Approval Of Demerger Would Not Entail The Benefit Of Set-Off Under Section 72A Of Income Tax Act: ITAT

The Bench, consisting of S. S. Viswanethra Ravi (Judicial Member) and Inturi Rama Rao (Accountant Member), held that Section 72A (5) of the Income Tax Act, 1961 has been enacted empowering the Assessing Officer to deny the benefit of set-off of brought forward business losses, and hence, merely because the scheme of demerger was approved by the High Court would not ipso facto entitle the assessee to the benefit of set-off, if the scheme was contrary to the objects behind the enactment of the provisions of Section 72A.

The ITAT observed that the scheme of demerger was carried out by the assessee only with the sole object of availing the tax benefit and that the assessee had no intention of carrying on the business of the demerged undertaking. Thus, the ITAT upheld the order of the Assessing Officer in denying the set-off.

During the relevant previous year, Highway Solutions of Cummins Auto Services Ltd., a 100% subsidiary of the assessee company M/s. Cummins Sales & Services (I) Ltd., was demerged and vested with the assessee company. The scheme of the demerger was approved by the High Court of Bombay. The assessee company claimed set-off of the brought forward business losses and unabsorbed depreciation losses relating to the demerged undertaking against the assessee's taxable income, as provided under Section 72A (4) of the Income Tax Act.

During the assessment proceedings, the Assessing Officer (AO) found that the assets of the demerged undertaking were held for sale, indicating that there was no intention of the assessee to continue the business of the demerged undertaking. Thus, the AO concluded that the scheme of demerger was not carried out for a genuine purpose as contemplated under Section 72A (5) of the Income Tax Act. Therefore, the AO passed an order denying the claim of set-off of brought forward business losses and unabsorbed depreciation losses pertaining to the demerged undertaking.

The AO also made a disallowance of indirect expenses by applying Rule 8D(2)(iii) of the Income Tax Rules, 1962, which was inserted with effect from assessment year 2007-2008. The AO had opined that since Rule 8D is a procedural provision, it was applicable in all the pending matters.

Against this, the assessee filed an appeal before the Commissioner of Income Tax (Appeals) (CIT(A)).

The CIT(A) held that once the demerger was approved by the Bombay High Court, the AO had no jurisdiction to question the motive behind the demerger. The CIT(A) ruled that in the absence of any notification by the Central Government, as provided under Section 72A (5), the AO could not apply his own guidelines in order to arrive at a conclusion as to whether the demerger was for a genuine purpose or not. Hence, the CIT(A) passed an order directing the AO to allow the set-off of brought forward business losses and unabsorbed depreciation losses relating to the demerged undertaking.

The CIT(A) also ruled that the provisions of Rule 8D cannot be applied retrospectively and thus, the CIT(A) restricted the disallowances made by the AO under Section 14A of the Income Tax Act read with Rule 8D(2)(iii) of the Income Tax Rules.

Against this, the revenue department filed an appeal before the ITAT.

Section 14A of the Income Tax Act, 1961 provides that no deduction shall be allowed in respect of the expenditure incurred by the assessee in relation to income which does not form part of the total income under the Income Tax Act. Rule 8D of the Income Tax Rules provides methods for determining the amount of expenditure in relation to income not includible in total income. Section 72A of the Income Tax Act contains provisions relating to carry forward and set off of accumulated loss and unabsorbed depreciation allowance in the case of amalgamation or demerger.

The assessee M/s. Cummins Sales & Services submitted before the ITAT that the provisions of Rule 8D only have a prospective application and thus, they could not have been applied in the assessment year prior to the assessment year 2008-2009.

The ITAT observed that the provisions of Section 14A provide that where an assessee earns exempt income, the expenditure incurred in connection with earning of exempt income cannot be allowed. The ITAT noted that Rule 8D prescribes the method for computing the quantum of disallowance. The ITAT observed that the Supreme Court in the case of CIT versus Essar Teleholdings Ltd. (2018) had held that Rule 8D is prospective in nature and it cannot be applied for any assessment year prior to the assessment year 2008-2009. Thus, the ITAT upheld the order passed by the CIT(A) holding that the provisions of Rule 8D have no retrospective application.

Against the order passed by the CIT(A) allowing set-off of brought forward business losses and unabsorbed depreciation losses relating to the demerged undertaking, the revenue department submitted that the motive behind the scheme of demerger was only to avail the tax benefit and that it was not for a genuine purpose.

The revenue department averred that the assets of the demerged entity were held for sale, as shown in the Balance Sheet, which clearly indicated that the assessee had no intention of carrying on the business of the demerged undertaking.

The revenue department added that even though the Central Government has not prescribed any condition to determine whether or not the scheme of demerger is for a genuine purpose, however, since the material on record clearly established that the scheme of demerger was not for a genuine purpose, therefore, the assessee was not entitled to the benefit of set-off of brought forward business losses and unabsorbed depreciation losses.

The assessee M/s. Cummins Sales & Services (I) Ltd submitted that it was beyond the scope of the Assessing Officer to go behind the scheme of demerger. The assessee averred that since the scheme of demerger was approved and sanctioned by the High Court, it was binding on everyone including the income tax authorities.

The ITAT held that it is a settled position of law that the scheme of demerger, once approved by the High Court, cannot be re-visited by any statutory authority.

However, the ITAT observed that the provisions of the Income Tax Act have prescribed the conditions under which the set-off of brought forward business losses can be allowed in the case of amalgamation and demerger. Thus, the ITAT ruled that the mere fact of an amalgamation or demerger ipso facto does not entitle an assessee to claim the benefit of the set-off of brought forward business losses.

The ITAT noted that in the scheme of demerger approved by the High Court, no condition was mentioned about the issue of set-off of brought forward business losses and unabsorbed depreciation losses.

Hence, the ITAT held that the mere fact that the scheme of demerger or amalgamation was accorded approval by the High Court, did not automatically entitle the assessee to claim the set-off of brought forward business losses.

The ITAT observed that Section 72A (5) of the Income Tax Act empowers the Central Government to prescribe the conditions and guidelines to determine whether the scheme of demerger is for a genuine purpose or not. The ITAT noted that the Delhi High Court in the case of IEL Ltd. versus Union of India (1992) had held that the benefit of Section 72A cannot be availed if the sole idea of the amalgamation was only to avail the benefit of carried forward business losses and unabsorbed depreciation losses.

The ITAT noted that there is no difference in the object behind the enactment of the provisions contained in Section 72A (1), that governs the scheme of amalgamation, and in the provisions of Section 72A (4), that deals with the case of demerger. The ITAT held that both the provisions have been enacted with same objective.

The ITAT ruled that the object behind enacting the provisions of Section 72A was clear from the memorandum explaining the provisions of the Finance Bill of 1997.

The ITAT observed that the only object of the provisions of Section 72A is the revival of sick units and of relieving the Government of the uneconomical burden of taking over and running the sick units, as well as to save the Government from the social costs in terms of loss of production and unemployment.

The ITAT noted that after the scheme of the demerger, the assessee had not carried on any business of the demerged undertaking. The ITAT added that the fact that the assets of the demerged unit were held for sale showed the intention of the assessee of not carrying on the business of the demerged undertaking. The ITAT ruled that the scheme of demerger was carried out only with the sole object of availing the benefit of set-off of brought forward business losses and unabsorbed depreciation losses of the demerged undertaking.

The ITAT ruled that the reasoning of the AO in denying the set-off was consistent with the object behind the enactment of the provisions contained in Section 72A.

The ITAT added that Section 72A (5) has been enacted empowering the Assessing Officer to deny the benefit of set-off of brought forward business losses. Hence, the ITAT ruled that merely because the scheme of demerger was approved by the High Court would not ipso facto entitle the assessee to the benefit of set-off of brought forward business losses, if the scheme was contrary to the objects behind the enactment of the provisions of Section 72A.

The ITAT noted that the Bombay High Court in the case of Ballarpur Industries Ltd. versus CIT (2017) had ruled that the benefit of set-off of brought forward business losses cannot be allowed when the sole idea behind the scheme of amalgamation was only to avail the benefit of set-off of brought forward business losses.

Thus, the ITAT held that even though the Government of India has not laid down the criteria to determine under what circumstances a demerger can said to be for a non-genuine purpose, the benefit of set-off of brought forward business losses can still be denied by the AO, if it is contrary to the objects behind the enactment of the provisions of Section 72A.

"The ld. CIT(A) had granted the benefit of set-off of brought forward business losses in a perfunctory manner without looking into the objects behind the enactment of provisions of section 72A and appears to have been carried out by the submissions of the assessee that once the scheme of demerger is approved by the Hon'ble High Court, the assessing authority cannot go behind the scheme of demerger ignoring the provisions of section 72A, which governed the set-off of brought forward business losses in the case of amalgamation/demerger etc, which prescribes the conditions to avail the benefit of the scheme. In the circumstances, we find that the order of ld. CIT(A) is illegal and unreasonable."

The ITAT, thus reversed the order passed by the CIT (A) of allowing set-off of brought forward business losses and unabsorbed depreciation losses relating to the demerged undertaking.

The ITAT, therefore, partly allowed the appeal filed by the revenue department.

Case Title: DCIT versus M/s. Cummins Sales & Services (I) Ltd.

Dated: 27.06.2022 (ITAT Pune)

Representative for the Revenue Department/Appellant: Mr. Shivraj B. Morey

Representative for the Assessee/ Respondent: Mr. Ketan Ved

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