A demerger is a powerful corporate restructuring tool used to carve out a business undertaking into a separate entity. Whether the goal is to enhance operational focus, unlock shareholder value, or prepare a specific division for a future sale (hiving off), the primary objective is almost always to achieve tax neutrality for both the company and its shareholders.

The Holistic View of a Demerger

Unlike an asset sale or a slump sale, a demerger is often a court-monitored process that ensures a seamless “vertical split.” It is a holistic transformation where the resulting company mirrors the specific division of the parent company.

To be recognized as a ‘demerger’ and qualify for tax exemptions under Section 2(19AA) of the Income Tax Act, 1961 (ITA), the transaction must satisfy six core conditions:

• Transfer of a Functional Undertaking: The transfer must involve an entire business activity taken as a whole, rather than a mere cherry-picking of individual assets.
• The Going Concern Principle: The resulting company must continue the operations of the transferred unit without interruption.
• Total Transfer of Obligations: Every asset and, crucially, every liability associated with that specific undertaking must move to the new entity.
• Book Value Continuity: To prevent artificial revaluations, assets and liabilities must be transferred at the values appearing in the demerged company’s books immediately before the split.
• Shareholder Continuity: Shareholders holding at least three-fourths (75%) in value of the shares in the original company must become shareholders of the new company.
• Proportionate Issuance: The new company must issue shares to the existing shareholders on a proportionate basis.

Unlocking Tax Benefits under Section 47 of ITA

When the rigorous criteria of Section 2(19AA) are met, the transaction becomes tax-neutral under Section 47, providing a “safe harbour” from capital gains:

1. At the Corporate Level (Sec 47(vib)): The transfer of capital assets from the Demerged Company to the Resulting Company is exempt from Capital Gains Tax.
2. At the Shareholder Level (Sec 47(vic)): Shareholders do not face a tax liability when they receive new shares in the resulting company in exchange for the value “split” from their original holdings.

Market Insight: Major Indian restructurings, such as the Reliance Industries’ demerger of its financial services arm into Jio Financial Services, utilize this route to ensure that billions in value can be unlocked for shareholders without triggering an immediate, massive tax outflow.

Our Specialized M&A Team: End-to-End Solutions

A demerger is a high-stakes regulatory marathon. The definition of an “undertaking” is one of the most litigated areas of Indian tax law, making meticulous documentation and strategic planning non-negotiable.

We provide a seamless, 360-degree approach to these transitions:

• Strategic Deal Structuring: We analyse your business to ensure the split qualifies for tax neutrality, avoiding the “deemed dividend” or “capital gains” traps.
• End-to-End Execution: Our team can assist you during the entire demerger process by reviewing all documents from a tax perspective.

Ready to streamline your corporate structure? Contact us today to ensure your business split is executed with maximum financial efficiency and global compliance.