In a recent decision by the Mumbai Income Tax Appellate Tribunal (ITAT) in Sterling Holiday Resorts Ltd. v. DCIT for AY 2015–16, the Tribunal made a strict interpretation of "demerger" under section 2(19AA) of the Income-tax Act, 1961 (ITA), denying the benefit of carry forward of losses under section 72A of the ITA, where the prescribed conditions were not met.

Background

The assessee, Sterling Holiday Resorts Ltd. (formerly Thomas Cook Insurance Services India Ltd. – TCISL), was part of a group restructuring involving Sterling Holiday Resorts (India) Ltd. (SHRIL) (demerged company) and Thomas Cook (India) Ltd. (TCIL) (holding company).

Pursuant to a court-approved scheme of arrangement, the resort and timeshare undertaking of SHRIL was transferred to TCISL, while shares were issued by TCIL to the shareholders of SHRIL.

In the assessment proceedings for AY 2015–16, the assessee claimed carry forward and set-off of accumulated losses and unabsorbed depreciation (INR 240 crore) under section 72A of the ITA, on the basis that the transaction qualified as a tax-neutral demerger.

Notably, while the demerger issue was one of several grounds before the Tribunal, it assumed particular significance given the quantum involved and was ultimately decided against the assessee.

Issue

Whether the transaction qualifies as a "demerger" under section 2(19AA) of the ITA where:

• The undertaking is transferred to one entity (TCISL), but
• Shares are issued by the parent entity (TCIL) which belonged to the same group.

Assessing Officer's (AO) Position

The AO rejected the claim of tax neutrality on the following grounds:

• Non-compliance with section 2(19AA)(iv) of the ITA, as shares were not issued by the resulting company (TCISL) or its wholly owned subsidiary;
• Incorrect identification of resulting company, since TCIL (which issued shares) did not receive the undertaking;
• Separate legal identity of group entities, preventing interchangeability of holding and subsidiary;
• Additionally, that section 72A covers only business losses, not long-term capital losses, a separate, narrower ground for disallowing part of the claimed carry-forward.

Accordingly, the AO concluded that the transaction did not qualify as a demerger and denied benefits of carry-forward and set-off of loss as per section 72A of the ITA to the assessee. This position was upheld by the CIT(A).

Ruling

The Tribunal affirmed the above position and held that the arrangement fails to meet the conditions of section 2(19AA) of the ITA, thereby denying the benefit of section 72A of the ITA.

Key Observations

• Identity of the resulting company is fundamental: The Tribunal held that the same entity must both receive the undertaking and issue shares; the assessee did not issue shares to the shareholders of the demerged company.
• No substitution between holding company and subsidiary: The Tribunal rejected the assessee’s argument that the phrase “including a wholly owned subsidiary” in section 2(41A) permitted interchangeability between the holding company and subsidiary for purposes of issuing shares. It held that the resulting company is the entity that received the undertaking, and that a holding company, being legally distinct from its subsidiary, cannot discharge the subsidiary’s statutory obligation to issue shares.
• Strict compliance for tax neutrality: The Tribunal reiterated that section 72A is a conditional benefit requiring strict, literal compliance with statutory conditions, with no scope for liberal or purposive interpretation in a taxing statute.
• Assessee's reliance on "liberal interpretation" precedents expressly rejected: The assessee had argued for a beneficial/liberal construction, citing various case laws. The Tribunal held this reliance was "misplaced and not relevant to the facts of the case."
• Tribunal's own basis; strict/literal construction of taxing statutes: Relying instead on certain case laws of the Supreme Court, the Tribunal held that taxing statutes must be read literally, with nothing read in or implied, and that statutory conditions cannot be diluted through interpretative flexibility.

Implications

This ruling highlights that tax neutrality in demergers is contingent on strict, literal adherence to statutory mechanics and that arguments for a purposive or liberal reading, which work for other beneficial provisions, carry no weight in this context. 

It remains to be seen whether the assessee has filed a further appeal before the High Court and, if so, how the High Court will interpret the statutory conditions governing tax-neutral demergers. Also, the definition of "demerger" and "resulting company" remains substantively the same under the new Income-tax Act, 2025, and hence, the said ruling may also be relevant for demergers carried out under the new law.

Takeaway

Interestingly, similar group restructuring structures where undertakings are transferred to a subsidiary while shares are issued at the holding company level have been sanctioned in certain National Company Law Tribunal/High Court schemes, which have relied on the Bombay High Court's 2015 sanction of the Thomas Cook group's own scheme.

The present ITAT ruling in a tax assessment proceeding shows that company-law approval of a scheme does not automatically ensure tax neutrality. Structures of this kind may remain vulnerable to challenge from a tax perspective if the specific conditions under section 2(19AA) of the ITA are not strictly met.

Disclaimer: This article is based on publicly available information and the authors’ professional experience and market analysis. For questions regarding the underlying sources or analytical methodologies, please reach out to the author directly. The analysis reflects market trends and observations and is intended for general informational purposes only. It does not constitute investment, legal, or financial advice.