NOTE ON AMALGAMATION AND DEMERGER Facts of the case Our client had proposed a structure for scheme of arrangement

and wanted to know whether it would qualify as a scheme of arrangement or not under Section 390 to 394 of Companies Act, 1956 and if it does qualify as a scheme of arrangement whether it would be exempted from capital gains tax under Income Tax Act, 1961 or not. The structure was as following: 4 Promoters (1,2,3,4) held shares in a company called ABC and this ABC company held shares in company A, B, C, D, E, F, G and therefore these companies were indirectly subsidiaries of Promoters 1,2,3 and 4 also. These 4 promoters wanted to have direct shareholding in company A,B, C and D. To avoid capital gain tax, the client proposed a scheme whereby the company ABC would be demerged to form N1, N2, N3 and N4 resulting companies and these resulting companies thereafter will be merged/ amalgamated with companies A,B,C and D to enable the 4 promoters to have direct shareholding. Provisions relating to Amalgamation and Demerger Meaning of the Term Demerger: The term Demerger as such is not defined under the Companies Act, but falls within the ambit of the provisions of Sections 390 to 394 of the Companies Act, 1956. The word arrangement under section 390 (b) includes a reorganization of the share capital of the company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or by both those methods. Definition of Demerger under Income Tax Act Requirements to qualify as Tax-neutral Demerger Demerger is defined under Income Tax Act and as per the definition provided under Section 2(19AA) of the Income Tax Act. [(19AA)demerger, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 39480 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 (i) 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; (ii) 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;

(iii) 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; (iv) the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis; (v) 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 share-holders 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; (vi) the transfer of the undertaking is on a going concern basis; (vii) the demerger is in accordance with the conditions, if any, notified under subsection (5) of section 72A by the Central Government in this behalf. Explanation 1.For the purposes of this clause, undertaking shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity. Conclusion In case of demerger there has to be an undertaking that is proposed to be hived off and transferred to the resulting company, by the demerged company. In addition to this, it must be ensured that the transfer of such an undertaking/unit is on a going concern basis. [Here, an undertaking is defined to include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity. By analyzing the provision, we may infer that in order for a scheme of arrangement to qualify as demerger, it is mandatory (for a company proposing the demerger) to have an undertaking/business activity which is proposed to be hived off and such undertaking is a going concern.] Advise: This is one aspect that brought to the clients notice, if they want capital gains tax exemption there has to be transfer of an undertaking on a going concern basis. Secondly, there has to be a consideration in demerger. The Section provides that in consideration of the demerger, the resulting company has to issue its shares to the shareholders of the demerged company on a proportionate basis to the shareholders of the demerged company. Furthermore, Section 47 (vid) of the Income Tax Act provides the allotment of shares by the resulting company as consideration for the transfer of assets of the demerged company to the shareholders of the demerged company will not be regarded as transfer for the purposes of Section 45 and hence, is exempted from paying capital gains tax.

MERGERS/ AMALGAMATIONS UNDER COMPANIES ACT, 1956 AND INCOME TAX ACT The terms amalgamation or merger as such are not defined anywhere in the Companies Act, 1956, however, Sections 390 to 394 of the Companies Act govern amalgamation/merger under Indian law. Section 394(1)(b) provides that amalgamation is a scheme under which the whole or any part of the undertaking, property or liabilities of Transferor Company is to be transferred to the Transferee Company. Tax Implications on Amalgamation Section 2 (1B) of the Income Tax Act,1961 defines amalgamation as, in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that
(i)

all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation; all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation ; shareholders holding not less than three-fourths (3/4th) in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation,

(ii)

(iii)

Tax concession on Amalgamation Capital Gains Tax not attracted According to Section 47 (vi) where there is a transfer of any capital asset in the scheme of amalgamation, by an amalgamating company to the amalgamated company, such transfer will not be regarded as a transfer for the purpose of capital gain provided, the amalgamated company is an Indian company, and therefore, is exempted from capital gains tax. Tax Concession to shareholders of an amalgamating company under Section 47 (vii) where a shareholder of an amalgamating company transfers his shares, in a scheme or amalgamation, such transaction will not be regarded as transfer for capital gain purposes, if following conditions are complied with:

(i)

The transfer of shares is made in consideration of the allotment to him of any share or shares in the amalgamated company, and The amalgamated company is an Indian Company;

(ii)