Valuation vs Demerger: Kolkata ITAT Clarifies the Boundaries

 Recently, the Kolkata ITAT held that no addition under section 56(2)(x) can be made in respect of assets received pursuant to a qualifying demerger, where the prescribed conditions under the Income-tax Act are duly satisfied. The Tribunal further clarified that valuation principles as prescribed under Rule 11UA of Income-tax Rules (ordinarily applicable for determining fair market value of shares) cannot be imported to challenge a demerger that otherwise complies with the statutory framework.

The dispute arose in relation to a scheme of arrangement approved by the Hon’ble NCLT, pursuant to which the real estate undertaking of Oriental Sales Agencies (India) Pvt. Ltd. (‘OSAIPL’) was demerged into Emami Realty Ltd. (‘ERL’) with effect from 1 April 2019. During the assessment proceedings, the Assessing Officer (‘AO’) questioned whether the transaction qualified as a tax-neutral demerger. According to the AO, the liabilities relating to the undertaking had not been appropriately transferred on demerger and the share issuance by the resulting company (ERL) pursuant to the demerger did not reflect fair value. On this basis, the AO sought to invoke deemed gift tax provisions [section 56(2)(x)] and tax the alleged excess value of assets received by ERL.

Upon appeal, the Kolkata ITAT rejected the Revenue's position and upheld the tax neutrality of the demerger. The Tribunal observed that the liabilities pertaining to the transferred undertaking had in fact moved to the resulting company and that the Revenue's objections largely stemmed from inconsistencies in earlier disclosures that were subsequently corrected and adequately supported by documentary evidence. As regards valuation, the Tribunal noted that the statutory conditions governing a demerger require proportionate issuance of shares to the shareholders of the demerged company but do not prescribe any specific valuation methodology. Accordingly, valuation rules used in other contexts could not be imported to question the share entitlement ratio adopted under the demerger scheme. The Tribunal also observed that, in any event, the valuation undertaken by the registered valuer, supported by a fairness opinion from a SEBI-registered merchant banker, was commercially justified and had received approval from the relevant stakeholders and statutory authorities.

Importantly, the Tribunal drew a distinction between the scope of an NCLT's approval and the jurisdiction of the tax authorities. While acknowledging that the tax department is not bound by an NCLT-approved scheme in determining the tax consequences arising therefrom, the Tribunal emphasised that any such examination must remain within the confines of the Income-tax Act. Tax authorities may independently verify whether the conditions prescribed for a tax-neutral demerger have been satisfied; however, they cannot import requirements that are absent from the statute.

These ruling underscores the importance of the statutory framework governing tax-neutral demergers and limits the extent to which valuation-related considerations may be used to challenge such transactions. The Tribunal's decision suggests that Rule 11UA valuation principles cannot, by themselves, be invoked to deny the benefits otherwise available to a qualifying demerger. While the ruling may provide useful support for taxpayers undertaking genuine business reorganisations, companies should continue to maintain robust commercial rationale, appropriate valuation support and comprehensive documentation evidencing compliance with the prescribed conditions.