ITAT: Corporate Restructuring Must Meet All Conditions of Section 2(19AA) to Avoid Capital Gains Tax on Demerger

Introduction

In Reckitt Benckiser Healthcare India (P.) Ltd. v. Deputy Commissioner of Income-tax[i], the Income Tax Appellate Tribunal, Ahmedabad Bench (‘ITAT’), adjudicated upon a range of tax issues including the tax treatment of a demerger transaction, disallowance under s.14A of the Income-tax Act, 1961 (‘Act’), treatment of product registration expenses, and applicability of s. 80-IC benefits.

The most critical facet of this judgment centred around whether a purported demerger of the Assessee's “treasury unit” met the conditions envisaged under s. 2(19AA) of the Act, thereby qualifying for exemption from capital gains tax under s. 47.

Facts

• Reckitt Benckiser Healthcare India (P.) Ltd. ('Assessee') was engaged in manufacturing and marketing pharmaceutical and cosmetic products. The Assessee had invested in Sterling Addlife India Ltd. (SAIL) during the financial years (‘FYs’) 2002–03 to 2008–09.

• For the assessment year (‘AY’) 2011–12, the Assessee filed its return of income on 18.11.2011, declaring a normal total income of Rs. 27.56 crores and book profits under s. 115JB of the Act amounting to Rs. 128.80 crores.

• During the relevant year, the Assessee transferred its treasury unit to SAIL pursuant to a scheme of arrangement approved by the Hon’ble Gujarat High Court under ss. 391–394 of the Companies Act, 1956. Under this scheme, the shareholders of the Assessee received shares in SAIL.

• The Assessee treated this transaction as a tax-neutral demerger under s. 2(19AA) of the Act and claimed exemption from capital gains tax under s. 47(vib).

• The case was selected for scrutiny. Subsequently, the Assessing Officer (‘AO’) issued a show cause notice on 05.03.2015, seeking an explanation as to why the transaction should not be treated as a taxable transfer.

• During the assessment proceedings, AO made several key observations and noted that liabilities amounting to Rs. 37.15 crores (as on 31.03.2009) were not transferred along with the assets. Additionally, there was no clear segregation of the Treasury Unit as a distinct business undertaking. The transfer was neither carried out on a going-concern basis nor supported by dedicated infrastructure, personnel, or independent operations. It was further observed that the unit merely managed passive investments, which had historically been taxed either as capital gains or treated as exempt income, rather than as business income. in lieu of the aforementioned findings, the AO rejected the Assessee’s claim, and held that the transfer did not meet the statutory conditions of a demerger, specifically, the requirement that all liabilities related to the undertaking must also be transferred along with the assets.

• Aggrieved by the above, the Assessee challenged the assessment order before the Commissioner of Income-tax (Appeals) (CIT(A)) in 2018. The CIT(A), however, upheld the findings of the AO and reiterated that the transaction failed to satisfy the conditions of a demerger as defined under s.2(19AA). The Assessee, thus aggrieved, preferred an appeal before the ITAT.

Held

• The Tribunal upheld the findings of the AO, concluding that the Assessee had transferred only the assets of the Treasury unit while retaining liabilities. According to the Tribunal, this contravened the requirement under s 2(19AA)(ii) of the Act, which mandates the transfer of all liabilities relatable to the undertaking in the case of a demerger. The Tribunal noted the Assessee’s inconsistent treatment of assets and the lack of clear demarcation of the Treasury unit as a separate business activity. As a result, the transaction was not accepted as a valid demerger and was instead treated as a taxable transfer of capital assets under s. 45 of the Act. Additionally, the distribution of shares by SAIL to Reckitt’s shareholders was held to constitute a deemed dividend under s. 2(22), thereby attracting liability for Dividend Distribution Tax (DDT).

• The Tribunal deleted the disallowance of interest expenses, noting that the Assessee had sufficient interest-free funds. Product registration costs were treated as capital in nature, disallowing deduction under s. 37(1) of the Act. Full deduction under s. 80-IC of the Act was allowed as all business functions, including marketing, contributed to profits. Scrap income was held incidental to manufacturing and was deductible. Disallowance under s .40(a)(ia) could not inflate the deduction under s. 80-IC. Finally, the Tribunal upheld the Assessee’s provision for future sales returns, based on a scientific and consistent methodology, making it allowable under s. 37(1).

Our Analysis

This ruling serves as a cautionary precedent for corporate restructurings such as demergers, highlighting that approval of a scheme by the High Court under corporate law does not automatically confer tax neutrality under the Act. The Tribunal adopted a substance-over-form approach, stressing the need for strict compliance with all conditions under s. 2(19AA), including the transfer of all assets and liabilities, the requirement that the undertaking be transferred as a going concern, and a clear demarcation of the business segment.

In this case, discrepancies in financial reporting, lack of clear asset segregation, and the selective transfer of liabilities led the Tribunal to conclude that the transaction did not constitute a valid demerger, resulting in significant tax exposure.

The ruling also reinforces established principles of s. 14A disallowances, the distinction between capital and revenue expenditure, and the comprehensive evaluation of profits eligible for deduction under s. 80-IC. It underscores the importance of consistent and transparent accounting practices and cautions against structuring transactions solely to achieve tax-neutral outcomes.

End Note

[i] 2025 SCC OnLine ITAT 1907 dated 18.02.2025.

Authored by Shreya Manchanda, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.