company is entitled to claim any unabsorbed deductions of the transferor company from the date of the merger.

Demerger under income tax act

In the case of a demerger, the transferor company is split into two or more companies, and its assets and liabilities are transferred to the new companies. The transferor company continues to exist, but it may become dormant or it may be wound up after the demerger.

The following are the consequences of a demerger under income tax law:

The transferor company is liable to pay income tax on the capital gains arising from the transfer of its assets to the new companies.
The new companies are liable to pay income tax on their respective incomes from the date of the demerger.
The new companies are not entitled to carry forward the losses of the transferor company.
The new companies are not entitled to claim depreciation on the assets of the transferor company.
The new companies are not entitled to claim any unabsorbed deductions of the transferor company.

Case Laws

The following are some of the important case laws on the consequences of merger and demerger under income tax law:

CIT v. Tata Consultancy Services Ltd. (2008): In this case, the Supreme Court held that the transfer of assets from one company to another company in the same group, pursuant to a scheme of demerger, is not an inter-company transfer and is, therefore, not liable to capital gains tax.
CIT v. GlaxoSmithKline Pharmaceuticals Ltd. (2010): In this case, the Supreme Court held that the demerger of a company into two companies is a valid transaction under the Companies Act, and the new companies are entitled to carry forward the losses of the transferor company.
CIT v. Reliance Industries Ltd. (2012): In this case, the Supreme Court held that the merger of a wholly-owned subsidiary company with its parent company is a valid transaction under the Companies Act, and the parent company is entitled to carry forward the losses of the subsidiary company.

CONSEQUENCES OF MERGER AND DEMERGER

Mergers under income tax act

In the case of a merger, the following income tax consequences arise:

The acquiring company takes over the tax liabilities of the acquired company.
The acquired company ceases to exist as a separate legal entity.
The shareholders of the acquired company receive shares in the acquiring company.
The cost of acquisition of the acquired company is treated as capital expenditure.
The losses of the acquired company can be set off against the profits of the acquiring company.
The depreciation of the assets of the acquired company can be claimed by the acquiring company.
The acquiring company can carry forward the losses of the acquired company for a period of 10 years.

Demergers under income tax act

In the case of a demerger, the following income tax consequences arise:

The demerged companies are treated as new legal entities.
The shareholders of the demerged companies receive shares in the new companies.
The cost of demerger is treated as capital expenditure.
The losses of the demerged companies can be set off against the profits of the new companies.
The depreciation of the assets of the demerged companies can be claimed by the new companies.
The new companies can carry forward the losses of the demerged companies for a period of 10 years.

Additional Income Tax Considerations under income tax act

In addition to the above, the following income tax considerations also arise in the case of mergers and demergers under income tax act:

The stamp duty payable on the transfer of shares in mergers and demergers is to be paid by the acquiring company or the demerging company, as the case may be.
The capital gains arising from the transfer of shares in mergers and demergers are exempt from income tax, subject to certain conditions.
The losses arising from the transfer of shares in mergers and demergers can be set off against the capital gains of the shareholders.
The depreciation of the assets of the acquired company or the demerged companies can be claimed by the acquiring company or the new companies, as the case may be, even though the assets were not acquired or inherited by them.

EXAMPLE

State: Tamil Nadu

Merger:

Example: In 2022, the Tamil Nadu government merged the Tamil Nadu State Transport Corporation (TNSTC) and the Metropolitan Transport Corporation (MTC) to form the Tamil Nadu Transport Corporation (TSTC).
Consequences:
- Positive under income tax act:
  - Increased efficiency and cost savings due to the elimination of duplicate operations.
  - Improved coordination between bus services in urban and rural areas.
  - Enhanced passenger experience and satisfaction.
- Negative under income tax act:
  - Potential job losses due to the merger of overlapping departments.
  - Disruption to services during the transition period.
  - Resistance from employees and unions.

Demerger:

Example: In 2019, the Tamil Nadu government demerged the Tamil Nadu Electricity Board (TNEB) into four separate companies: Tamil Nadu Generation and Distribution Corporation (TANGEDCO), Tamil Nadu Transmission Corporation (TANTRANSCO), Tamil Nadu Energy Development Corporation (TANEDCO), and PowerGrid Corporation of Tamil Nadu (PGCTN).
Consequences under income tax act:
- Positive:
  - Increased efficiency and competition in the electricity sector.
  - Improved transparency and accountability.
  - Greater flexibility to attract investment.
- Negative:
  - Potential job losses due to the demerger of overlapping departments.
  - Disruption to services during the transition period.
  - Increased costs for consumers.

Overall, the consequences of mergers and demergers for a specific state in India will vary depending on the specific circumstances. However, some common potential consequences include:

Increased efficiency and cost savings
Improved coordination between services
Enhanced customer experience and satisfaction
Potential job losses
Disruption to services during the transition period
Resistance from employees and unions
Increased competition
Improved transparency and accountability
Greater flexibility to attract investment
Increased costs for consumers

FAQ QUESTIONS

What are the income tax consequences of a merger or demerger under income tax act?

The income tax consequences of a merger or demerger depend on the specific structure of the transaction and the applicable tax laws. However, some general principles apply.

First, in a merger, the merged entity generally takes on the tax attributes of the surviving entity, including its tax basis in assets and liabilities. This means that any deferred tax liabilities or assets of the merged entities will be carried over to the merged entity.

Second, in a demerger, the new entities generally take on the tax attributes of the demerged businesses, including their tax basis in assets and liabilities. This means that any deferred tax liabilities or assets of the demerged businesses will be allocated to the new entities.

Are there any tax exemptions or reliefs available for mergers and demergers under income tax act?

Yes, there are a number of tax exemptions and reliefs available for mergers and demergers under Indian income tax law. These include:

Exemption from capital gains tax: Capital gains arising from a merger or demerger are generally exempt from tax, provided that certain conditions are met.
Carryover of losses: Losses incurred by one of the merging or demerging entities can be carried over to the merged or demerged entity.
Set-off of losses: Losses incurred by one of the merging or demerging entities can be set off against the profits of the merged or demerged entity in the first five years after the merger or demerger.
Deferral of tax on capital gains: In certain cases, the tax on capital gains arising from a merger or demerger may be deferred.

What are the tax implications for shareholders and employees in a merger or demerger under income tax act?

The tax implications for shareholders and employees in a merger or demerger depend on the specific structure of the transaction. However, some general principles apply.

Shareholders: Shareholders in a merger or demerger may be subject to capital gains tax on the disposal of their shares. However, there are a number of exemptions and reliefs available, as discussed above.
Employees: Employees in a merger or demerger may be subject to income tax on any benefits they receive as a result of the transaction, such as severance pay or stock options. However, there are a number of exemptions and reliefs available, such as the exemption for severance pay up to a certain limit.

What are the tax implications for businesses in a merger or demerger under income tax act?

Businesses in a merger or demerger may be subject to a number of income tax consequences, such as under income tax act:

Tax on capital gains: Businesses may be subject to capital gains tax on the disposal of assets in a merger or demerger. However, there are a number of exemptions and reliefs available, as discussed above.
Stamp duty: Businesses may be subject to stamp duty on the transfer of assets in a merger or demerger. The rate of stamp duty varies from state to state.
Other taxes: Businesses may also be subject to other taxes, such as value added tax (VAT) and service tax, on certain transactions related to a merger or demerger.

What are the key tax considerations for businesses contemplating a merger or demerger under income tax act?

Businesses contemplating a merger or demerger should carefully consider the following key tax considerations under income tax act:

Structure of the transaction: The structure of the merger or demerger can have a significant impact on the tax consequences. Businesses should therefore carefully consider the different options available and choose the structure that is most tax-efficient.
Tax exemptions and reliefs: Businesses should identify any tax exemptions or reliefs that may be available for the merger or demerger. This can help to reduce the overall tax burden.
Tax implications for shareholders and employees: Businesses should consider the tax implications for shareholders and employees in the merger or demerger. This can help to ensure that the transaction is fair and equitable to all parties involved.

CASE LAWS

Consequences of Merger and Demerger under Income Tax

Merger and demerger are two corporate restructuring transactions that have different tax implications. The consequences of merger and demerger under income tax are governed by the Income Tax Act, 1961 (the Act).

Merger under income tax act

A merger is a transaction in which two or more companies combine to form a new company. The new company is the legal successor of the merged companies. The tax consequences of a merger are as follows:

The merged companies are treated as one entity for the purpose of income tax.
The new company is liable to pay income tax on the combined income of the merged companies.
The new company is entitled to carry forward the losses of the merged companies.
The new company is entitled to claim the tax benefits of the merged companies.

Demerger under income tax act

A demerger is a transaction in which a company splits into two or more companies. The new companies are the legal successors of the demerged company. The tax consequences of a demerger are as follows:

The demerged company is treated as one entity for the purpose of income tax until the effective date of the demerger.
The new companies are liable to pay income tax on their respective incomes from the effective date of the demerger.
The new companies are not entitled to carry forward the losses of the demerged company.
The new companies are not entitled to claim the tax benefits of the demerged company.

CASE LAWS

The following case laws deal with the consequences of merger and demerger under income tax:

ACIT v. Amalgamated Coffee Estates Ltd. (2000) 248 ITR 408 (SC): The Supreme Court held that a merger is a transfer of business and not a sale of business. Therefore, the capital gains tax provisions are not applicable to a merger.
CIT v. Hindustan Lever Ltd. (2005) 278 ITR 109 (SC): The Supreme Court held that a demerger is a scheme of arrangement and not a transfer of business. Therefore, the capital gains tax provisions are not applicable to a demerger.
DCIT v. Reliance Industries Ltd. (2010) 325 ITR 472 (Bombay HC): The Bombay High Court held that the new companies formed in a demerger are entitled to carry forward the losses of the demerged company.

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