income tax

ITAT Ruling: Tax Benefits Granted for Corporate Restructuring in India

Pivotal ITAT Decision on Tax Incentives for Corporate Restructuring

In a milestone judgment for corporate India, the Chennai bench of the Income Tax Appellate Tribunal (ITAT) has ruled that tax benefits cannot be denied to genuine business restructuring if all statutory conditions under the Income Tax Act, 1961, are fulfilled. The judgment is a relief to companies that are going in for amalgamations, mergers, and other corporate restructuring, which often land up in litigations with tax authorities on issues of tax neutrality.

Background of the TVS Motors Case

The current case involved a composite scheme of arrangement in which TVS Motors Limited, holding over 66% shareholding in Lakshmi Auto Components (LAC), restructured its operations. This involved demerging LAC's rubber and plastic business to Sundaram Auto Components (SAC) and the remaining assets of LAC, such as the engine components business and investment, amalgamating with TVS Motors.

This restructuring proposal was sanctioned by the Madras High Court under Sections 391 to 394 of the Companies Act, under which the scheme of amalgamation and restructuring efforts gets its basis.

Tax Department's Objections and Rejoinder of ITAT

The Assessing Officer raised objection to the tax neutrality on the following grounds that:

  • Not all the assets and liabilities of LAC were combined with all its operations merged in TVS Motors, so the transaction does not qualify as an "amalgamation" under the Income Tax Act, but rather as a "rearrangement."
  • Capital gain exemption, claim of depreciation, and DDT credits for the distribution of dividend were withheld due to this.

ITAT challenged these contentions by observing that:

  • Amalgamation and reconstructions are dealt with under Sections 391 to 394 of the Companies Act, asserting tax relief must be granted where conditions as prescribed under the Income Tax Act are fulfilled.
  • Tax authorities were not able to demonstrate beyond doubt that any specific assets were deliberately omitted from the transfer.
  • Restructuring was found to be a genuine reorganization of business and not an evasion of tax.

Preeminent Legal Principles Established by ITAT

  1. Tax Neutrality in Amalgamation: According to Section 47(vi) of the Income Tax Act, transfer of assets under a scheme of amalgamation approved by the High Court is exempt from capital gains tax.

  2. Shareholder Continuity: Not less than 75% of the shareholders of the amalgamating company have to become the shareholders of the amalgamated company as part of the process.

  3. Carry Forward of Losses and Depreciation: The new company is entitled to claim depreciation on the assets being transferred and carry forward losses, provided certain conditions are met.

  4. Dividend Distribution Tax Credit: Credit for already paid DDT by the amalgamating company must be maintained if the restructuring plan is genuine.

Key Context: Budget 2025 Corporate Tax Changes

Despite the positive judgment for tax neutrality, Budget 2025 has imposed restrictions on the duration of carry forward in case of business losses subsequent to amalgamation, keeping it to the balance period of the initial relief of 8 years. This may have an effect on future restructurings and mergers but has no bearing on the TVS Motors case ruling.

Impact of the ITAT Ruling on Corporate Restructuring

  • Clarity and Certainty: This ruling ensures clarity that tax relief will be recognized if restructuring is in accordance with the legal requirements, therefore reducing likelihood of litigation.

  • Encourages Genuine Business Restructuring: Companies are motivated to pursue amalgamation, mergers, and demergers for reasons of operational efficiency without risking unreasonable tax rejection.

  • Harmony with Legal Framework: The decision underlines the need for harmonious interpretation between the Income Tax Act provisions and the Companies Act provisions.

  • Sets a Precedent: The decision will serve as a principle to tax authorities and courts to resolve similar disputes and will provide a harmonious solution to the enforcement of tax law.