Case Law: Can Assets & Liabilities transferred under Debt Restructuring through Scheme of Arrangement amount to Demerger

Facts of the Case:

1. Petitions were filed u/s 391(2) & 394 of the Companies Act, 1956, praying sanction of scheme of arrangement regarding the restructuring of corporate debt of M/s Siel Limited i.e., assessee which was duly approved by the Hon’ble High Court of Delhi vide its order dated 26-08-2003.
2. The four companies which filed the petitions were M/s Shivaji Marg Properties Ltd. (100% equity with M/s Siel Limited), M/s Siel Holdings Limited (100% equity with M/s Siel Sugar Limited), M/s Siel Sugar Limited and the assessee.
3. The debt restructuring was undertaken due to substantial accumulated losses of M/s Siel Limited.
4. As a result of arrangement, the lenders of the assessee were given three options and as part of options selected by various lenders:
   • 32% of the total land valued at Rs. 65 crores was assigned to M/s Shivaji Marg Properties Limited along with the same amount of debt (Rs. 65 crores).  From the sale of the said land, the corresponding debt was to be discharged, i.e., M/s Shivaji Marg Properties Ltd. was a self-liquidated company.
   • The investments valued at Rs. 35 crores were assigned to M/s Siel Holding Limited along with equivalent amount of debt and the said debt was to be discharged by selling the said shares i.e., Siel Holding Ltd. was also a self-liquidated company.
   • The two sugar units (supra) of the assessee company were vested in M/s Siel Sugar Limited, for which the shareholders of the assessee company were granted the shares of M/s Siel Sugar Limited in the ratio mentioned in the order of the High Court.
   • M/s Siel Limited, i.e., the assessee was to continue to operate the residual business of Chemicals and Vegetable Oils.
5. In the return of income, assessee has treated transaction for transfer of land to M/s Shivaji Marg Properties Limited and transaction for transfer investments to M/s Siel Holdings Limited as a “transfer” u/s 2(47) of the Act which is chargeable to tax and has thereby computed Long Term Capital Loss therein as there was no consideration, however vis a vis transaction for transfer of two sugar units of the assessee company to M/s Siel Sugar Limited it was claimed by the assessee that this is a “transfer” which is exempt from tax u/s 47(vib) of the Act.
6. Further, in preceding years the assessee has made some investments (INR 18 crore) and has also advanced loans to its group companies (INR 28 crore) of which one investment in which one investment (equity 18 crore & loan 10 crore) was transferred to Siel Holdings Limited.

Assessing Officer (AO) View

1. Transactions flow out of a common Scheme of Arrangement, the assessee cannot paint some transactions (i.e. vesting of land and investments) as a “transfer” which is chargeable to tax and thereby claiming loss thereunder and on a flip side claim that vesting of sugar units is a transaction of “demerger” not chargeable to tax u/s 47(vib) of the Act. AO therefore disallows the claim for Long Term Capital Loss of Rs. 42,22,93,246/-.
2. There is no provision in the scheme of arrangement for treating the transfer of property and assets vested in the demerged companies in different manner for different entities.
3. The assessee has deployed its interest-bearing funds for non-business activities i.e., investment in group entities. Relying upon the fact that identical disallowances have been made by his predecessor on this very issue in earlier years, the AO continued to follow the same line of action that the interest on funds deployed for equity shares, preference shares, loans, etc., shall be disallowed in this year as in earlier years.

CIT(A) View

1. Ld CIT(A) has upheld the above disallowance, though on a different footing.
2. For ensuring payment to lenders, certain assets of the assessee were identified and the corresponding debt was also identified. What was assigned to M/s Shivaji Marg Properties Ltd. and M/s Siel Holding Limited were assets of Rs. 65 crores with debt of Rs. 65 crores and the assets of Rs. 35 crores with the debt of Rs. 35 crores. Rs. 65 crores and Rs. 35 crores were the market values of the assets assigned and the corresponding debt was the value of debt after considering the waiver of interest/principal as the case may be. The assets and liabilities were assigned as one unit of zero value. Consequently, the question of any loss as a result of these assignments does not arise.
3. In such situation, the question where such a transfer falls under demerger u/s 47(vib) becomes infructuous and is only an academic exercise.
4. On interest disallowance, the nexus of borrowed funds debts and these investments have been established by the operation of the decision of the Hon’ble High Court.
5. The claim u/s 36(1)(iii) is allowed in respect of interest paid for money borrowed for the purpose of business. The shares acquired in subsidiary companies and interest-free advances to an associate concerned does not fall within the definition of section 36(1)(iii) and, therefore, the interest on borrowed funds utilized for the said purpose cannot be allowed as a deduction. Hon’ble ITAT decision in similar case of Assessee was based on the fact that borrowed funds till that year were not utilized for these interest free advances and investments.
6. It needs to be mentioned here that M/s Siel Sugar Ltd. was renamed as Mawana Sugar on 16.06.2004. After that, it was amalgamated back with the assessee is Siel Ltd. w.e.f., 01.10.2006. Later, the name of assessee was changed to Mawana Sugar Ltd. w.e.f. 04.01.2008. The entire sequence of financial restructuring from October 1999 to 2006 establishes that the entire funds of the assessee formed a common Hotchpot.

Appeal Grounds:

There were two main grounds for the appeal:

• One, transfer of assets/liabilities pursuant to the SOA to M/s Shivajimarg Properties Limited & M/s Siel Holdings Limited constitute demerger as per Section 2(19AA) of the Act or not?
• Two, on facts and in law the CIT(A) erred in upholding the action of AO in making the following disallowances out of interest cost claimed as deduction by the assessee:

(i) Interest of Rs 2,96,55,000/- calculated @15% p.a on Investments and Advances made to M/s Jay Engineering Works.

(ii) Interest of Rs 2,58,80,700/- calculated @ 15% p.a on Interest free advances given to subsidiary companies, i.e M/s SFSL Limited and M/s SFSL Investment Ltd.

Assessee plea before Hon’ble ITAT:

1. Definition of “demerger” as per provisions of section 2(19AA) of the Act is satisfied in this case vis-à-vis transfer of sugar units to M/s Siel Sugars Limited, however the conditions stated in this section are not satisfied for “transfer” of land and investments to M/s Shivaji Marg Properties Limited and M/s Siel Holdings Limited as no consideration was issued and the transfer is of “assets/liabilities” and not “Undertaking”.
2. There is a material difference in the provisions of section 394 of the Companies Act and section 2(19AA) of the Income Tax Act. Under section 394 even individual assets can be demerged, whereas u/s 2(19AA), only an “undertaking” can be demerged.
3. It was submitted that for this very reason, the transaction for transfer of sugar units to M/s Siel Sugars Limited was claimed as exempt u/s 47(vib) of the Act, however, the other two transactions were claimed as chargeable to tax.
4. While referring to the case made out by the Ld CIT(A), it was submitted that there is an elementary mistake made by Ld CIT(A) when he alleges that “combined units assigned to two companies in both the cases were of zero value”.
5. On an overall analysis of the financial statements of the assessee it is seen that there are enough surplus of own funds to cover the investments made and loans advanced.

Hon’ble ITAT View

1. The entire scheme is nothing but restructuring of debts by the Assessee. Their limited purpose was to liquidate the debts only. Therefore, as per the commercial transactions, the assets and liabilities belong to the assessee and assessee has recorded the value of the assets at cost in their books of account and the assets were transferred at market value. Therefore, once the conditions of definition of demerger are not satisfied, then the transaction has to be treated as regular capital transaction.
2. The assessee has rightly recorded the transaction at cost and determined the indexed cost of the respective assets and treated the transfer value of the land and shares as sale consideration. The difference they claimed as long term capital loss.
3. CIT (A) has observed that the assessee has transferred assets and liabilities at the same cost, that means the assets were transferred at zero, therefore, there is no loss or gain to the assessee. He observed that the lenders had waived the interest, therefore, provisions of section 41(1) of the Act are applicable.
4. He has missed the point of commercial aspect in these transactions, the assessee recorded the value of the assets at cost in its Balance Sheet and transferred the assets at fair market value, i.e., Value of land on the date of transfer was Rs. 15,28,41,099/- and transferred at the value of Rs. 65,00,00,000/- and liquidated the liabilities to that extent.
5. On the date of transfer, the indexed cost of the land was Rs. 68,31,99,113/-. That means the assessee has settled the value of liabilities of Rs. 65 crores at the cost of Rs. 68.32 crores. How can we say that the assets were transferred at zero cost. It lacks commercial understanding.
6. Similarly, for the transfer of shares, the book value of shares were Rs. 53.95 crores and its indexed cost was Rs. 77.23 crores on the date of transfer and settled the liabilities worth Rs. 35 crores. Therefore, the transactions of transfer of assets and liabilities to its SPVs with the specific purpose of liquidating the assets and settling the liabilities cannot be equated with the demerger. Thus, ITAT agree with the method of transaction recorded by the assessee in their books and computation of income. Accordingly, the grounds raised by the assessee are allowed.
7. On disallowance of interest cost, the issue under consideration is settled in favour of the assessee by the Coordinate benches and orders of CIT(A) in the earlier assessment years. Therefore, the investments and loans/ advances lent to its sister concerns are squarely covered in favour of the assessee.

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