2025 (7) TMI 379 - HC - Income Tax

Business losses and unabsorbed depreciation carry forward allowed when Section 72A(4) restrictions don't apply to asset transfers

Pr. Commissioner of Income Tax-1 Versus NOCIL Limited

The Bombay HC upheld ITAT's decision allowing carry forward of business losses and unabsorbed depreciation. The court held that Section 72A(4) ... Carry forward loss of earlier years denied for a set off against the income in view of the provisions of Section 72A(4) - whether there was demerger of the Plastic Product Division and Petro Chemical Division? - scope of definition of words ‘demerger’ appearing in Section 2 (19AA) as well as the definition of the words ‘demerger company’ in Section 2(19AAA) and the words ‘resulting company’ in Section 2 (41A) CIT(A) partly allowed the Appeal of the assessee and permitted to carry forward the business loss and unabsorbed depreciation, inter alia, on the ground that there was in fact no demerger as contemplated under the IT Act between the assessee on the one hand and Relene Petrochemicals Pvt. Ltd., and NOCIL Petrochemicals Ltd., on the other - ITAT accepting the assessee's contention that there was no demerger of divisions HELD THAT:- For Section 72A(4) of the Act to be attracted, there must first be a ‘demerger’ as understood under the provisions of the IT Act. The Tribunal came to the conclusion, and in our view correctly, that one of the conditions prescribed is that all the properties and liabilities relatable to the division/undertaking [being demerged], should be transferred to the ‘resulting company’ by virtue of such demerger. Secondly, for the demerger, consideration to be paid by the ‘resulting company’ is by way of issuance of shares to the share holders of the ‘demerged company’. CIT(A) as well as the ITAT came to a factual finding, and which is not disputed even before us, that the Scheme of re-structuring approved by this Court (exercising its company jurisdiction) involved transfer of only specified assets and liabilities of the Petrochemicals Division and the Plastic Products Division of the assessee to Relene Petrochemicals Pvt. Ltd., and NOCIL Petrochemicals Ltd., respectively. Further, it is also a finding of fact by the two authorities below that the consideration paid by the ‘resulting company’ namely – RPPL and NPL was not by issuance of any shares but the payment was made in cash and which was also permitted under the said Scheme approved by this Court (in its company jurisdiction). Once this is the factual situation before us, and which is undisputed, we find that CIT (A) and the ITAT were fully justified in coming to the conclusion that the provisions of sub-section (4) of Section 72A were not attracted in relation to the Scheme of arrangement between the Assessee and RPPL and NPL sanctioned by this Court in its company jurisdiction. No substantial Question of Law. The primary legal question considered by the Court was whether the Income Tax Appellate Tribunal (ITAT) was justified in accepting the assessee's contention that there was no demerger of the Plastic Product Division and Petro Chemical Division, despite the scheme approved by the Bombay High Court defining the transfer of these divisions as a demerger under the relevant statutory provisions. This raised the issue of whether the conditions under Section 2(19AA) of the Income Tax Act, 1961 ('IT Act') were fulfilled, and consequently, whether the assessee was entitled to carry forward and set off business losses under Section 72A(4) of the IT Act.The factual matrix involved the assessee filing a return declaring nil income for Assessment Year (A.Y.) 2004-05, which was initially processed under Section 143(1) and subsequently scrutinized under Section 143(3), resulting in an income determination primarily on capital gains. The case was later reopened under Section 147, and during reassessment, the Assessing Officer disallowed the carry forward of business losses on the ground that the provisions of Section 72A(4) were attracted due to a demerger. The assessee challenged this, contending that no demerger as defined under the IT Act had taken place.In addressing the issue, the Court examined the legal framework governing the concept of 'demerger' under the IT Act. Section 72A(4) restricts the carry forward and set off of business losses in cases of demerger, but the applicability of this provision depends on the precise statutory definition of 'demerger' contained in Section 2(19AA). The Court noted that the terms 'demerger,' 'demerged company' (Section 2(19AAA)), and 'resulting company' (Section 2(41A)) are interconnected and crucial to interpreting Section 72A(4). The Court emphasized that for Section 72A(4) to apply, there must be a demerger as understood under the IT Act, which entails the transfer of all properties and liabilities of the undertaking to the resulting company, and the consideration must be paid by the issuance of shares to the shareholders of the demerged company.Applying this legal framework to the facts, the Court found that the scheme of restructuring approved by the Bombay High Court, exercising its company jurisdiction, involved the transfer of only specified assets and liabilities of the Petrochemicals and Plastic Products Divisions to two separate companies. Importantly, the consideration paid by the resulting companies was not by issuance of shares but in cash, as permitted under the scheme. This factual finding was undisputed and was affirmed by both the Commissioner of Income Tax (Appeals) [CIT(A)] and the ITAT.The Court reasoned that since the transfer did not fulfill the essential conditions of a demerger under Section 2(19AA)-specifically, the transfer of all assets and liabilities and consideration by share issuance-the provisions of Section 72A(4) were not attracted. Consequently, the assessee was entitled to carry forward and set off business losses. The Court upheld the factual findings of the CIT(A) and ITAT and concluded that the substantial question of law raised by the Revenue was not justified.Regarding competing arguments, the Revenue contended that the scheme approved by the High Court defining the transaction as a demerger should bind the income tax authorities and that the statutory definition under Section 2(19AA) was satisfied. The Court rejected this, clarifying that the approval of the scheme under company law jurisdiction does not override the specific requirements of the Income Tax Act. The Court underscored the necessity of a strict interpretation of the statutory definitions for the applicability of Section 72A(4).The Court's significant holding can be encapsulated in the following reasoning: 'for Section 72A(4) of the Act to be attracted, there must first be a 'demerger' as understood under the provisions of the IT Act. One of the conditions prescribed is that all the properties and liabilities relatable to the division/undertaking should be transferred to the 'resulting company' by virtue of such demerger. Secondly, consideration to be paid by the 'resulting company' is by way of issuance of shares to the shareholders of the 'demerged company'.' This principle was determinative in concluding that the scheme did not constitute a demerger under the IT Act.In summary, the Court affirmed that the scheme of arrangement approved by the Bombay High Court did not satisfy the statutory definition of demerger under the Income Tax Act, and therefore, the provisions of Section 72A(4) disallowing carry forward of business losses were not applicable. The appeal was dismissed with no order as to costs, reinforcing the principle that the tax consequences of corporate restructuring must be determined strictly in accordance with the Income Tax Act's definitions and not solely on the characterization under company law schemes.