Budget 2019: Proposal to remove ambiguity on tax neutrality of demerger is a positive move in right direction

In a bid to align with International Financial Reporting Standards (IFRS), India introduced Indian Accounting Standards (Ind-AS) by modifying the IFRS to suit the Indian economy’s requirements. As per the regulatory framework, many large Indian corporates have transitioned in line with Ind-AS for financial reporting. The fundamental difference between prevailing Indian accounting standards (IGAAP) and Ind-AS is that Ind-AS is governed by the principles of substance over form and fair valuation. Although the Indian tax laws are also governed by the principle of substance over form, several other accounting guidance under Ind-AS has the potential to give rise to tax implications on transactions which were not otherwise subject to tax. Whilst some of the Ind-AS and tax incongruities with respect to book profit taxation were addressed by Finance Act 2018, there were many other aspects which remained unaddressed. [caption id=“attachment_5759311” align=“alignleft” width=“380”] Representational image. Reuters[/caption] Finance Bill 2019 has put to rest one such variance with respect to demerger. A brief background on the issue is as under: 1) As per the tax laws, demerger is regarded as tax neutral subject to satisfaction of certain conditions. One of the conditions for tax neutral demerger is that the resulting company should record the assets and liabilities of the undertaking at the value as appearing in the books of account of the demerged company. 2) Ind-AS provides guidance with respect to accounting principles for “Business Combinations” for all types of business combinations including demergers that did not have a specific accounting treatment under Indian GAAP (Generally Accepted Accounting Principles). 3) As per the said accounting guidance, if the resulting company and demerged company are not under common control within the same group then assets and liabilities are to be recorded in the books of the resulting company at their respective fair values. As can be observed, the contradiction in provisions of Ind-AS and requirements of the tax laws has been a major concern for corporates as there is an ambiguity over the tax treatment of the entire transaction. The taxpayer’s position for claiming tax neutrality for the entire transaction of demerger has been a matter of concern due to compliance with the applicable accounting framework. Lately, large corporate houses, based on commercial requirements, have undertaken corporate restructuring involving demerger and with ambiguity in the tax law, the industry was compelled to take divergent views on this matter. The announcement made in the Budget 2019 brings some relief in such situations. It proposes to ease out the anomaly created due to Ind-AS by aligning accounting requirements of Ind-AS with the tax neutrality of demerger. The Finance Bill 2019 has proposed that tax neutrality of demerger under the tax law shall not be affected in case resulting company accounts for assets and liabilities, acquired pursuant to the demerger, at their respective fair values. This proposal is a positive move in the right direction and will be well received by corporate houses across the nation. However, this proposal will be effective from Financial Year 2019-20. Hence, a question that arises is what would be the state of cases where such reorganisation has already taken place prior to Financial Year 2019-20. While some light at the end of the tunnel is now seen with this proposed change, there are a few other wrinkles that still need to be ironed out when it comes to a contract between the accounting treatment under Ind-AS and tax treatment—companies may have to wait longer for this! (Anil Talreja is partner with Deloitte India, Madhvi Jajoo is senior manager and Rohit Gupta is manager with Deloitte Haskins and Sells LLP)