A demerger is a type of corporate reorganisation in which an organisation splits off a portion of its operations into a separate corporation. For a variety of reasons, an organisation may decide to demerge. The most typical goal is to increase shareholder value by separating out distinct activities that may perform well if they are separated from the core firm. Separation, where partners who previously worked together in a joint venture or as part of an acquisition decide to pursue their own paths, is another reason for a demerger.

A demerger is a process approved by the National Companies Law Tribunal (NCLT) in which all of the assets and liabilities of the specified business undertaking, as well as the employees, are transferred to the transferee entity on a continuing concern basis. In exchange for a demerger, the transferee entity gives its shares to the transferor entity's shareholders.

Do you, however, understand the tax ramifications of a demerger?

Section 2(19AA) of the Income Tax Act of 1961 defines a demerger. A demerger is usually tax-free, although it can have tax consequences. The author's goal in this essay is to discuss the taxes provisions for a demerger.
Demerger and Income Tax Act, 1961

Provisions related to Demerger under Income Tax Act:

As per S.2(19AA) of the Income Tax Act, 1961, defines the term demerger, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company in such a manner that:

1. All the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;
2. All the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger;
3. The property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;
4. The resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis except where the resulting company itself is a shareholder of the demerged company;
5. The shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company;
6. The transfer of the undertaking is on a going concern basis;
7. The demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf.

When will a demerger be tax neutral?

A demerger will be tax neutral in the following circumstances:
Various transactions are not deemed transfers for the purpose of capital gains tax under Section 47 of the Income Tax Act of 1961. As per Section 47(vi b), if there is any transfer of a capital asset from the demerged organisation to the succeeding organisation in a demerger, and the resulting organisation is an Indian organisation, the transaction will not be regarded a transfer for the purpose of capital gains tax.

According to Section 47(vi) (d), if the resulting organisation issues or transfers shares to the shareholders of the demerged organisation in a demerger scheme, and the transfer is made in consideration of the undertaking's demerger, the transaction will not be considered a transfer for the purpose of capital gains tax.

There are no implications of a presumed dividend on the issue of shares by the new organisation, according to clause (v) of Section 2(22) of the Income Tax Act, 1961. When shares are distributed to the shareholders of the demerged organisation as a result of a demerger (whether or not there is a capital decrease in the presumed organisation), they are not included in the definition of the dividend.

Section 72A (4) of the Income Tax Act of 1961 gives a demerger the benefit of set-off and carry-forward of unabsorbed loss and depreciation. If a demerger opts for a company reorganisation, this provision will benefit them. It should be underlined that such a demerger should have been pursued solely for legitimate economic reasons.

When will a demerger be taxed?
The resulting organisation is taxed as a business successor under Section 41(1) of the Income Tax Act of 1961. When a deduction or allowance is provided in any assessment year in respect of a loss, trading, or spending liability sustained by the assessee (first-mentioned individual) in a prior year, Section 41(1)(a) applies. The assets gained by such individual or the value of benefit arising to him shall be deemed to be gains and profits of the profession or business and chargeable to income tax as the income of that previous year, whether the profession or business in resp; or

(b) the successor in business (resulting organization) has gained any amount whether in cash or in any other way in respect of which loss or expenditure was suffered by the assessee (first mentioned individual) or some profit in respect to business liability referred to in clause (a) by way of revocation or termination thereof, the amount gained by the resulting organization or the value of profit arising to the resulting organisation shall be deemed to be gains and profits of the profession or business, and chargeable accordingly to income tax as the income of that previous year.

Whether a demerger scheme could be sanctioned under Income Tax Act provisions and corporate laws of India if there is no consideration?
The Gujarat High Court has answered the above-mentioned question in the case of Vodafone Essar Gujarat Limited (Gujarat HC). The court ruled against the demerger plan. Furthermore, the scheme was deemed to be a conduit/device with the sole purpose of evading and avoiding taxes such as stamp duty, income tax, VAT, and registration fees. The fact that different accounting treatments are offered to transferor organisations with a positive net worth as compared to those with a negative net worth with a motive to avoid maximum tax was recognised as evidence of the motive being tax avoidance.

Could it be true that a tax-neutral demerger of investments would be considered under Section 2(19AA) of the Income Tax Act of 1961?
If the transfer does not comply with Section 2(19AA) of the Said law, the incentive for demerger under Section 47 (vii a) is not available.

It was held in Income Tax Officer v. M/s Datex Ohmeda (India) Pvt Ltd (ITAT Kolkata) that the transfer of the assessee-trading organisation's and business division was not in accordance with the provisions of Section 2(19AA) to treat the same as a demerger for the purpose of the Income Tax Act, and that the assessee-organisation was not eligible for the Section 47 (vii a) incentive. All obligations connected to the undertaking, being transferred by the corporation, are subject to section 2(19AA) (ii) of the Income Tax Act, 1961.

All liabilities relating to the undertaking transferred by the demerged organisation immediately before to the demerger should become liabilities of the resulting organisation, according to the requirement embodied in section 2(19AA) (ii) of the Income Tax Act,1961. However, in this case, the transfer of the T&D division did not comply with Section 2(19AA), and so the incentive under Section 47 (vii a) of the Income Tax Act,1961, was not available.

Provisions for Cross-border Demerger:
The Companies Act of 2013 does not clearly enable or prohibit cross-border demergers. Cross-border demergers are only possible in India if Section 232(I)(b) of the Companies Act, 2013 is interpreted together with Section 234 of the Companies Act, 2013. The Legislature, via explanation, or any appellate tribunal, through order or decision, can put an end to the argument. Currently, the Income Tax Act of 1961 stipulates that the emerging entity from a demerger must be an Indian entity. To date, there is no provision for a cross-border demerger.

Conclusion:
To summaries, a demerger is a type of corporate reorganisation in which a company divides a portion of its operations into a separate firm. A demerger is usually tax-free, although it can have tax consequences. There will be no capital gains if capital assets are transferred and the successor organisation is an Indian organisation, according to Section 47(vi b). Similarly, there will be no capital gains when the successor organisation issues or transfers shares to shareholders of the demerged organisation, according to Section 47(vi) (d).

The resulting organisation is taxed as a business successor under Section 41(1) of the Income Tax Act of 1961. The Companies Act of 2013 does not clearly enable or prohibit cross-border demergers. Cross-border demergers are only possible in India if Section 232(I)(b) of the Companies Act, 2013, is read in conjunction with Section 234 of the Companies Act, 2013.

The Legislature, through explanation, or any Appellate Tribunal, through order or judgement, can put an end to the argument. Currently, the Income Tax Act of 1961 stipulates that the emerging entity from a demerger must be an Indian entity. There isn't anything in the law about the cross-border demerger.