Grasim’s Rs 5,872-Crore Tax Relief Has Crucial Lessons For Demergers

Grasim Industries Ltd. won the high-stake tax battle relating to its 2017 M&A. The M&A scheme involved the merger of Aditya Birla Nuvo Ltd. and demerger of its financial services business.

During the tax scrutiny, the income tax department raised a demand of over Rs 5,800 crore. The tax office had claimed that the demerger of the financial services business primarily contained investment in shares of a subsidiary that constituted over 95% of the value of the assets demerged. 

In its view, such assets did not constitute an ‘undertaking’ which is critical to classify the transaction as a tax-neutral demerger. The tax office, therefore, held that demerger is not tax-neutral and instead amounted to a ‘deemed dividend’ entailing benefit to Grasim’s shareholders.

The Income Tax Appellate Tribunal, Mumbai bench dismissed the department's case while providing nuanced factual and legal analysis to rule in favour of Grasim.

The order discusses principles relating to an ‘undertaking’ – a pre-requisite for a tax-neutral demerger. A mere holding of shares in a company may not be regarded as an ‘undertaking’.

The guidance from the Tribunal ruling would also assist in future M&As wherein “investment” activities are sought to be segregated from the main business.

Grasim undertook the M&A involving:

• Merger of Aditya Birla Nuvo (ABNL) with Grasim from 1 July 2017.

• Demerger of Financial Services Business (FS Business) of ABNL + Grasim (Merged Entity) into Aditya Birla Financial Services Ltd., later renamed to Aditya Birla Capital Ltd. (ABFSL / ABCL) effective 4 July 2017. ABFSL held 90.23% in Aditya Birla Finance Ltd. (ABFL). ABNL held the balance 9.77% stake in ABFL.

• On 30 June 2017, i.e., a day before the effective date of the merger, a private equity fund acquired a stake in ABFSL.

Typically, a transaction of merger or demerger is tax neutral for the companies and shareholders involved if certain conditions are satisfied. For example, in the case of a demerger, one such requirement is that the business must qualify as an 'undertaking’ and should be transferred as a going concern. An undertaking as per the tax laws includes a part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole. It specifically excludes individual assets or liabilities or their combination which does not constitute a business activity.

The tax authorities held that the FS Business, which has been demerged by Merged Entity to ABNL, did not meet the 'undertaking' criteria. The reason for arriving at this conclusion was that out of the total book value of assets of Rs 1,876 crores belonging to FS Business, shares held in ABFL had a value of Rs 1,729 crores. Tax authorities were thus of the view that the intention was to transfer a 9.77% stake held in ABFL by the Merged Entity to ABNL, and there is no 'undertaking' as such.

Pursuant to demerger, shareholders of the Merged Entity were allotted shares by ABFSL / ABCL based on value of FS Business. The tax officer rejected the tax-neutral demerger and held that Grasim indirectly distributed value equivalent to 9.77% shares in ABFL to its shareholders. Accordingly, the fair value of the shares allotted by ABFSL / ABCL on demerger is treated as a "deemed dividend” distribution at Rs 24,037 crores. The DDT and interest were computed as Rs 5,872 crores.

The litigation has travelled through various forum within the tax department, the High Court on a writ petition and ITAT over the last four years.

The appellate tribunal ruled that the FS 'undertaking' of Grasim constituted a separate business activity. Along with investment in ABFL, other assets worth about Rs 150 crores, including fixed assets, preference shares, inter-corporate deposits, and mutual funds, were transferred. In addition, borrowings, current liabilities and deferred tax liabilities were also transferred. If transferred to a new company, such assets would have required registration as a Non-Banking Financial Company (‘NBFC’) with the Reserve Bank of India. ITAT also held that mere non-disclosure of FS business as a separate business in the tax return form because of insufficient columns therein does not go against the assessee.

ITAT ruled that Grasim's case was not that of loading an extra asset to the undertaking or offloading a critical asset. ITAT undertook an “undertaking” analysis based on various factual aspects (discussed later) around the FS Business of the Merged Entity. ITAT relied on a High Court ruling and held that had it been a mere transfer of shares, it could not have been said to be a transfer of an undertaking. ITAT also concluded that all other conditions for a tax-neutral demerger are satisfied.

On the issue of deemed dividend categorisation[1], ITAT held that there was no distribution by Grasim of any of its assets to the shareholders and in any case, the specific provisions around deemed dividend exclude the distribution of shares pursuant to demerger to the shareholders of the demerged company.

One of the arguments by Grasim was that once the Court approved the Scheme and the tax office did not file any objection during the process, they could not have raised a tax demand later. However, ITAT has ruled that while tax authorities cannot rewrite the provisions of the Scheme, they have a right to examine the taxability of transactions even after the approval by Court/NCLT.

ITAT noted following critical factual aspects while determining if the “undertaking” existed:

• Background and a history of activities in relevant business (in this case - financial).

• Adequate disclosures of the activity as a separate business activity in annual reports, director's reports, financial statements, tax returns (Income-tax and indirect tax), and tax audit reports.

• Discussions in reports by external institutions such as credit agencies.

• Offering income in the tax return as business income.

• Reporting of ‘revenue from operations in the financial statements.

• Involvement of specific Key Management Personnel and employees in operating the financial / investment activity.

• Transfer of employees, licenses, litigations, etc., along with all assets and liabilities pertaining to the financial / investment activity in the Scheme of demerger.

• Regulatory or contractual reasons for carrying out the financial / investment activity through a subsidiary.

A corporate group may consider existence of these and other factors before initiating a scheme.  Alternatively, some of these aspects could be proactively documented to demonstrate the existence of the ongoing business undertaking.  The existence of “undertaking” is crucial not only for demerger but also for “slump sale” transaction.  For slump sale transactions, absence of undertaking, results in adverse income tax as well as GST implications.

Before we sign off, we reiterate the ITAT’s conclusion that a M&A Scheme once approved by the NCLT without any tax objection does not debar tax authorities from examining the scheme during the regular tax scrutiny.

[1] As per Section 2(22)(a) of the Income-tax Act, 1961- any release of assets by a company to its shareholders is regarded as deemed dividend. Therefore, as per the law prevailing at that time, the company was required to pay DDT on such deemed dividend amount.

Ameya Kunte is the founder of boutique consulting firm Globeview Advisors. He co-founded content platform Taxsutra in 2019. Chirag Chordia, manager at Globeview Advisors LLP also contributed to the piece.

The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.