No tax exemption for fast-track demergers in new I-T bill, experts say will hamper ease of business

The proposed I-T bill grants tax neutrality only to demergers, excluding fast-track demergers. This creates a tax cost for transactions using the fast-track route, thereby defeating its objective of ease of doing business, he said. “A more inclusive tax treatment would align with company law reforms and promote business restructuring,” Mohan said.

Demerger definition

Under the existing Income-tax Act, 1961, which will be replaced by the new law, demergers enjoy capital gains exemption as long as certain conditions are met. It also allows some fast-track demergers to qualify for tax-neutral treatment through liberal interpretation.

The draft bill restricts tax neutrality to schemes undertaken through Sections 230 to 232 of the Companies Act, which require approval of the National Company Law Tribunal. Since fast-track demergers under Section 233 do not go through NCLT but require clearance from the regional director, they fall outside the scope of the new definition.

Such transactions would no longer qualify for exemptions and would be subject to capital gains tax, depending on whether the transferred assets are short-term or long-term and other factors such as indexation benefits.

The change not only increases the tax cost for genuine internal restructurings but also introduces legal inconsistency between company and tax laws, experts say.

Policy logic

“The ministry of finance stated in their submission to the select committee that fast-track demergers were not granted tax neutrality because they lacked court or tribunal oversight, and that the valuations involved could potentially lead to tax avoidance. These concerns can be sufficiently addressed without a blanket denial of tax neutrality to all fast-track demergers,” Bhavin Shah, Partner, Price Waterhouse & Co, said.

“A blanket denial will compel companies to go back to the longer tribunal-driven process. This will lead to a tax situation where companies could be charged with capital gains tax without any real income.”

The concern is particularly acute for startups, MSMEs, and group companies, which often rely on the fast-track demerger route for speed and cost efficiency.

Startups and MSMEs

“The main reason that such demergers are not tax exempt or tax neutral is that they are non-court monitored, without NCLT oversight, hence there are concerns about the valuation manipulation,” Sandeep Sehgal, Partner, chartered accountant firm AKM Global, said.

“The law tends to create a clear boundary that only court-approved schemes will benefit from tax neutrality provisions. This could create genuine hardship for intra-group restructurings, especially among startups and MSMEs who rely on the fast-track route. Going forward, companies will need to reassess the tax costs of fast-track demergers.”

Khaitan & Co, in a paper, said, “Fast-track demergers were introduced to provide a simplified, time-efficient alternative to traditional demergers, primarily benefiting small and closely held companies. The proposed Bill suggests that tax-neutral treatment may not extend to fast-track demergers.”

Alvarez & Marsal also flagged the issue in its commentary on the proposed law. “The Bill grants tax neutrality to only court-approved demergers, overlooking fast-track demergers.”

BJP MP Baijayant Panda-led finance select committee submitted its report on the draft Bill to the Lok Sabha on July 16 with 285 recommendations.