It may be topical to deal with
a problem likely to be faced by all companies planning to demerge/ amalgamate
with appointed dates in between a particular previous year, and a resolution of
this issue is likely to help all such companies. The point concerns clause 7A of
Sec. 10A of the ITA and its likely interpretations, the flaws it has in its
present form and the amendment it needs to be able to reflect the true intention
of law. A retrospective amendment may be essential in the interest of fairness
to all and will be consistent with the spirit of the true intention of the law,
as no one can afford to rest their case on likely interpretation of the same in
an assessee’s favour, though it may be strong on merit. If readers agree, they
may take it up at appropriate levels in all possible Departmental and MOF
forums, in the light of the forthcoming Budget discussions which may have
already started in the Finance Ministry.
Background
Sec. 10A was originally
introduced by the Finance Act, 1981 w.e.f. A.Y. 1981-82 to provide complete tax
holiday for industrial undertaking situated in FTZ primarily for the purpose of
promotion of exports and for achieving certain other objectives which were
brought in CBDT Circular No. 308 dated 23-6-1981. Following text of the said
circular is very important as it summarizes the prime object of Sec. 10A.
"With a view to encouraging the
establishment of export oriented industries in the free trade zone, the Finance
Act, 1981 has inserted a new section 10A…".
Finance Minister, considering
its above objectives and the importance of amalgamations/demergers, made
amendments in the Income-tax Act to extend the benefits to the company who
acquires the undertaking (eligible for 10A) through amalgamation/Demerger. (Sec.
10A (7A)).
Effect of the amendment made
by Finance Act, 2003
A new sub-section 7A was
brought in under Sec. 10A which is reproduced herein below:
“10A. Special provision in
respect of newly established undertakings in free trade zone, etc.
(7A) Where any undertaking of
an Indian company which is entitled to the deduction under this section is
transferred, before the expiry of the period specified in this section, to
another Indian company in a scheme of amalgamation or demerger, (i)(a) no
deduction shall be admissible under this section to the amalgamating or the
demerged company for the previous year in which the amalgamation or the demerger
takes place; and (i)(b) the provisions of this section shall, as far as may be,
apply to the amalgamated or the resulting company as they would have applied to
the amalgamating or the demerged company if the amalgamation or demerger had not
taken place.”
The Memorandum in the Finance
Bill reads as under:
With a view to give boost to
the export- led growth, it is necessary to eliminate the hurdles in the Mergers
and Acquisitions ( M & A ) and the other modes of business restructuring, it is
accordingly, proposed to insert a new subsection (7A) in section 10A and a
sub-section (7A) in section 10B, to provide that where an undertaking of an
Indian company is transferred to another company under a scheme of amalgamation
or demerger, the deduction shall be allowable in the hands of amalgamated or the
resulting company. However no deduction shall be admissible under these sections
to the amalgamating company or the demerged company for the previous year in
which amalgamation or demerger takes place. As a consequence sub-sections (9),
(9A) and the explanation there after in sections 10A and 10B, become redundant
and are proposed to be omitted, so that the tax benefit is not lost on change of
ownership of the eligible undertaking.
The Hon'ble Finance Minister in
his budget speech mentioned:
‘IT is India’s showpiece
success story. We have to not just maintain its momentum of growth, but
continuously encourage it. Therefore it is proposed that the concessions
extended to IT under sections 10A and 10B of the Income-tax Act will continue as
originally envisaged. As per law such companies as are currently covered by
these exemptions lose the benefits upon change in their ownership or
shareholding. This is not logical. I am, therefore, removing these restrictions;
the benefit of such tax exemptions will remain even in case of amalgamation or
demerger. ‘
The clear intention of the
amendment was to extend the benefit to the undertaking (eligible for Sec. 10A
benefit) and NOT to deprive the benefit in case the ownership of the undertaking
changes due to amalgamation/ demerger. However it appears that while making the
amendment it was assumed that such amalgamations/demergers would take place from
the beginning of the year (i.e. w.e.f. 1st April).
However the amendment completely overlooked the situation where the
amalgamation/demerger takes effect from any other day other than 1st April.
Consequences
To understand the consequences,
let us assume a situation where amalgamation/demerger is w.e.f 1st October,
2006.
Say for example, Company A
demerges its one of the undertaking (eligible for Sec 10A benefits), on
1-10-2006 to Company B. in view of the provisions of sec 10A (7A), Company A
will not get benefit of deduction in FY 2006- 07. As per the decision of Supreme
Court in Marshall Sons & Co. (I) Ltd. vs. ITO (223 ITR 809) that all profits and
losses up to the appointed date would be taxable/assessable in the hands of the
transferor company. Therefore Company A would be taxable for its profits for the
period 1-4-2006 to 31-9-2006 and in view of Sec. 10A (7A), it will not be
entitled to the deduction u/s 10A for those profits.
On the other hand, Company B
will be taxable only for the profits for the period 1-10-2006 to 31-3-2007 and
therefore it can claim deduction only in respect of profits for that period.
Obviously Company B cannot claim deduction of an amount that is not included in
its total income. This indirectly means that the profits for the period up to
the appointed date would not enjoy the benefit of deduction u/s 10A at all.
In the above situation the
benefit will be available u/s 10A only for six months. (October to March) to the
new entity and the benefit of sec. 10A will be completely lost for the period of
six months to the old entity. This is clearly not the intention and in true
spirit of Sec. 10A.
SUGGESTIONS FOR
RATIONALISATION.
-
The benefit of Sec. 10A
should not be denied to the entity transferring the undertaking but benefit
should be allowed till the appointed date to the amalgamated or resulting
company considering the fact that benefit is to the ‘undertaking‘ and is not
restricted to the entity.
-
The indirect implication of
the amendment should be to ensure that double benefit is not made available
for the same period to both demerged and demerging entities.
This anomaly can be removed by
simply adding a proviso to the said Clause stating “that in case of
amalgamations/demergers taking place with appointed dates falling on any day
between the first day and the last day of the previous year, the benefit of Sec.
10A shall be made available to both the entities in the respective period which
will be exclusive to both the entities in such a manner that neither the
demerging nor the demerged entity avails of the exemption pertaining to the same
period in the respective previous year.”
