2025 (3) TMI 289 - AT - Income Tax

Demerger fails Section 2(19AA)(ii) test as company retained liabilities while transferring assets creating capital gains liability

Reckitt Benckiser Healthcare India Private Limited, (Formerly known as Reckitt Benckiser Healthcare India Ltd) Versus Dy. Commissioner of Income-tax, Circle-3 (1) (2), Ahmedabad And (Vice-Versa)

The ITAT Ahmedabad ruled against the assessee on the primary issue of capital gains taxation arising from demerger of treasury undertaking. The tribunal ... Levy of capital gains u/s 45 considering demerger of the treasury undertaking as non-qualifying demerger - HELD THAT:- Provisions of Section 2(19AA)(ii) which mandates that all the liabilities relatable to the undertaking are also to be transferred to the demerged company, and considering the explanation of the Counsel that the existing liabilities of Rs. 37.15 crores were knocked off against the transfer of assets of Rs. 39.23 crores is against the provisions of the Section 2(19AA)(ii). Thus, it can be found that the assessee has only transferred the assets while keeping the liabilities with them. The explanation of the assessee that the liability belonging to other segments whereas assets belong to the Treasury Segment cannot be accepted. Hence, it can be held that the Revenue Authorities have rightly treated the demerger as transfer of capital assets. The process of demerger generally consists of following transactions - Transfer of assets and liabilities by the transferor company to the resulting transferee company, Transfer/ extinguishment of shares of the transferor company and Issuance of shares of resulting transferee company to the shareholders of the transferor company. All the abovementioned transactions have been specifically exempted from the levy of capital gains tax by virtue of various clauses forming a part of Section 47 of the IT Act subjected to the applications of provisions of Section 2(19AA) of the Act. It is also settled position of law that the scheme of demerger once approved by the Hon’ble Jurisdictional High Court, it cannot be re-visited by any statutory authority. At the same time, the provisions of Income-tax Act had prescribed the conditions under which the benefits can be accorded in the case of demerger which means that mere fact that ipso facto does not entitle an assessee to claim benefit. The harmonious interpretation of the Corporate Law and Income-tax Law and the Orders of the Hon’ble High Court is sine qua non for the benefit of the tax payer as well as for the interest of the exchequer. The vary purpose of demerger which is for better conducting of the business cannot be curtailed by the Income-tax Department and the assessee would be eligible for business in accordance with the provisions of Section 2(19AA) Section 2(22)(a) & Section 47. In the instant case, the assessee failed to comply with the provisions of Section 2(19AA) (ii) & (iii). Hence, the order of the Ld. CIT(A) on these grounds are affirmed. Decided against assessee. Disallowance u/s 14A - AO was not satisfied with the correctness of the claim of the assessee in respect of expenditure incurred in relation to income which does not form part of total income - HELD THAT:- Respectfully following the decision of the Tribunal in assessee’s own case for AY 2008-09 [2018 (8) TMI 2167 - ITAT AHMEDABAD] the disallowance made by the Assessing Officer u/s. 14A to the extent of interest expenses is hereby deleted. Nature of expenses - Product registration expenses - AO held that the Marketing Intangibles are created by these product registration expenses and hence, it is a capital expenditure not allowable u/s 37(1) - HELD THAT:- As decided in own case [2018 (8) TMI 2167 - ITAT AHMEDABAD] for AY 2008-09 assessee has incurred these expenses for registering its product in various countries to enable the assessee to sell the product in such counties. We observed that in absence of registration, the assessee would not be able to sell the product in the foreign countries as per the regulatory requirement of different countries, it is mandatory to get the product of the assessee registered in respect of counties for the purpose of selling in the overseas markets. Therefore, the finding of the assessing officer that assessee is getting benefit of enduring nature of registration of product has no merit. Reduction of claim u/s 80IC to Baddi Unit - as per AO since the Baddi unit of the assessee-company only possesses manufacturing assets and is engaged solely in manufacturing activities, the profits of the Baddi unit should be restricted to those derived from manufacturing alone - HELD THAT:- We find that this issue stands covered in assessee's own case [2018 (8) TMI 2167 - ITAT AHMEDABAD] provisions of section 80IC do not require assessee to split the activities and contribute the profit attributable to separale activities which constitute one business. Also considered the decision Cadila Healthcare Ltd. [2012 (6) TMI 13 - ITAT AHMEDABAD] wherein on identical facts on claim of deduction from eligible profits derived by a Baddi unit of a pharmaceutical company it is held that that eligible profits should not be artificially segregated in to manufacturing, marketing and brand profits. Scrap Sale Income - assessee had earned miscellaneous income comprises of scrap income from Baddi unit - HELD THAT:- We find that the issue stands covered by the decision of Tribunal in assessee’s own case for AY 2009-10 [2022 (3) TMI 919 - ITAT AHMEDABAD] as held that compensation received by industrial undertaking from insurance companies on account of loss raw materials and finished products in fire, would be eligible for deduction u/s. 80IA of the Act. In view of the above, we do not find any infirmity on the order of ld. CIT(A) in allowing the claim of deduction u/s. 80IC of the Act on scrap income. Deduction u/s 80IC on the disallowance made under section 40(a)(ia) was disallowed - DR argued that the enhancement of profit on account of disallowance u/s 40(a)(ia) cannot increase the deduction u/s 80IC - HELD THAT:- AO has erred in disallowing the deduction and we uphold the order of the Ld. CIT(A) on this issue. Disallowance on account of provision for expiry of goods - AO held that this is not an expenditure, but a future expectation of incurring certain expenditure which may be more or less than for what provision is made - HELD THAT:- CIT(A) correctly deleted the addition on the ground that the assessee has recognized the provisions for sales return based on scientific basis and past experience and hence the same was alloawable expenditure. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in this judgment are:Whether the demerger of the treasury undertaking qualifies as a demerger under Section 2(19AA) of the Income-tax Act, 1961, and whether it should be exempt from capital gains tax under Section 47(vib) of the Act.Whether the transaction of demerger should be treated as a distribution of assets to shareholders, thereby attracting dividend distribution tax under Section 2(22) of the Act.Whether the disallowance under Section 14A of the Act was correctly applied in relation to expenses incurred for earning tax-free income.Whether the product registration expenses should be treated as capital expenditure or revenue expenditure.Whether the reduction of claim under Section 80IC for the Baddi unit was justified.Whether income from scrap sales should be eligible for deduction under Section 80IC.Whether the disallowance under Section 40(a)(ia) should affect the deduction under Section 80IC.Whether the provision for expiry of goods should be allowed as a deductible expenditure.2. ISSUE-WISE DETAILED ANALYSISIssue 1: Demerger and Capital Gains TaxLegal Framework: Section 2(19AA) and Section 47(vib) of the Income-tax Act, 1961.Court's Interpretation: The Tribunal upheld the view that the demerger did not qualify under Section 2(19AA) as the essential conditions were not fulfilled, particularly the transfer of liabilities.Key Evidence: The lack of transfer of liabilities and the selective allocation of assets were pivotal.Application of Law: The Tribunal found that the demerger was not in compliance with the provisions of Section 2(19AA), thus attracting capital gains tax.Competing Arguments: The assessee argued that all conditions of Section 2(19AA) were met, but the Tribunal disagreed based on the evidence.Conclusion: The Tribunal confirmed the levy of capital gains tax.Issue 2: Dividend Distribution TaxLegal Framework: Section 2(22) of the Income-tax Act.Court's Interpretation: The Tribunal agreed with the Revenue that the transaction amounted to a distribution of assets to shareholders.Conclusion: The Tribunal upheld the levy of dividend distribution tax.Issue 3: Disallowance under Section 14ALegal Framework: Section 14A of the Income-tax Act and Rule 8D of the Income-tax Rules.Court's Interpretation: The Tribunal partly allowed the appeal, deleting the disallowance related to interest expenses but upheld the administrative expenses disallowance.Conclusion: The appeal was partly allowed.Issue 4: Product Registration ExpensesLegal Framework: Section 37(1) of the Income-tax Act.Court's Interpretation: The Tribunal upheld the CIT(A)'s decision that these expenses were revenue in nature.Conclusion: The appeal on this ground was dismissed.Issue 5: Reduction of Claim under Section 80ICLegal Framework: Section 80IC of the Income-tax Act.Court's Interpretation: The Tribunal found that the entire business activity should be considered for deduction, not just manufacturing.Conclusion: The appeal on this ground was dismissed.Issue 6: Scrap Sale IncomeLegal Framework: Section 80IC of the Income-tax Act.Court's Interpretation: The Tribunal held that income from scrap sales was eligible for deduction under Section 80IC.Conclusion: The appeal on this ground was dismissed.Issue 7: Disallowance under Section 40(a)(ia)Legal Framework: Section 40(a)(ia) and Section 80IC of the Income-tax Act.Court's Interpretation: The Tribunal, following CBDT Circular No. 37/2016, held that disallowances under Section 40(a)(ia) should enhance profits for deduction purposes.Conclusion: The appeal on this ground was dismissed.Issue 8: Provision for Expiry of GoodsLegal Framework: Relevant case laws and principles on provisions for liabilities.Court's Interpretation: The Tribunal upheld the CIT(A)'s decision that the provision was based on a scientific basis and was allowable.Conclusion: The appeal on this ground was dismissed.3. SIGNIFICANT HOLDINGSThe Tribunal affirmed the Revenue's treatment of the demerger as a taxable transfer, thereby attracting capital gains and dividend distribution taxes.Disallowance under Section 14A was partly upheld, with interest disallowance being deleted.Product registration expenses were treated as revenue expenditure, not capital.The Tribunal upheld the CIT(A)'s decision on the eligibility of scrap sale income for deduction under Section 80IC.Disallowance under Section 40(a)(ia) was held to enhance profits eligible for deduction under Section 80IC, following CBDT Circular No. 37/2016.The provision for expiry of goods was allowed as a deductible expenditure.