Make demergers tax-neutral, biz houses nudge govt

Ahead of the Union Budget 2026-27, Indian business houses have urged the government to make demergers tax-neutral, particularly in cases involving transfer of investments in associate companies with 25 per cent or more shareholding, under the new Income Tax Act.

Illustration: Dominic Xavier/Rediff

This may possibly help some companies planning to go public, according to a source.

Industry representatives believe that addressing these issues will improve ease of doing business, facilitate legitimate restructuring, and reduce future tax disputes.

They have told the government that Indian business groups have historically relied on their listed operating companies to finance large greenfield projects.

In several sectors, regulators require certain businesses to be run through separate companies, rather than within the main operating entity.

“These are undertakings held as investments and should be treated as such in demerger rules,” a person familiar with the discussions said.

Under the current law, a demerger must involve the transfer of a “business undertaking”. However, demergers involving only strategic investments — such as equity stakes in subsidiaries or associates — run the risk of being treated as impermissible, as investments alone are often not regarded as an “undertaking” for the purpose of the provision.

Industry argues that despite consolidation and equity accounting standards in India, the law does not explicitly recognise such investment divisions as “undertakings”, resulting in litigation and uncertainty.

They have also sought a consequential amendment to the Income Tax Act to protect the carry-forward of business losses in the hands of the subsidiary or associate, especially where shareholding changes by more than 49 per cent due to a court-approved demerger.

Vaibhav Gupta, partner, Dhruva Advisors, said the “undertaking” requirement has led to substantial litigation.

“Whether a single investment or a group of strategic investments meet the business-undertaking test has been contentious.

“Clear guidance will help minimise future disputes,” he said.

Industry has also asked the government to revisit another condition, which mandates that 100 per cent of demerger consideration must be issued only in the form of shares of the resulting company.

Several groups argue that complex reorganisations may require a mix of shares and debt instruments, such as bonds, to arrive at an optimal capital structure.

Dipesh Jain, partner, Economic Laws Practice (ELP), said the share-only requirement “can act as a show-stopper in mergers and acquisitions (M&A) activity” and it should be reconsidered.

Industry is also seeking clarity on whether fast-track demergers undertaken under Section 233 of the Companies Act, 2013 will obtain tax neutrality under the new law.

A senior government official told Business Standard that the revenue department had already explained its position to the parliamentary committee and that it has “nothing more to add”.

According to the official, Section 233 demergers will not qualify as tax-neutral, as they are not supervised by a court or tribunal, unlike schemes approved under Sections 230-232.

Tax experts say this restrictive approach may hinder genuine reorganisations.

Rohinton Sidhwa, partner, Deloitte India, said the stance is “surprising”, noting that the tax department always has the ability to invoke the General Anti-Avoidance Rules (GAAR) as protection.

In fact, it has applied GAAR provisions even to court-approved mergers and demergers.

An email sent to the finance ministry remained unanswered till the time of going to press.

Himanshu Parekh, partner, KPMG in India, said permitting tax neutrality for fast-track demergers “will greatly help industry”, particularly for simple group reorganisations.

He added that clarity is also needed where the demerged company is an investment-holding or financial-services entity.