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Budget 2019: Finance Minister Removes Ambiguity On Tax Neutrality Of Demergers 

Amendment in the definition of demerger becomes effective from April 1, 2020.

Indian five hundred rupee banknotes are arranged for a photograph in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)
Indian five hundred rupee banknotes are arranged for a photograph in Mumbai, India (Photographer: Dhiraj Singh/Bloomberg)

Demerging companies compliant with Indian Accounting Standards can heave a sigh of relief.

Finance Minister Nirmala Sitharaman, in the budget for 2019-20, proposed changes to the Income Tax Act, 1961 to amend the definition of ‘demerger’ to remove ambiguity about tax exemption available to such transactions after the rollout of the Indian Accounting Standards.

A demerger entails transfer of property and liability of an existing company to one or more existing or new companies under the income tax law. The transfer must be made at valuations in the books of the demerging company immediately before the transaction. Demergers meeting this criterion were exempt from the capital gains tax under Section 47 of the income tax law.

But the Indian Accounting Standard 103 pertaining to business combinations stipulates that “fair value accounting” should be followed in demergers. Fair value is defined as “the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction”.

Recording property and assets transferred at fair value caused a mismatch between the valuations assigned by the demerging entity and the resulting company.

This ambiguity affected the tax neutrality of demergers.

The budget revised the existing definition, saying that such transactions will be considered as a demerger even in case of a mismatch if it arises because of valuation of assets under the Ind AS.

The clarification will:

  • Aid demergers of Ind-AS compliant companies.
  • Harmonise accounting standards and income tax laws.
  • Remove existing ambiguities.

“The move to Ind AS accounting was disruptive and many measures (like Income Computation and Disclosure Standards) were taken in tax laws to make them coexist. However, the definition of demerger stood out as one of the sore thumbs, which is now being addressed,” Vishwas Panjiar, partner at Nangia Advisors, told BloombergQuint. “The proposed amendments will now rectify this anomaly.”

The amendment in the definition, however, becomes effective from April 1, 2020.

Rationalising the provisions of demerger with the accounting provisions of Ind-AS will provide clarity on an issue which had created ambiguity on the tax neutrality provisions, said Mehul Bheda, partner, Dhruva Advisors. “But the government should have made the clarification retrospective so as to the clear the cloud on demergers made effective in the earlier years.”