Module 5

Tax Planning in Respect of Amalgamation or De-merger as per the Income Tax Act, 1961
Amalgamation and demerger are common corporate restructuring strategies that companies use
to achieve various business objectives, such as operational efficiency, market expansion, or
unlocking shareholder value. The Income Tax Act, 1961 provides specific provisions to facilitate
such restructurings without significant tax burdens. Here's a guide on tax planning in the context
of amalgamation and demerger under the Act:
1. Amalgamation:
Definition (Section 2(1B)):
 Amalgamation refers to the merger of one or more companies with another company or
the merger of two or more companies to form a new company. For an amalgamation to
be recognized under the Income Tax Act, it must meet specific conditions, such as the
transfer of all assets and liabilities and the shareholders holding at least three-fourths of
the shares of the amalgamating company receiving shares in the amalgamated company.
Key Tax Planning Aspects:
1. Tax Neutrality (Section 47):
 Transfer of Assets: The transfer of assets from the amalgamating company to the
amalgamated company is not considered a "transfer" for capital gains purposes,
provided the amalgamation meets the conditions specified in the Act.
 Shareholders’ Perspective: No capital gains tax is levied on the shareholders of
the amalgamating company when they receive shares of the amalgamated
company in exchange for their original shares.
2. Carry Forward and Set Off of Losses (Section 72A):
 Unabsorbed Losses and Depreciation: The amalgamated company can carry
forward and set off the accumulated losses and unabsorbed depreciation of the
amalgamating company, provided the amalgamated company continues to hold at
least 75% of the book value of fixed assets for five years and carries on the
business of the amalgamating company for at least five years.
3. MAT Credit (Section 115JB):

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  Credit for MAT Paid: The amalgamated company is entitled to claim the MAT
(Minimum Alternate Tax) credit brought forward from the amalgamating
company, ensuring that tax benefits are not lost due to the amalgamation.
4. Tax Planning for Shareholders:
 Tax-Free Share Exchange: Shareholders should ensure that the exchange of
shares during amalgamation meets the conditions of Section 47, allowing them to
defer capital gains tax liability.
 Strategic Shareholding: Careful planning of shareholding structures can ensure
that shareholders maintain or enhance their control post-amalgamation, without
triggering adverse tax consequences.
5. Expenditure on Amalgamation (Section 35DD):
 Deduction for Expenditure: The expenditure incurred wholly and exclusively
for the purpose of amalgamation is eligible for a deduction in five equal
installments over five years under Section 35DD.

Tax Incentives to the Amalgamating Company

(a) Exemption from Capital Gains Tax

 Section 47(vi): No capital gains tax on transfer of capital assets by an amalgamating

company to an Indian amalgamated company, if:
o All assets and liabilities are transferred.
o Shareholders holding 75% in amalgamating company become shareholders of
amalgamated company.

(b) Transfer of Shares between Foreign Companies

 Section 47(via): No capital gains tax on transfer of shares of an Indian company by one
foreign company to another foreign company, if:
o At least 25% of shareholders of amalgamating foreign company remain
shareholders of amalgamated foreign company.
o The transfer is not taxable in the foreign country.

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(c) Transfer of Certain Licences / Undertakings

 Section 47(xii), 47(xiiia), 47(xiiib): Exemption for transfer of telecom licences, spectrum
rights, or oil and natural gas business undertakings during amalgamation.

(d) Plant and Machinery

 Section 32AD(1): Investment allowance benefit is not withdrawn if plant/machinery is

transferred to an Indian amalgamated company and conditions are fulfilled.

Tax Incentives to the Amalgamated Company

(a) Carry forward of Unabsorbed Expenditure

 Section 35(5): Unabsorbed scientific research expenditure of amalgamating company is

allowed to amalgamated company.

(b) Amortisation of Licence / Spectrum Fees

 Sections 35ABB(7) and 35ABA(6): Unamortised telecom licence or spectrum

expenditure is allowed to amalgamated company.

(c) Deduction of Amalgamation Expenses

 Section 35DD: Amalgamation expenses allowed as deduction over 5 years (1/5th each
year).

(d) Preliminary Expenses

 Section 35D: Preliminary expenses allowed as deduction over 5 years (1/5th each year).

(e) Voluntary Retirement Scheme (VRS) Expenses

 Section 35DDA: VRS expenditure is allowed in 5 equal annual instalments.

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(f) Expenses on Scientific Research (Sec 35(5))
If the amalgamating company had unclaimed scientific research expenses, the amalgamated
company can claim the balance deduction. This ensures continuity of tax benefits and promotes
ongoing R&D activities.

(g) Expenses on Prospecting, Extraction or Production of Mineral Oil or Natural Gas (Sec
35E(7))
Unclaimed eligible expenditure on mineral oil or natural gas activities of the amalgamating
company can be claimed by the amalgamated company. This allows smooth transfer of long-
term resource projects without losing tax benefits.

(h) Deduction in respect of Preliminary Expenses (Sec 35D(5))

Unamortised preliminary expenses like feasibility reports, surveys, legal charges etc. are allowed
to the amalgamated company. This ensures such initial project costs continue to be deductible
after merger.

(i) Deduction in respect of Amalgamation Expenses (Sec 35DD)

Legal, consultancy and filing fees for amalgamation are allowed as deduction to the
amalgamated company in 5 equal annual instalments. This helps reduce the cost burden of
corporate restructuring.

(j) Actual Cost of Depreciable Assets (Sec 43(1) Explanation 2)

The amalgamated company must adopt the same actual cost of assets as in the books of the
amalgamating company. This avoids any artificial increase or decrease in cost due to
amalgamation.

(k) Written Down Value of Depreciable Assets (Sec 43(6)(c) Explanation 2)

The WDV of the amalgamating company’s assets gets added to the WDV of the amalgamated
company. This maintains continuity of depreciation and prevents double deduction.

(l) Deduction for Profits from Infrastructure Undertakings (Sec 80-IA/80-IB/80-IC)

If an eligible unit merges, the amalgamated company gets the remaining profit-linked deduction
period. The amalgamating company stops claiming it from the year of amalgamation.

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(m) Units in Special Economic Zones (Sec 10AA(7A))
If an SEZ unit is transferred in amalgamation, its remaining tax holiday continues with the
amalgamated company. This applies only if the merger is government-approved and the unit
continues to operate.

(n) Carry Forward of Losses and Unabsorbed Depreciation (Sec 72A)

If conditions like continuity of business and shareholding are met, the amalgamated company
can carry forward and set off the amalgamating company’s losses and unabsorbed depreciation.
This is a key incentive for reviving financially weak companies.

2. De-merger:
Definition (Section 2(19AA)):
 A demerger involves the transfer of one or more undertakings from one company to
another company, typically resulting in the creation of a separate entity or the spinning
off of a division. For a demerger to be recognized under the Income Tax Act, it must
meet specific conditions, including the transfer of all assets and liabilities of the
undertaking and the issue of shares by the resulting company to the shareholders of the
demerged company on a proportionate basis.
Key Tax Planning Aspects:
1. Tax Neutrality (Section 47):
 Transfer of Assets: Similar to amalgamation, the transfer of assets during a
demerger is not treated as a "transfer" under Section 47, provided the demerger
meets the conditions specified in the Act, thereby avoiding capital gains tax.
 Shareholders’ Perspective: Shareholders of the demerged company are not
subject to capital gains tax when they receive shares of the resulting company, as
the transaction is not treated as a "transfer."
2. Carry Forward and Set Off of Losses (Section 72A(4)):
 Proportionate Loss Carry Forward: The resulting company can carry forward
the proportionate share of accumulated losses and unabsorbed depreciation of the
demerged company, subject to compliance with conditions like maintaining
continuity of business.

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 3. Cost Allocation for Shareholders (Section 49(2C) & 49(2D)):
 Cost of Acquisition: The cost of acquisition of the shares of the resulting
company and the demerged company is determined in proportion to the net book
value of the assets transferred. This helps in minimizing capital gains tax liability
on any future sale of shares.
4. MAT Credit (Section 115JB):
 MAT Credit Transfer: Similar to amalgamation, the MAT credit of the
demerged company is apportioned between the demerged and resulting
companies based on the assets transferred, allowing both companies to utilize the
credit.
5. Strategic Tax Planning:
 Restructuring for Efficiency: De-merger allows for the separation of businesses,
enabling focused management and potential tax efficiencies through optimized
capital structures.
 Spin-offs: Spin-offs through demerger can be tax-efficient methods for unlocking
shareholder value, with shareholders receiving shares in the new entity without
immediate tax implications.
6. Expenditure on De-merger (Section 35DD):
 Deduction for Expenditure: Similar to amalgamation, the expenditure incurred
exclusively for the demerger is deductible in five equal installments over five
years.
Tax Incentives for Resulting Company

(a) Exemption from Capital Gains – Transfer of Licence to Operate Telecommunication

Services

As per Section 47(vii), when a demerged company transfers its licence to operate
telecommunication services to the resulting company (an Indian company), such transfer is not
regarded as a transfer. The resulting company can claim deduction of unamortised expenditure
on the licence in the same manner as the demerged company.

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(b) Preliminary Expenses

As per Section 35D(5A), if the demerged company had unamortised preliminary expenses, they
shall be allowed to the resulting company. The resulting company can claim them over the
remaining instalments as if the demerger had not occurred.

(c) Expenses for Amalgamation

As per Section 35DD(1A), where a demerged company had incurred expenditure wholly and
exclusively for the purpose of demerger, the resulting company is allowed to claim such
expenses. The deduction is allowed in five equal annual instalments starting from the year of
demerger.

(d) Expenses Incurred under Voluntary Retirement Scheme

As per Section 35DDA(4), unamortised VRS expenditure of the demerged company shall be
allowed as deduction to the resulting company. The deduction is spread over the remaining
instalments as if no demerger had occurred.

(e) Expenses on Prospecting etc. of Certain Minerals

As per Section 35E(7A), if a demerged company had incurred eligible expenditure on

prospecting, extraction or production of certain minerals, such unclaimed expenditure can be
claimed by the resulting company. This ensures continuity of deduction benefits for long-term
projects.

(f) Expenses on Prospecting etc. of Petroleum and Natural Gas

As per Section 35E(7A), if a demerged company had incurred expenditure on prospecting,

extraction or production of petroleum and natural gas, the resulting company can claim
deduction of the remaining eligible amount. This allows uninterrupted benefit for ongoing oil
and gas projects.

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(g) Actual Cost of Depreciable Assets

As per Section 43(1) Explanation 7A, the actual cost of the transferred capital asset to the
resulting company shall be the same as it was to the demerged company. This prevents any
artificial increase or decrease in cost due to demerger.

(h) Written Down Value (WDV) of Depreciable Assets

As per Section 43(6)(c)(ii), the WDV of the block of assets of the demerged company shall be
added to the WDV of the block of assets of the resulting company. This ensures continuity of
depreciation without double deduction.

(i) Deduction in respect of Profits from Undertaking

As per Sections 80-IA(8), 80-IB(12), 80-IC(7) and 80-IE(6), deduction is allowed for profit-
based undertakings if the demerger satisfies all conditions. The resulting company becomes
eligible to claim the deduction for the unexpired period, reducing its tax liability.

Tax Planning in Respect of Slump Sale as per Income Tax Act, 1961
A slump sale refers to the transfer of a business undertaking as a going concern for a lump-sum
consideration without assigning values to individual assets and liabilities. The Income Tax Act,
1961 provides specific provisions to deal with the tax implications of such transactions.
Key Provisions for Slump Sale under the Income Tax Act, 1961
1. Definition of Slump Sale (Section 2(42C)):
 A slump sale is defined as the transfer of one or more undertakings as a result of
the sale for a lump-sum consideration, without assigning values to individual
assets and liabilities.
2. Computation of Capital Gains (Section 50B):

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  Section 50B of the Income Tax Act deals with the taxation of slump sales. It
treats the gains arising from a slump sale as capital gains.
 The difference between the sale consideration and the net worth of the
undertaking (as per the book value of the assets and liabilities) is treated as a
capital gain.
 The net worth is calculated as the value of all assets minus the value of all
liabilities of the business undertaking on the date of transfer.
3. Tax Treatment of Slump Sale:
 If the undertaking has been held for more than 36 months, the resulting capital
gains are considered long-term capital gains (LTCG) and taxed accordingly.
 If the undertaking has been held for less than 36 months, it is considered short-
term capital gains (STCG) and is taxed at the applicable rates.
 The benefit of indexation is not allowed when calculating the capital gains under
a slump sale.
4. No Deemed Consideration (Stamp Duty Valuation):
 Unlike regular sales of capital assets, where deemed consideration based on stamp
duty value might apply, in a slump sale, the consideration agreed upon between
the parties is taken as the full value, irrespective of the stamp duty value.
5. Depreciation and Unabsorbed Losses:
 In the case of a slump sale, depreciation claimed on the assets transferred or
unabsorbed depreciation and losses remain with the seller and cannot be
transferred to the buyer.
 However, the buyer can claim depreciation on the purchased assets from the date
of acquisition, based on the consideration paid for the slump sale.
6. Exemptions and Deductions:
 Section 54EC: If the capital gains from a slump sale are invested in specified
bonds (such as REC or NHAI bonds), the seller can claim an exemption on the
gains, subject to a maximum investment limit and conditions.
 Section 54GB: Exemption for reinvestment in the equity shares of eligible start-
ups or small and medium enterprises (SMEs), subject to specific conditions.

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 Tax Planning Considerations for Slump Sale:

1. Long-Term vs. Short-Term Capital Gains:

 For favorable tax treatment, ensuring the business undertaking has been held for
more than 36 months is essential. LTCG is taxed at a lower rate (currently 20%
plus applicable surcharges and cess) compared to STCG, which is taxed at
regular income tax rates.
2. Tax-Saving Investments:
 Investing in bonds under Section 54EC within 6 months of the slump sale can
help the seller save on capital gains tax.
 Exploring options under Section 54GB for reinvestment into eligible startups can
also provide tax relief.
3. Structuring Consideration:
 Proper planning of the consideration to ensure it qualifies as a slump sale under
Section 50B is crucial, as incorrect valuation or assigning individual values to
assets could lead to the transaction being taxed under different provisions of the
Income Tax Act, leading to higher tax liabilities.
4. Due Diligence:
 It’s important to conduct a thorough due diligence of the net worth of the
business and ensure that the liabilities are properly accounted for, as they impact
the capital gains calculation.

Tax Planning in Respect of Conversion of a Firm into a Company

Converting a firm into a company is a common corporate restructuring strategy in India. It is
often undertaken to take advantage of the benefits associated with corporate structure, such as
limited liability, perpetual succession, and access to capital markets. However, from a tax
perspective, the conversion must be carefully planned to minimize tax liabilities and ensure
compliance with the provisions of the Income Tax Act, 1961. Below is a detailed overview of the
tax planning considerations for such a conversion:
1. Understanding the Legal Framework:

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  Section 47(xiii): This section of the Income Tax Act, 1961, provides specific conditions
under which the conversion of a firm into a company is tax-neutral. If all the conditions
are satisfied, the transfer of assets from the firm to the company is not treated as a
"transfer" and hence does not attract capital gains tax.
 Key Conditions for Tax Neutrality:
1. All Assets and Liabilities Transferred: All assets and liabilities of the firm must
be transferred to the company.
2. Shareholders’ Compensation: All the partners of the firm immediately before
the conversion must become shareholders of the company, and their shareholding
in the company should be in the same proportion as their capital accounts in the
firm.
3. No Other Consideration: The partners should not receive any consideration
other than shares in the company.
4. Minimum Shareholding: The partners must hold at least 50% of the voting
power in the company for a minimum of five years from the date of conversion.
2. Tax Implications of Not Meeting Section 47(xiii) Conditions:
 Capital Gains Tax: If any of the conditions under Section 47(xiii) are not met, the
transfer of assets from the firm to the company may be treated as a "transfer," triggering
capital gains tax liability. The capital gains would be computed based on the fair market
value (FMV) of the assets on the date of conversion.
 Stamp Duty and Other Taxes: Apart from capital gains tax, the conversion may also
attract stamp duty on the transfer of immovable properties, and other applicable taxes
such as VAT or GST on the transfer of business assets.
3. Tax Planning Strategies:
 Compliance with Section 47(xiii) Conditions: Ensure that the conversion process
complies with all the conditions of Section 47(xiii) to avail of the tax exemption. This
includes careful planning of the shareholding pattern and ensuring that no consideration
other than shares is provided to the partners.
 Valuation of Assets: Conduct a proper valuation of the firm’s assets before the
conversion. Although Section 47(xiii) provides a tax exemption, it’s important to have a

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 record of the asset values to ensure accurate accounting in the company’s books post-
conversion.
 Carry Forward of Losses and Unabsorbed Depreciation (Section 72A): The losses
and unabsorbed depreciation of the firm can be carried forward and set off against future
profits of the company, provided the conditions of Section 72A are met. This can be a
significant tax planning advantage for the new company.
 Minimum Shareholding Requirement: Plan the shareholding structure to ensure that
the partners retain at least 50% of the voting power in the company for five years. Any
change in the shareholding pattern that results in a reduction below this threshold could
trigger capital gains tax on the original transfer.
 Timing of Conversion: Consider the timing of the conversion to optimize tax benefits.
For example, converting the firm at the beginning of the financial year can simplify
accounting and tax compliance for the new company.
4. Post-Conversion Compliance:
 Company Formation and Registration: Ensure that the company is properly
incorporated under the Companies Act, 2013, and that all necessary filings are completed
with the Registrar of Companies (RoC).
 Transfer of Statutory Registrations: Transfer all statutory registrations such as GST,
PAN, TAN, and other business licenses from the firm to the company.
 Maintenance of Books of Accounts: The company must maintain proper books of
accounts from the date of conversion. The opening balances should reflect the assets and
liabilities transferred from the firm.
5. Tax Advantages of Conversion:
 Corporate Tax Rates: Companies often benefit from lower tax rates compared to firms,
especially with the introduction of concessional tax rates for domestic companies under
Section 115BAA and Section 115BAB.
 Access to Capital Markets: Conversion into a company allows for easier access to
equity financing through the issuance of shares, which can be a tax-efficient way to raise
capital compared to debt financing.
 Limited Liability: The partners benefit from limited liability protection, which shields
their personal assets from business liabilities.

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  Perpetual Succession: A company enjoys perpetual succession, which ensures
continuity of business operations irrespective of changes in ownership or management.
6. Potential Pitfalls:
 Non-Compliance with Conditions: Failing to meet any of the conditions under Section
47(xiii) can result in a significant tax burden, including capital gains tax on the transfer of
assets.
 Holding Period for Tax Benefits: If the partners do not maintain the required
shareholding for five years, the exemption under Section 47(xiii) could be revoked,
leading to retroactive tax assessments.

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