Merger, Demerger and Income-tax Applicability – A Brief Overview

Merger, Demerger and Income-tax Applicability – A Brief Overview

1. Concept of Merger (Amalgamation)

In income-tax law, a merger is treated as an “amalgamation” as defined in section 2(1B) of the Income-tax Act.

An amalgamation means transfer of all properties and liabilities of one or more companies (amalgamating companies) to another company (amalgamated company), and:

                1.            At least 75 percent of shareholders of the amalgamating company become shareholders of the amalgamated company; and

                2.            The transfer is in consideration of shares, not cash.

This definition ensures that only genuine business reorganisations and not “sales” qualify as tax-neutral.

Tax Applicability for Merger

Where the conditions of section 2(1B) are satisfied:

No capital gains arise for the amalgamating company on transfer of assets (section 47(vi)).

Shareholders of the amalgamating company do not attract capital gains on receiving shares (section 47(vii)).

The amalgamated company receives the assets at the tax WDV / cost of the amalgamating company (sections 43, 50, 55).

Accumulated losses and unabsorbed depreciation of the amalgamating company may be carried forward by the amalgamated company (section 72A), subject to continuity of business conditions.

MAT credit, depreciation, and other tax attributes generally follow the scheme as per judicial principles.

Tax neutrality is withdrawn if conditions of section 72A or scheme requirements are violated.

2. Concept of Demerger

A demerger is defined in section 2(19AA).

It means a transfer of an undertaking by a demerged company to a resulting company, where:

                1.            All assets and liabilities of that undertaking are transferred at book value;

                2.            The transfer is made on a going-concern basis;

                3.            Shareholders of the demerged company receive shares of the resulting company in proportion to their shareholding;

                4.            The consideration is wholly in shares; and

                5.            The resulting company issues shares to the shareholders of the demerged company.

Only when these statutory conditions are satisfied does a demerger become tax-neutral.

Tax Applicability for Demerger

When conditions of section 2(19AA) are satisfied:

Transfer of assets from the demerged company to the resulting company is not regarded as transfer (section 47(vib)).

Shareholders receiving shares of the resulting company do not incur capital gains (section 47(vid)).

The resulting company takes assets at the same tax cost / WDV (section 43, 50).

Tax depreciation continues based on apportioned WDV (Rule 8AB).

Losses and unabsorbed depreciation relating to the demerged undertaking are transferred to the resulting company (section 72A(4)).

Capital gains in the hands of shareholders arise only when they subsequently sell shares.

3. Common Tax Principles in Merger and Demerger (Tax-neutral Reorganization)

The fundamental principle is continuity of business, not a disposal of assets.

Transfers under section 47 are exempt from capital gains.

Carry-forward of losses is allowed only in statutory mergers/demergers meeting section 72A conditions.

Book value continuity is mandatory in demergers and optional in mergers depending on accounting method, but tax WDV/cost continuity is mandatory.

Any violation of statutory conditions results in capital gains taxation.

4. Key Sections Relevant

Definitions: Sections 2(1B), 2(19AA)

Exempt transfers: Sections 47(vi), 47(vii), 47(vib), 47(vid)

Cost/WDV: Sections 43, 50, 55

Carry forward of losses: Section 72A

Apportionment of cost of capital assets in demerger: Rule 8AB

Tax on subsequent sale of shares/assets: Normal capital gains provisions apply

5. Summary

A merger (amalgamation) and demerger are special forms of corporate restructuring recognized under the Income-tax Act. If the statutory conditions are fulfilled, such transactions are treated as tax-neutral, meaning:

No capital gains tax for the companies or their shareholders at the time of transfer.

Tax attributes such as losses, depreciation, WDV, and cost of acquisition continue in the hands of the amalgamated/resulting company.

Subsequent sale of shares/assets is taxable normally.

The law ensures that genuine reorganizations are not taxed like commercial transfers.