This document provides an overview of the demerger process under Indian law. It begins with definitions of a demerger and discusses the key tax considerations from the 2019 Union Budget. It then explains the different types of demergers and compares the demerger provisions under the Companies Act and Income Tax Act. The remainder of the document outlines the regulatory requirements and process for undertaking a demerger according to the Companies Act, SEBI regulations, and important documentation needed.

1. Demerger - Tax & Regulatory
Perspective
Prepared by: Abhishek Pathak
September, 2019

2. Overview – Demerger
A demerger is a form of restructuring whereby one or more business undertakings of a company are
transferred either to a newly formed company or to an existing company and the remainder of the
company’s undertaking continues to be vested in the first company. The consideration for such transfer
will flow into the hands of the shareholders of the demerged undertaking either through issue of shares or
other instruments (for it to qualify as a tax neutral demerger) or by way of cash. A demerger must also be
conducted through a scheme of arrangement under the Companies Act with the approval of the High Court.
As per the Union Budget – 2019
Rationalization of the Definition of Demerger
- Demerger in case of Ind - AS compliant companies currently, Section 2(19AA) of the Act provides for
various conditions for a demerger of an undertaking to be tax neutral.
- One such Condition is that the resulting company should record property and liabilities of undertaking
at the value appearing in the books of the demerged company. In the past, it has led to hardship in
case of Ind - AS compliant companies that are statutorily required to record such assets and liabilities
at value that could be different from the book value recorded by demerged company.
- Accordingly, an exception has been proposed under section 2(19AA) of the Act whereby such
requirement will not be applicable in case resulting company records value of property and liabilities
in compliance of Ind AS, even where such value is different from book value recorded by demerged
company.
The proposed amendment will take effect from 1 April 2020 and accordingly will apply from AY 2020-
21 onwards.
Following conditions needs to be fulfilled for the tax neutral demerger:
1. All the properties and liabilities of the undertaking immediately before the demerger must become
the property or liability of the resulting company by virtue of the demerger.
2. The properties and liabilities must be transferred at book value.
3. In consideration of the demerger, the resulting company must issue its shares to the shareholders
of the demerged company on a proportionate basis (except where the resulting company itself is
a shareholder of the demerged company).
4. Shareholders holding at least 3 / 4th in value of shares in the demerged company become
shareholders of the resulting company by virtue of the demerger. Shares in demerged company
already held by the resulting company or its nominee or subsidiary are not considered in calculating
3 / 4th in value.
5. The transfer of the undertaking must be on a going concern basis.
6. The demerger must be subject to any additional conditions as notified by the Central Government
under Section 72A (5) of the ITA.

3. Types of Demerger
Demerger can take various forms namely:
Divestiture/Sell-offs: The parent company divests a part of the company to the third party for
cash or securities. Such sale may cover assets, product lines, subsidiaries or division of the
undertaking. This transaction may be beneficial to both the companies. The seller may benefit
from the sale proceeds which could be put to more profitable use in other businesses within the
group or used to mitigate financial distress. Sell – off may also add value to the seller by eliminating
negative synergy, or by releasing the negative energy, or by releasing the managerial resources
hitherto to pre-empted, by the divested business, The buyer acquire the business because of the
better strategic fit. Further the acquired business is related to any of the existing business. The
buyer may enjoy increased market share and market power.
Spin offs – In case of spin-offs, a part of the business is separated and created as a new company.
The existing shareholders in the parent company get proportionate shares in the newly created
company, so there is no change in ownership and the same shareholders continue to own the
newly created entity in the same proportion as previously held in the parent company. There is
no money transactions involved, and subsidiary assets are not revalued. After Spin-off, the
shareholders own shares in two companies rather than in just one. This increase the flexibility of
the shareholders portfolio decisions, since they now have a freedom to alter the proportion of
their portfolio’s invested in each company.
Split up: This is a process of reorganizing whereby all the capital stock and assets are exchanged
for those of two or more newly established companies, resulting in the liquidation of the parent
company. This is breaking up of the company into new entities through series of spin offs.
Equity Carve-Outs: As the name suggests, parent company carve out a portion of the capital stocks
of the subsidiary for offer to sale to the general public. They are similar to spin-offs but with the
minority of the shares in the floated subsidiary being offered to public. This gives increased cash
inflows to the parent company.

4. Difference between demerger provision of Companies Act, 2013 and
Income Tax Act, 1961:
Since the provisions of the Companies Act, 2013 are in line with the provisions of the Income Tax Act, 1961
there is not much difference between the two acts except the following:
S. No Companies Act, 2013 Income Tax Act, 1961
1
Demerger could be achieved either as the
part of the scheme of arrangement under
section 230 – 233 or by the process of sale of
the undertaking.
Demerger must be only through the scheme of
arrangement under section 230 – 232 of Companies
Act, 2013 and not otherwise. Sale of undertaking is
specifically excluded.
2
The scheme of arrangement could envisage
the payment of consideration to the
transferor company or could be in
consideration of the settlement of certain
debts as part of scheme of compromise.
The consideration cannot be paid to the transferor
company but only to the shareholder of the
transferor company.
3
It is not necessary that all the property and
the related liability need to be transferred to
the transferee company
It is necessary that all the property and all the
related liabilities must be transferred to transferee
company.
4
The transferee company may or may not
consists of the shareholders of the transferor
company.
The transferee company must have as the
shareholders persons holding not less than three –
fourths in the value of the share in the transferor
company.
5
There is no need to comply with any of the
directions under section 72A of the Income
Tax Act, 1961.
Section 72A of the Income Tax Act, 1961 should be
complied.
6
The property and / or liabilities transferred
could be at values agreed and relevant
amount could also be part of the values
transferred
The property and the liabilities must be at the value
appearing in the books of account of the transferor
company immediately prior to demerger and
revaluation of assets or liabilities must be ignored.

5. Demerger - Important considerations / Regulations
Securities & Exchange Board of India (SEBI Regulations)
Companies Act, 2013
IFRS / Accounting Standard
Stamp Duty
Exchange Control
Foreign Direct Investments
Indirect Tax
Direct Tax
Overseas Tax Regulations
Competitions Commission of India Regulation
Listing Agreements & Disclosure Requirements

6. Demerger – Process
Important Consideration:
- No scheme of arrangement would be sanctioned unless an auditor’s certificate to the effect that the
accounting treatment specified in the scheme is in conformity with the prescribed AS has been filed
with the NCLT.
- However, such certificate is not required in case of merger/amalgamation between parent and its
wholly-owned subsidiary or two or more small companies. Approval of NCLT is also not required in
such cases.
- Appointed date approved by the NCLT would be considered as the acquisition date for business
combinations under Ind AS, in case NCLT approves an appointed date different from acquisition date.
- All listed entities are required to obtain observation/no-objection letter from stock exchange on the
proposed scheme of arrangement before filing such scheme with the court/NCLT for approval.
Guidelines issued by SEBI need to be adhered while undertaking the schemes of arrangements.
- Additionally, all schemes of arrangements should be disclosed to the stock exchanges as they are
deemed to be material events/information under the Listing Regulations.
Preparation of scheme of
arrangement & other
Documents
Board meetings of all
companies to approve the
scheme of arrangement.
Approval from stock
exchange if listed
File chairman's report &
petition with high court
Conduct meetings as per
the orders of the high
court - if dispensation not
granted
Application to high court
seeking directions on
convening / dispensation
meetings of shareholders /
creditors - all companies
Approval of ROC and
regional director to the
arrangement
Final hearing at the High
Court
Court order to be filed
with Registrar of
Companies

7. Demerger – Regulatory Perspective
A company undertaking a scheme of arrangement is governed by the provisions of Section 230 and 232
of the 2013 Act.
A company can restructure its arrangements with creditors or shareholders in a number of ways:
A. Reorganization of the company’s share capital by the consolidation of shares of different classes
or by the division of shares into shares of different classes, or by both of those methods
B. Reduction of share capital.
C. Corporate debt restructuring (consented by not less than 75 per cent of the secured creditors).
D. Buy-back of securities.
E. Take-over offer.
F. Merger / amalgamation of any two or more companies.
G. Demerger/division of companies.
A company that undertakes any of the above mentioned schemes of arrangement would need to comply
with certain procedure. The procedure is as follows:
Application to the NCLT:
An application to the NCLT can be made for the proposed scheme of compromise/arrangement in Form
No. NCLT-1. This application can be made by the company, any creditor or member of the company or by
the liquidator (in case of a company being would up). The above application should be accompanied by
appropriate disclosures (by way of an affidavit in Form No. NCLT-6) and also include:
A. All material facts relating to the company such as the latest financial position of the company, the latest
auditor’s report on the accounts of the company and the pendency of any investigation or proceedings
against the company
B. Reduction of share capital, if any, included in the compromise or arrangement.
Order and notice of the meeting:
On receipt of the application, the NCLT could order a meeting of the shareholders / creditors to be held in
the prescribed manner.
Notice to statutory authorities:
A notice in Form No. CAA.3 along with the prescribed documents should be given to the CG, income-tax
authorities, RBI, SEBI, ROC, stock exchanges, official liquidator, Competition Commission of India (CCI) and
other sectoral regulators/authorities which are likely to be affected by the compromise or arrangement. A
period of 30 days has been provided to the above mentioned authorities to make a representation on the

8. proposed scheme and if no such response is received, it would be presumed that they have no
representations. This notice is not required in case of merger/ amalgamation between parent and its
wholly- owned subsidiary or two or more small companies.
Scheme exempted from meeting:
In case a scheme of compromise/arrangement has been approved by the creditors/class of creditors with
at least 90 per cent value, NCLT could dispense with calling of a meeting of such creditors/class of creditors.
Voting on the scheme:
Person in receipt of notice may vote on the proposed scheme either in person, through proxies or through
electronic means within one month from the date of receipt of notice.
Objection to the scheme:
An arrangement can be objected only by a person holding at least 10 per cent shareholding or owing 5 per
cent debt as per the latest audited financial statements.
Auditor’s certificate on compliance with AS:
A scheme would not be sanctioned unless an auditor’s certificate to the effect that the accounting
treatment specified in the scheme is in conformity with the prescribed AS has been filed with the NCLT.
Approval of the scheme:
A scheme of compromise or arrangement approved by creditors/members representing three-fourths in
value and sanctioned by the NCLT (by an order) would be binding on the company, its creditors/members,
its contributories and on the liquidator (in case of winding up).
Order of the NCLT:
An order of the NCLT approving the scheme shall, inter alia, provide an option to preference shareholders
to obtain arrears of dividend in cash or accept equity shares equal to the value of the dividend payable, in
case of scheme involving conversion of preference shares into equity shares and exit offer to dissenting
shareholders. Such an order should be filed with the ROC within 30 days of the receipt of the order by the
company.
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9. Important Consideration – Documents Required
A demerger can be completed by making an application to the High Court and through orders issued by a
Judge. Hence, to commence the demerger process, an application must be filed in Form 33 along with the
affidavits of the promoters and the following documents:
1. Memorandum and Articles of Association of the Company
2. Latest Audited Balance Sheets
3. List of Shareholders and Creditors
4. Extract of Board Resolution approving the Scheme
5. Scheme of Arrangement*
6. Draft notice of Meeting, Explanatory Statements, and replacement or substitute
*contains annexures as below
1. Petition for Demerger
2. CTC of Scheme- Approved by Board of Directors
3. MOA, AOA - Demerged
4. Audited financials & Directors Report
5. Certified True Copy of Unaudited Financial Statements
6. List of Equity Shareholders
7. List of Directors
8. True copy of Board Resolution - Demerged
9. CTC of COI, MOA, AOA of Resulting company
10. True copy of audited Financial Statement of Resulting company
11. True copy of Unaudited FS of Resulting company
12. List of ESH - Resulting company
13. List of Directors - Resulting Company
14. Certified True Copy of Board Resolution
15. Valuation report- Demerged
16. Valuation report- Resulting
17. True copy of Swap ratio certificate
18. Certificate of Statutory Auditors - Certifying Accounting Treatment
19. True copy of consent/ no objection letters of ESH- Demerged
20. True copy of consent/ no objection letters of ESH- resulting
21. CA certificate certifying creditors - Demerged
22. True copy of consent/ No objection letter given by Unsecured creditors- Demerged
company
23. Certificate of CA certifying creditors - Resulting
24. NOC of Secured creditors
25. True copy of consent/ No objection letter given by Unsecured creditors along with CA
Certificate - Resulting
26. Letter for non- consideration as creditor- demerged
27. Letter for non- consideration as creditors- resulting
28. Vakalatnama along with the Board resolutions
29. Affidavit pertaining to Sectoral and Regulatory Authorities
30. Affidavit of No Investigation or Proceedings

10. Requirements of the Listing Regulations – Securities & Exchange
Board of India (SEBI)
The Listing Regulations prescribe following in relation to the schemes of arrangements undertaken by a
listed company:
 Filing of draft scheme of arrangement with the stock exchange (Regulation 37):
A listed entity that desires to undertake a scheme of arrangement (including with an unlisted entity)
under the requirements of the 2013 Act is required to obtain a no objection letter or an observation
letter from the stock exchange. No scheme of arrangement could be filed with the court or NCLT
unless the listed entity has obtained an observation/no-objection letter from the stock exchange.
Further, the validity of the observation/no objection letter is six months from the date of issuance
within which the draft scheme should be submitted to the court/NCLT for approval. The schemes of
arrangement for merger of a wholly-owned subsidiary with the parent entity would not be required
to be filed with SEBI (under the Listing Regulations). Such schemes should be filed with the stock
exchanges for the purpose of disclosure.
 Conditions for undertaking scheme of arrangement:
SEBI, through its various circulars, has laid down detailed requirements to be complied with by listed
entities while undertaking schemes of arrangements. These, inter alia, includes the following: –
Scheme of arrangement with unlisted entities: The percentage of shareholding of pre-scheme public
shareholders of the listed entity and the Qualified Institutional Buyers (QIBs) of the unlisted entity,
in the post scheme shareholding pattern of the merged entity should not be less than 25 per cent.
 Approval of shareholders to a scheme of arrangement:
Voting for approval of the scheme will be only through e-voting. Additionally, in certain cases, SEBI
has mandated that a scheme of arrangement would be approved only if the votes cast by the public
shareholders in favor of the proposal are more than the number of votes cast by the public
shareholders against it. These, inter alia, includes schemes where parent listed entity has acquired
equity shares of the subsidiary from shareholders of subsidiary and the subsidiary is being merged
with the parent listed entity. – Detailed compliance report: Listed entities are required to submit a
detailed compliance report (as per the prescribed format) confirming compliance with various
regulatory requirements specified for schemes of arrangement and all AS with the stock exchange.

11.  Requirements of stock exchanges to supersede the scheme (Regulation 11):
A listed entity is required to ensure that any scheme of arrangement/amalgamation/merger/
reconstruction/reduction of capital, etc. presented to any court or NCLT should not violate, override
or limit the provisions of securities law or requirements of the stock exchange. Such a provision is
not applicable to the units issued by the listed mutual funds.
 Disclosures (Regulation 30 read with Part A of Schedule III):
Every listed entity is required to disclose the scheme of arrangement
(amalgamation/merger/demerger/restructuring) or any other restructuring to the stock exchange
without application of the guidelines for materiality as such events are considered as deemed to be
material.
Stamp Duty Implications on Demerger / Scheme of arrangement
The levy of the stamp duty is emanated from the Constitution of India 1950, and the Indian Stamp Act,
1899 (‘Stamp Act’) being a fiscal statute lays down the law relating to duty levied in the form of stamps on
instruments recording transactions. The levy and collection of the stamp duty on M&A is subject matter of
the States in India by virtue of the legislative entry 63 in the State List and Entry 44 in the concurrent list in
the 7th Schedule of the Constitution.
The stamp duty implications pursuant to the scheme of amalgamation sanctioned by the Hon’ble High
Courts in India in terms of the provisions contained in Indian Stamp Act, 1899 (to the extent adopted by
National Capital Territory of Delhi with relevant modifications).
The list of instruments chargeable with stamp duty along with the applicable rates has been mentioned in
Schedule I of the Stamp Act. The term conveyance, being one of the instrument on which stamp duty is
levied, has been modified by various states.
As a matter of abundant caution, several states such as Rajasthan, Maharashtra, Gujarat, recently Haryana,
etc. have specifically included a court order approving a scheme of amalgamation under the definition of
“conveyance” under the relevant schedules/acts providing stamp duty rates. However, states which do not
have such an explicit inclusion continue to face the dilemma.
In this regard, Delhi has adopted the Stamp Act with certain modifications and is among those states which
have not expressly included the order of High Court approving the scheme of amalgamation under the
definition of conveyance.
Meaning of Conveyance
The term of conveyance has been defined in section 2(10) of the Stamp Act as produced below:

12. “Conveyance includes a conveyance on sale and every instrument by which property, whether movable
or immovable, is transferred inter vivo and which is not otherwise specifically provided for by Schedule
I.”
Rate of Stamp Duty*
In terms of stamp duty, though the state laws provide for rates of stamp duty to be paid on various
instruments, it is observed that generally there is no specific entry for a High Court order sanctioning the
scheme of amalgamation or demerger, in the absence of which High Courts have taken the view that the
High Court order involving the transfer between two juristic persons of certain movable and immovable
property, is a ‘conveyance’ and should therefore be chargeable to stamp duty under that head, and the
scheme of arrangement itself is an ‘instrument’ under which the going concern is transferred. This position
has been consolidated by the Supreme Court in Hindustan Lever and Anr. v. State of Maharashtra and Anr.7
The Bombay High Court has held that a scheme of arrangement entails transfer of a going concern, and not
of assets and liabilities separately. As a going concern, the value of the property transferred under a scheme
of arrangement is reflected from the shares allotted to the shareholders of the transferor company
under the scheme. Accordingly, under the Bombay Stamp Act, 1958 (applicable in the state of
Maharashtra*), stamp duty payable on conveyance relating to amalgamation of companies is 10% of the
aggregate of the market value of the shares issued or allotted in exchange or otherwise and the amount
for consideration paid for such demerger, provided that it shall not exceed
(i) 5% of the total true market value of the immovable property located within the state of
Maharashtra* and as transferred by the transferor company to the resulting company; or
(ii) 0.7% of the aggregate of the market value of the shares issued or allotted and the amount of
consideration paid for the demerger, whichever is higher.
*assumed

13. Demerger – Income Tax Perspective
The segregation of two or more existing business undertakings operated by a single corporate entity can
be achieved in a tax- neutral and non – tax neutral manner under a ‘demerger’. The key provisions under
Indian law relating to demerger are discussed below:
Indian tax law defines ‘demerger’ as the transfer of one or more undertakings to any resulting company,
pursuant to a court-approved scheme of demerger such that as a result of the demerger:
- All the property and liabilities relating to the undertaking being transferred by the demerger company
immediately before the demerger become the property and liabilities of the resulting company.
- Such property and liabilities are transferred at values appearing in the books of account of the
demerged company (for determining the value of the property, any revaluation is ignored).
- In consideration of a demerger, the resultant company issues its shares to the shareholders of the
demerged company on a pro rata basis.
- Shareholders holding three-quarters of the shares in the demerged company become shareholders of
the resultant company (any shares already held by the resultant company or its nominees are
excluded for the purposes of this calculation).
- The transfer of the undertaking is on a going-concern basis.
‘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. It does not include individual assets or liabilities or any
combination thereof not constituting a business activity.
In a demerger, the shareholders of the demerged company receive shares in the resultant company.
The cost of acquisition of the original shares in the demerged company is split between the shares in
the resultant company and the demerged company in the same proportion as the net book value of
the assets transferred in a demerger bears to the net worth of the demerged company before
demerger.
(‘Net worth’ refers to the aggregate of the paid-up share capital and general reserves appearing in
the books of account of the demerged company immediately before the demerger.)
Generally, the transfer of any capital asset is subject to transfer tax (capital gains tax) in India.
However, a demerger enjoys a dual tax-neutrality with respect to transfer taxes under Indian tax law:
both the demerged company transferring the undertaking and the shareholders transferring their part
of the value of shares in the demerged company are tax-exempt.

14. Other provisions of the income tax law are as follows:
 The unabsorbed business losses, including depreciation (i.e. amortization of capital assets) of the
demerged company directly related to the undertaking transferred to the resultant company are
treated as unabsorbed business losses or depreciation of the resultant company. If such losses,
including depreciation, are not directly related to the undertaking being transferred, the losses
should be apportioned between the demerged company and the resulting company in the
proportion in which the assets of the undertaking have been retained by the demerged company
and transferred to the resulting company.
 The unabsorbed business losses of the demerged company may be carried forward and set off
in the resultant company for that part of the total permissible period that has not yet expired by
the resultant company and the demerged company in the same proportion in which assets have
been transferred and retained pursuant to demerger.
 Where a business unit/undertaking that develops/ operates an infrastructure facility or
telecommunication service, or is in the business of power generation, transmission or
distribution, etc., is demerged, then the tax benefits it enjoys cannot be claimed by the resultant
company where the income tax law specifically disallows such a claim.
 If any undertaking of the demerged company enjoys any tax incentive, the resulting company
generally can claim the incentive for the unexpired period, even after the demerger.
 The total depreciation on assets transferred to the resulting company in a financial year is
apportioned between the demerged company and the resulting company based on the ratio of
the number of days for which the assets were used by each during the year. Depreciation up to
the effective date of transfer is available to the demerged company and thereafter to the
resulting company.
 The expenses of a demerger can be amortized in five equal annual installments, starting in the
year of the demerger.
 A step-up in the value of the assets is not permissible either in the books or for tax purposes.
Under Section 47 of the Income Tax Act, the following transfers relating to demerger do not attract capital
gains tax liability:
1. Transfer of assets in a scheme of demerger from the demerged company to the resulting company, if
the resulting company is an Indian company.
2. Transfer of shares in an Indian company by a demerged foreign company to a resulting foreign
company if both the conditions below are satisfied:

15. 3. Shareholders holding at least 3/4th in value of the shares of the demerged company continue to
remain shareholders of the resulting company; and
4. Such transfer does not attract capital gains tax in the country of incorporation of the demerged
company.
5. Transfer of a capital asset being shares in a foreign company by the demerged foreign company to the
resulting foreign company, where such transfer results in an indirect transfer of Indian shares.6 The
conditions to be satisfied to avail this exemption are the same as above.
6. Transfer or issue of shares by resulting company to shareholders of the demerged company in
consideration of demerger of the undertaking.
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16. In the hands of Taxability/ Treatment Section
Conditions/ Remarks
Demerged
Company
No capital gains tax on
transfer of assets
47(vib)
Resulting company
should be an Indian
company
Shareholders
of Demerged
Company
No capital gains tax on receipt
of shares from the resulting
company
47(vid)
Cost of Assets
for Resulting
Company:
- Depreciable
Assets
- CapitalAsset
= WDV of depreciable asset to be
the same as WDV in the hands of
the DemergedCompany
= No specific provision for
costof CapitalAssetacquired
- Expln 7Ato 43(1)
- Expln 2B to 43(6)(c)
- 49(1)
Resulting company
should be an Indian
company
Cost of
acquisition of
shares received
on demerger by
the shareholders
= Cost of acquisition of shares in
demerged company be split on the
basis of net book value of the assets
transferred bearing to the Net
worth of the Demerged Company
immediately beforesuchdemerger
49(2C)
Period of holding
of shares
received on
demerger by the
shareholders
Period of holdingof shares received
on demerger by the shareholders
Period of holding of
shares received on
demerger by the
shareholders
Period of holding of
shares received on
demerger by the
shareholders
Period ofholdingof
capital assets.
Period of holding of capital assets
Period of holding of
capital assets
Period of holding of
capital assets
Demerger - Tax Considerations Summarized
`
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17. Demerger - Tax Considerations Summarized
Cost split up in the hands of shareholders
“Cost of acquisition of shares of resulting company” [Section 49(2C)]
= Cost of acquisition of shares Net book Value of the assets
in demergedCompany X transferredin the demerger
Net worth of the demerged company
beforethe demerger
“Cost of acquisition of the original shares held by the shareholders in the demerged company”
[Section49(2D)]
Cost of acquisition of shares in demerged company – cost of acquisition of shares of resulting company
arrived at under section 49(2C)
”Net worth” is defined as the aggregate of the paid up share capital and general reserves as appearing in
the books of account of the demerged company immediately before the demerger.
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18. Demerger – General Anti – Avoidance Rules
The General Anti-Avoidance Rule (“GAAR”), contained in Chapter X-A of the ITA authorizes the income
tax authorities to tax ‘impermissible avoidance arrangements’ i.e., arrangements where the main
purpose is to obtain a tax benefit; and which:
a. create rights or obligations which are not ordinarily created between persons dealing at arm’s
length,
b. Result directly or indirectly in the misuse or abuse of the provisions of the ITA,
c. lack commercial substance or are deemed to lack commercial substance, in whole or in part, or
d. are entered into or carried out by means or in a manner that is not ordinarily employed for bona fide
purposes.
While applying GAAR, tax authorities may disregard entities in a structure, deny benefits available under
the DTAA, reallocate income and expenditure between parties to the arrangement, alter the tax
residence of such entities and the legal situs of assets involved, treat debt as equity and vice versa. Under
the Indian Income Tax Rules (“ITR”) special exemptions from the GAAR is available in certain
circumstances including:
- where the tax benefit arising to all parties to the arrangement does not exceed a sum of INR 30
million (approximately USD 450,000) in the relevant financial year;
- where investments are made prior to April 1, 2017; and
- For non - residents directly or indirectly investing in offshore derivative instruments (such as
participatory notes issued by Foreign Portfolio Investors (“FPIs”) / Foreign Institutional Investors
(“FIIs”)).
However, FPIs / FIIs claiming benefits under a DTAA may be scrutinized under the GAAR. It is also
important to note that even if certain prior investments are grandfathered, any corporate arrangement
may become subject to scrutiny under the GAAR on its implementation starting April 1, 2017. Therefore,
in light of the GAAR, it would be advisable that the commercial rationale behind each step in the
corporate arrangement should also be adequately documented.
- The risk of applicability of GAAR provisions arises in case of non-tax neutral demerger, as there is
uncertainty regarding the tax implication s arising for the transferor company, the transferee
company and the shareholders of Transferor Company.
- Hence, it would be important to demonstrate the commercial substance of undertaking a non-tax
neutral demerger, and also, that the main purpose of the said demerger is not to obtain a tax
benefit, to be able to argue non-applicability of GAAR provisions.
- In case GAAR provisions are applicable, tax implications arising for abovementioned parties may
change, and would then need to be evaluated depending upon the manner in which the tax
authorities combine/ characterize the transaction.

19. Demerger – Implications under Indirect Taxes
Demerger of two entities typically should not attract GST as this does not involve transfer of goods or
services.
Input Tax Credit
Section 18 enshrines the provisions regarding availment of input tax credit by taxable person. Section
18(3) of the CGST Act as well as rule 41 of the CGST Rules stipulates that in case of change of constitution
of a registered taxable person on account of sale, merger, demerger, amalgamation, lease or transfer
of business, the registered person would be allowed to transfer the unutilized input tax credit to
transferor. In this context, the registered person is required to furnish the details of sale, merger, de-
merger, amalgamation, lease or transfer of business in Form GST ITC-02 electronically on the Common
Portal along with a request to transfer the unutilized input tax credit lying in his electronic credit ledger
to the transferee. The transferee would accept the details so furnished by the transferor on the
Common Portal and, upon such acceptance, the unutilized credit would be credited to his electronic
credit ledger.
In the case of demerger, the input tax credit would be apportioned in the ratio of the value of assets of
the new units as specified in the demerger scheme.
Demerger – Accounting Aspects
The typical accounting entries that are passed in the books of demerged and resulting companies under
Indian GAAP to give effect to a demerger are as follows:
In the books of the demerged company
Particulars Amount (Dr) Amount (Cr)
Current liabilities XXX
XXX
Loan fund (secured) account XXX
Provision for depreciation account XXX
Reserves & surplus* (loss on demerger) XXX
To Fixed assets and capital WIP
To Current assets
To Investments
(Being the assets and liabilities of demerged undertaking taken
out of the books on transfer of the undertaking to resulting
company vide scheme of arrangement)

20. In the books of the resulting company
Demerger - Competition Commission of India (CCI)
The provisions relating to Combinations in the Competition Commission Act 2002 deals with the
Compromises & Arrangements including mergers / demergers /amalgamations etc. The provisions have
been explained below:
Broadly, combination under the Act means acquisition of control shares, voting rights or assets,
acquisition of control by a person over an enterprise where such person has direct or indirect control
over another enterprise engaged in competing businesses, and mergers and amalgamations between
or amongst enterprises when the combining parties exceed the thresholds set in the Act. The thresholds
are specified in the Act in terms of assets or turnover in India and abroad. The word Combination &
Merger are used interchangeably.
Entering into a combination which causes or is likely to cause an appreciable adverse effect on
competition within the relevant market in India is prohibited and such combination shall be void.
Threshold Limit for Combinations
APPLICABLETO ASSETS TURNOVER
In India Individual `1,500 cr. `4,500cr.
Group `6,000cr. `18,000cr.
InIndia and
outside
ASSETS TURNOVER
Total Minimum
Indian
Component
Total Minimum
Indian
Component
IndividualParties $ 750 m `750 cr $ 2,250 m `2,250cr
Group $ 3 bn. `750 cr. $ 9 bn. `2,250cr.
Particulars Amount (Dr) Amount (Cr)
Fixed assets and capital WIP XXX
XXX
XXX
XXX
XXX
Current assets XXX
Investment XXX
Reserves & surplus* (in the event of loss on demerger) XXX
To Current liabilities
To Loan fund (secured) account
To Provision for depreciation account
To R e s e r v e s & surplus* (in the event of profit on
Demerger)
(Being the assets and liabilities of demerged undertaking
taken over by resulting company and allotment of shares
to the members of demerged company)

21. The turnover shall be determined by taking into account the values of sales of goods or
services.Thevalueofassetsshallbedetermined by taking the book value of the assets
as shown in the audited books of account of the enterprise, in the financial year
immediately preceding the financial year in which the date of proposed merger falls, as
reduced by any depreciation. The value of assets shall include the brand value, value
of goodwill, or Intellectual Property Rights etc. referred to in explanation (c) to section
5 of the Act.
EXEMPTION NOTIFICATIONS
In exercise of the powers conferred by clause (a) of Section 54 of the Act, the Central
Government, in public interest, has exempted:
A. an enterprise, whose control, shares, voting rights or assets are being acquired has
either assets of the value of not more than INR 250 crore in India or turnover of
not more thanINR750croreinIndiafromtheprovisionsofSection 5 of the said Act
for a period of five years.
B. Banking company in respect of which the Central Government has issued a
notification under Section 45 of the Banking Regulation Act, 1949, from the
applicationof the provisions of Sections 5 and 6 of the Act for a period offiveyears.
COMBINATIONS IN RESPECT OF WHICH NOTICE NEED NOT NORMALLY BE FILED
The Combination Regulations provide that notice in respect of certain combinations,
specified under Schedule I*, need not normally be filed with the Commission as those
transactions are ordinarily not likely to cause appreciable adverse effect on competition
in India.
____________________________________________________________________________
*For Schedule – I refer:
https://www.cci.gov.in/sites/default/files/advocacy_booklet_document/combination.pdf
Even though I am tempted, ever so often, I know that the conclusion is no time to make new
points, arguments or cram facts. I make sure I’ve conveyed all the important facts in the body of
the note. Kindly share your views,
Happy Reading!!!
Regards
Abhishek Pathak
Mergers & Acquisitions - Tax & Regulatory
Contact:
Ph.No. - (+91) 95555-43787, (+91) 99997-87439
linkedin: https://www.linkedin.com/in/abhishekpathak9/
Email: abhishekpathak@outlook.in