As the Union Budget 2026–27 draws closer, one issue has quietly gained significant traction among India’s largest business houses, tax professionals, and corporate advisors:
the need to make demergers tax-neutral, especially when they involve strategic investments in subsidiaries and associate companies.
While the matter may seem technical on the surface, its implications reach deep into India’s corporate restructuring landscape, affecting IPO pathways, capital flows, ease of doing business, and litigation volumes. This article breaks down the entire story from every angle and explains why tax-neutral demergers are becoming a pressing demand.
The Core Problem: A Law Out of Sync With Modern Corporate Structures
Under the current Income Tax Act, a demerger qualifies as tax-neutral only if it involves the transfer of a “business undertaking.”
But the law does not clearly recognise investment divisions essentially portfolios of strategic stakes in subsidiaries or associates—as undertakings.
As a result, companies transferring such investments during a demerger risk losing tax-neutrality. This leads to:
- Capital gains tax exposure
- Loss of carry-forward losses
- Litigation over interpretation
- Uncertainty for businesses planning internal restructuring or going public
This uncertainty has become a major stumbling block for genuine reorganisations.
Why Investment-Holding Divisions Matter?
India’s corporate architecture has evolved significantly over the past decade. Business groups commonly operate through a web of:
- Subsidiaries
- Joint ventures
- Associate entities
- Investment arms
- Special Purpose Vehicles
These layers are not created arbitrarily. They exist because:
- Regulators mandate separate entities for certain activities
- Investors prefer ring-fenced structures
- Banks often require project-specific SPVs
- Corporate governance norms discourage mixing unrelated businesses
Investment divisions are thus integral to group strategy and management. Yet, they remain unrecognised by tax law as “undertakings,” creating a legal mismatch that fuels disputes.
The 100% Share-Consideration Requirement: A Practical Barrier
Another hurdle is the requirement that shareholders of the demerged company must receive only shares of the resulting company as consideration. In practice, many reorganisations require:
- Bonds
- Debentures
- Preference shares
- Hybrid instruments
The restriction makes commercially necessary restructurings difficult, if not impossible.
Fast-Track Demergers Under Section 233: The Unresolved Grey Area
Section 233 of the Companies Act, 2013 introduced fast-track mergers and demergers to reduce tribunal burden.
However, the tax department holds that Section 233 schemes do not qualify as tax-neutral because they are not supervised by a court or tribunal.
This contradicts the broader agenda of:
- Simplifying corporate procedures
- Reducing litigation
- Promoting ease of doing business
The result is that companies hesitate to use a process specifically designed to make restructuring faster and easier.
Where GAAR Fits In: A Layer of Ambiguity
The presence of the General Anti-Avoidance Rules (GAAR) complicates the landscape further.
GAAR allows tax authorities to disregard transactions lacking commercial substance.
Industry experts argue that GAAR already provides the necessary safeguards against abuse.
If GAAR exists, there is little justification for denying tax-neutral treatment to genuine demergers, even under simplified procedures like Section 233.
Why This Matters for India’s Economic Future
1. IPO Preparation Becomes Smooth
Companies preparing for public listing often need to reorganise investments and business structures. Tax ambiguity delays the entire process and complicates valuation.
2. M&A Activity Gains Momentum
Flexible and tax-neutral structures encourage strategic acquisitions and consolidations.
3. Litigation Drops Significantly
Today, the interpretation of “undertaking” alone fuels a large share of tax disputes surrounding demergers.
4. Better Capital Allocation
Businesses can move assets to the most efficient entities without fearing tax repercussions.
5. Investor Confidence Strengthens
Foreign investors demand predictability. Clarity in demerger taxation improves trust in India’s corporate governance framework.
What Industry Wants the Government to Do
Industry bodies and business houses are urging the government to introduce four key changes:
1. Recognise investment divisions as “undertakings.”
This aligns tax law with accounting practices and business realities.
2. Allow carry-forward of losses in all genuine demergers.
Losses should not lapse simply because of shareholding changes.
3. Relax the 100% share-consideration rule.
Allow a blend of instruments so that corporate finance structures can remain practical.
4. Extend tax-neutrality to Section 233 demergers.
Removing the court-approval requirement aligns tax practice with corporate law reforms.
The Road Ahead: What Budget 2026–27 Could Bring
The government may consider one or more of the following reforms:
- Broader definition of “undertaking”
- Flexibility in consideration structure
- Tax-neutral treatment for Section 233 schemes
- Protection of losses during restructuring
Even a partial reform would be a significant step forward.
Business houses are hopeful, though no firm indication has been given yet.
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