The world is soon going to become a village; therefore, it is time to standardize business practices all over the world, and global uniform accounting standards and practices are the need of the hour. The Indian Accounting Standards or IND AS have also been designed accordingly. Transactions would be perceived differently with the advent of IND AS, as it focuses on the substance of the transaction rather than merely its form or nomenclature.
IND AS 103, which deals with “Business Combinations,” has significant impact on the structuring of acquisitions/ sales, i.e., both third party acquisitions and common control acquisitions. IND AS 103 deals with business combinations, which inter alia, include amalgamations, demergers, slump sales, etc. Briefly, any transaction that would result in an acquirer obtaining control of one or more businesses would be covered under the purview of IND AS 103.
While IND AS indeed covers a plethora of transactions, certain areas might potentially be in conflict with the provisions of the Income Tax Act, 1961 (ITA). This article tries to elucidate on the disparity between the requirements of IND AS 103 and certain provisions of the ITA in relation to demergers.
Book value v. fair value
As per the provisions of IND AS 103, in acquisition accounting, in case of acquisition of a business from a third party (either by way of a merger or demerger), the same needs to be accounted at fair value in the books of the acquirer. Section 2(19AA) of the ITA defines the term “demerger” and lays down certain conditions, which need to be complied with to avail the various tax benefits under the ITA. One such requirement under section 2(19AA) is to ensure that the assets and liabilities of the transferor company (demerged company) have to be transferred at their book values.
Therefore, the moot question is how will the requirements of section 2(19AA) be complied with when IND AS requires assets and liabilities to be recorded at fair value in the books of the acquirer.
It is evident that only the demerged company can make the transfer, i.e., the company that owns the assets and liabilities and not the resulting company. There is also no reference express or implied to any action of the resulting company or the value recorded in the resulting company’s books in section 2(19AA). Thus, the value at which the resulting company records in its books of account, the assets and liabilities obtained in a demerger, should not be relevant for the purposes of the condition stipulated in section 2(19AA)(iii). Consequently, merely because the resulting company records the assets and liabilities received in the demerger at their fair values, which may not be equal to the amounts appearing in the books of accounts of the demerged company, before the demerger, should not result in contravention of the said condition.
Given the importance of the issue, the Central Board of Direct Taxes should expressly clarify the same.
Goodwill arising on demerger and depreciation thereon
Another question is whether the resulting company can claim depreciation on goodwill arising on the demerger. Explanation 7A to section 43(1) of the ITA provides that the actual cost of asset to the resulting company shall be taken to be the same as it would have been if the demerged company had continued to hold the capital asset for the purpose of its own business. The proviso to the Explanation further provides that such actual cost shall not exceed the written down value of such capital asset in the hands of the demerged company.
Similarly, Explanation 2(B) to section 43(6) of the ITA provides that the written down value of the block of assets in the case of the resulting company shall be the written down value in the hands of the demerged company immediately before the demerger. In addition, the sixth proviso to section 32(1) provides that the aggregate deduction of depreciation to the demerged company and the resulting company shall not exceed the deduction as if the demerger had not taken place and such deduction shall be apportioned between the demerged and resulting company in the ratio of number of days for which the assets were used by them.
What emerges from a combined reading of the above provisions is that as a demerger is tax neutral under the ITA, the impact thereof on the claim of depreciation by both the demerged and the resulting companies should be such as if the demerger has not taken place. Therefore, intangible assets that are not recorded in the books of the demerged entity may not be eligible for depreciation in the books of the resulting company.
However, the above position may not apply to any goodwill that has arisen on account of such demerger. Therefore, if the goodwill represents any business or commercial right, it should be eligible for depreciation. However, the said claim would depend on the facts and circumstances of each case and can be litigated if not supported by appropriate rationale and valuation.
The views expressed in this article are personal. It includes input from Nidhi Mehta, Associate Director, M&A Tax, PwC India, and Kshitij Jain, Assistant Manager, M&A Tax, PwC India.