Transfer of Assets and no Liabilities to be treated as Non-Compliant Demerger – ITAT, Ahmedabad

Recently, the Ahmedabad Bench of the Income Tax Appellate Tribunal (“ITAT”) upheld the order of the learned Commissioner of Income Tax (appeals) treating the transfer of “Treasury Business” as non-compliant demerger u/s 2(19AA) of the Income Tax Act, 1961 and levied tax in the hands of the demerged company & its shareholders.

Facts of the Case:

• Reckitt Benckiser Healthcare India Private Limited (“Assessee” or “Reckitt” or “Demerged Company”) is engaged in the business of manufacturing and marketing of pharmaceuticals & Cosmetic products.
• During AY 2011-12, the assessee transferred “Treasury Unit” as an undertaking to Sterling Addlife India Limited (“SAIL” or “Sterling” or “Resulting Company”) through a demerger which was approved by the Hon’ble High Court.
• In response to said transfer by way of a demerger, Sterling issued 2,68,01,557 of its shares to the shareholders of the assessee company.
• Assessing Officer issued a show cause notice dated 05.03.2015 asking the assessee to show cause as to why the transfer of so-called treasury unit, which was claimed as demerger by the assessee company, should be treated as not a demerger within the meaning prescribed under the Income-Tax Act.
• On account of non-compliant demerger, AO levied tax in the hands of the Company as capital gains u/s 45 of the Act & deemed dividend (as shares issued by the resulting company treated as deemed release/distribution of assets by the assessee company.

Critical Issues Involved:

• As a part of the undertaking, the Assessee has not transferred certain investments in subsidiaries which are claimed to be a part of the core business. The department treated the same as not all assets pertaining to the undertaking were transferred. Further, there were certain mismatches w.r.t the amount of investment in mutual funds transferred which again treated as non-complaint demerger.
• The schedules to the accounts for the year ended 31.03.2009 show the Treasury Segment Assets at Rs 39,23,05,436 and the Treasury Segment Liabilities at Rs. 37,15,82,049. Similarly, schedules to the accounts for the year ended 31.03.2010 show the Treasury Segment assets at Rs. 36,24,90,963 and Treasury Segment Liabilities at Rs. NIL. There does not seem to be any corresponding reduction in assets or income generated as per your trial balances, which could lead to reduction of liabilities. Thus, it would be assumed that the liabilities of the Treasury Segment as on 31/03/2009 at Rs 37.15 crores were not transferred in the scheme of demerger.
• It is seen from the submissions of the appellant as well as the findings of the A.O. and in fact that the business of treasury undertaking was never well defined/demarcated and was created only for the sake of demerger.
• Though there is a mention of treating the “Treasury segment” not a business activity but not enough discussion seems to have happened on this critical point. This may be due to other conditions for meeting the “Compliant demerger” has not met with thus, the Hon’ble Tribunal must have confined itself on that point.
• Consideration issued during the non-qualifying demerger assumed as deemed release I distribution of assets by the Appellant to its shareholders as dividend under provisions of section 2(22) of the Act.

Assessing Officer’s Contention:

• The Assessing Officer observed that all the assets and liabilities of the treasury segment have not been transferred to the resulting company pursuant to the scheme of demerger and that the treasury segment has not been transferred as a going concern and therefore, it is a clear violation of the conditions prescribed u/s 2(19AA) of the Income Tax Act.
• The Assessing Officer, on examination of the transfer held that there was never a clear demarcation or separation of the assets of the Treasury segment from the assets of the assessee as a whole and that the very basic condition of transfer of all assets and liabilities of the undertaking being demerged has not been fulfilled.
• SAIL was the subsidiary of the appellant in AY 2008-09. Further, according to the appellant, in order to diversify its own business operation in two hospital industries it had made investment in SAIL from A.Y.2002-03 to A.Y.2008-09. The treasury undertaking handled the investment in SAIL as well as it also handled the investments in mutual funds etc. but it did not handle the investments in two other subsidiaries of the appellant as mentioned earlier. Thus, it is clear that the appellant has selectively allotted the activities to be undertaken by the treasury undertaking and all the similarly placed investments or activities were never part of the treasury undertaking.
• If Treasury Segment was created to look after the subsidiaries of the appellant then the investment in other subsidiaries such as Paras Overseas Holding Ltd. and Paras Inc. USA should have become the assets of the Treasury Segment.
• According to the A.O., the shares of Blue Information Ltd., Trent Limited and bonus shares of IDBI Ltd. were not reflected as assets of the Treasury Segment. Further, the shares of Shivalik Waste Management Ltd. were also not reflected as assets of the Treasury Segment in the trial balance for FY 2008-09. However, the shares of Blue Information Ltd., Trent Ltd., bonus shares of IDBI Ltd. and shares of Shivalik Waste Management Pvt. Ltd. were shown as assets before the Hon’ble High Court.
• Treasury Undertaking of the assessee fulfils all the conditions laid down in section 2(19AA) of the Act. Hence, the demerger of the Treasury Undertaking by the assessee to Sterling should be held to be in compliance with provisions of section 2(19AA) of the Act and accordingly, the demerger of treasury undertaking be exempted from capital gains tax under section 47(vib) of the Act.

Appeal Grounds:

Ground No. 1: Levy of capital gains under section 45 of the Act considering demerger of the treasury undertaking as non-qualifying demerger.

Ground No. 2: Levy of dividend distribution tax.

Assessee Pleading:

• Treasury Undertaking of the assessee fulfils all the conditions laid down in section 2(19AA) of the Act. Hence, the demerger of the Treasury Undertaking by the assessee to Sterling should be held to be in compliance with provisions of section 2(19AA) of the Act and accordingly, the demerger of treasury undertaking be exempted from capital gains tax under section 47(vib) of the Act.
• All the properties of the Treasury undertaking, immediately before the demerger, became the property of Sterling by virtue of the demerger.
• The Treasury undertaking did not have any liabilities appearing in the Trial Balance as on the date of demerger. Accordingly, since no liabilities were existing on the date of demerger, the condition laid down by section 2(19AA) of the Act stands fulfilled.
• Some investment which was wrongly transferred as a part of the demerged undertaking was bought back after realising the mistake.
• The consideration was issued by the resulting company pursuant to the demerger is in accordance with swap ratio report.

Revenue Pleading:

• Transfer of Sterling’s shares and units of mutual funds to Sterling in exchange of new shares allotted by Sterling as transfer of capital assets is chargeable to capital gains under section 45 of the Act, and distribution of new shares allotted by Sterling as being distributed by the assessee to its shareholders as dividend under section 2(22) of the Act.
• The Assessee has not transferred the treasury undertaking on a going concern basis to Sterling, and it was only a transfer of capital asset and not a demerger of treasury undertaking as per section 2(19AA) of the Act.
• The Assessee has selectively allotted the activities to be undertaken by treasury undertaking and all the similarly placed investments or activities were never part of the treasury undertaking.
• There was different asset values which are being shown in the books of account than what actually was transferred as a part of demerged undertaking.

ITAT Opinion:

• From the concurrent reading of the provisions of Section 2(19AA)(ii) which mandates that all the liabilities relatable to the undertaking are also to be transferred to the demerged company, and considering the explanation of the Counsel that the existing liabilities of Rs.37.15 crores were knocked off against the transfer of assets of Rs.39.23 crores is against the provisions of Section 2(19AA)(ii). Thus, it can be found that the assessee has only transferred the assets while keeping the liabilities with them.
• The explanation of the assessee that the liability belonging to other segments whereas assets belong to the Treasury Segment cannot be accepted. Hence, it can be held that the Revenue Authorities have rightly treated the demerger as a transfer of capital assets.
• The legal obligation of the Revenue Authorities to examine the taxability as per Section 2(22) and Section 2(19AA) cannot be treated as pre-empted by the Hon’ble High Court.
• In the instant case, the assessee failed to comply with the provisions of Section 2(19AA) (ii) & (iii). Hence, the order of the Ld. CIT(A) on these grounds are affirmed.

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