Transfer of capital assets between holding and subsidiary company or vice-versa and its tax implications

Dear Friends,

As you are aware that the term "Business Restructuring" is composed of two words," Business" and "Restructuring". We know that the "Business", includes trade, commerce, manufacture, profession etc. The word "Restructuring" means the rearrangement of affairs of a business organization. Reorganization of affairs of a business such that it will sustain in long run and compete, competitive environment. We are living in an ultra-modern society, there is cut throat competition in each field and to survive in this competitive environment we have to change our strategies time to time on the basis of technological developments and strategic partnership so that we stand in the market. An organization will not stand and achieve sustainability in long term, if it will not change according to the modern demand. There are lot of big companies, multinational companies indulge in cross border merger activities to widen their area of activities or expansion and to capture world market. The invention of modern technologies has brought the world in our figure tips and hence it is necessary for an organization to arrange its affairs so that it creates a strong financial as well as a dominating position in the domestic and world market in long run. A business organization have to update its strategies vis-à-vis its competitors and also search areas of possible comparative advantage.

Corporate restructuring is an action taken by the corporate entity to modify its capital structure or its operations significantly. Generally, corporate restructuring happens when a corporate entity is experiencing significant problems and is in financial jeopardy.

WIKIPEDIA

Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Other reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to a crisis or major change in the business such as bankruptcy, repositioning, or buyout. Restructuring may also be described as corporate restructuring, debt restructuring and financial restructuring.

INVESTOPEDIA

Restructuring is an action taken by a company to significantly modify the financial and operational aspects of the company, usually when the business is facing financial pressures. Restructuring is a type of corporate action taken that involves significantly modifying the debt, operations, or structure of a company as a way of limiting financial harm and improving the business.

Corporate Restructuring is a wider term and also involves mergers, demergers, amalgamations, conversions, reorganization of ownerships of business, debts restructuring, loan restructuring etc.

In a case of an organization in distress for not able to pay its creditors apply for loan /debt restructuring so that it will sustain in the market rather than going in liquidation. There are some organizations which are facing problem in decline of sale due to change in choice of customers or due to change technology and availability of new and modern products in the market can acquire another competitor through merger /acquisition for reduce competition in long run. There are thousands of acquisitions have been done by Indian companies in overseas market to capture that market and expand their area of activities. Ow a day we have global presence and Indian companies are the most trusted companies all over the world.

HOLDING AND SUBSIDIARY COMPANIES

A holding company is a type of financial organization that owns a controlling interest in other companies, which are called subsidiaries. The parent corporation can control the subsidiary's policies and oversee management decisions but doesn't run day-to-day operations.

Essentially, if one company holds more than 50% of the shares of another or appoints a majority of the other company’s directors, the second company is a subsidiary of the first. The first company is called the holding company.

If the holding company owns 100% of the shares of the subsidiary, the subsidiary is known as a wholly owned subsidiary (WOS).

On the other hand, a Subsidiary Company is a company whose majority of share capital is hold by another company. When a company A Ltd., whose whole share capital is hold by B Ltd., then A Ltd., becomes subsidiary of B Ltd.

Holding Company

Section 2(46) of the Companies Act, 2013 defines Holding Company. The company is said to be the holding company if that particular company holds/owns at least 50% of the other companies and has the authority to make management decisions, influences and controls the company’s board of directors. A holding company may exist for the sole purpose of controlling and managing subsidiary companies.

Subsidiary Company

Section 2 (87) of the Companies Act, 2013 defines the term subsidiary or subsidiary company. It states that a company is said to be the subsidiary of another company i.e., holding company if the holding company is

1. Controlling the composition of the Board of Directors; or
2. exercises or controls more than one-half (more than 50%) of the total voting power either at its own or together with one or more of its subsidiary companies.

A Holding and Subsidiary structure is generally created to spread area of operations and control of management effectively. Let’s consider a company engaged in FMCG products and also wants to do business of consumer durables and electronics. Then there is difficulty in keeping all these products under one umbrella or under one company, since their process, raw materials, administrative procedures etc. are totally different from others. Then ABC Ltd., in FMCG can establish some subsidiaries suppose XYZ Ltd., doing business of consumer durable and electronics and DEF Ltd., handling soap, oil and other related products. In this way ABC Ltd., having majority shares that is more than 50% control the affairs of XYZ Ltd., and DEF Ltd., and expand its area of operations in different field without any difficulty.

Holding-subsidiary structure can also be used by companies to create different brands and brand categories for different kinds of products. For example, Vivanta is the budget brand of the Taj Group of Hotels. Companies may prefer to house different brands under different verticals. It enables them to bundle a brand and its intellectual property together in the event of a sale. This planning is typically done beforehand or when the company’s operations expand and they need to be ‘organized’ or ‘restructured’ in a new way.

Companies use this structure of subsidiaries when they enter in overseas market and where they form Wholly Owned Subsidiaries (WOS) /Subsidiaries in each country. This model will help then easy entry and exits from the overseas market.

This Holding and Subsidiary structure is also easy and important for investment purpose also. A Holding companies having various subsidiaries in different fields if wants to sale its business or wants some more investment then Holding company can dilute its holding in a subsidiary and allots share of its subsidiary to the investors. A Holding company if wants, then sale its subsidiary to another company directly by transferring its holding to the investing company and interested in particular type of product.

PLEASE NOTE THAT

1. A holding company is not liable for provident dues of a Subsidiary Company.
2. Workmen of subsidiary Company are not workmen of holding Company.
3. It was held that holding company is not liable for wages of its subsidiary company which was under winding up.
4. A holding Company can’t be penalized for violation of foreign exchange provisions of Subsidiary Company.
5. Holding and subsidiary companies are independent legal entities, and are to be treated as such.
6. These can’t be treated as one single unit for all purposes. Holding and subsidiary are separate and distinct legal entities.

TRANSFER OF ASSETS BETWEEN HOLDING AND SUBSIDIARY

SECTION 43(1) In sections 28 to 41 and in this section, unless the context otherwise requires—

Explanation 6 When any capital asset is transferred by a holding company to its subsidiary company or by a subsidiary company to its holding company, then, if the conditions of clause (iv) or, as the case may be, of clause (v) of section 47 are satisfied, the actual cost of the transferred capital asset to the transferee-company shall be taken to be the same as it would have been if the transferor-company had continued to hold the capital asset for the purposes of its business.

Transactions not regarded as transfer

SECTION 47 OF IT ACT,1961

Nothing contained in section 45 shall apply to the following transfers: —

(iv) any transfer of a capital asset by a company to its subsidiary company, if—

(a) the parent company or its nominees hold the whole of the share capital of the subsidiary company, and

(b) the subsidiary company is an Indian company;

(v) any transfer of a capital asset by a subsidiary company to the holding company, if—

(a) the whole of the share capital of the subsidiary company is held by the holding company, and

(b) the holding company is an Indian company:

Provided that nothing contained in clause (iv) or clause (v) shall apply to the transfer of a capital asset made after the 29th day of February, 1988, as stock-in-trade;

1. When a Capital Asset (other than Block of Asset) is transferred

Where a parent company transfers a Capital Assets to its 100% subsidiary company or vice versa, the actual cost of asset transferred to the transferee company will be taken to the same as it would have been if the transferor company had continued to hold the capital asset for the purpose of its business provided that the transferee company is an Indian Company.

2. When a Block of Asset is transferred

Where in any previous year a Block of Asset is transferred by a parent company to its 100% subsidiary company or vice versa, the actual cost of Block of Asset transferred to the transferee company will be taken shall be written down value of the Block of Assets of transferor company for the immediately preceding previous year as reduced by the depreciation actually allowed in relation to the said previous year. Provided that the transferee company should be Indian Company.

SECTION 43(6) Explanation 2

Where in any previous year, any block of assets is transferred,

(a) by a holding company to its subsidiary company or by a subsidiary company to its holding company and the conditions of clause (iv) or, as the case may be, of clause (v) of section 47 are satisfied; or

(b) by the amalgamating company to the amalgamated company in a scheme of amalgamation, and the amalgamated company is an Indian company, then, notwithstanding anything contained in clause (1), the actual cost of the block of assets in the case of the transferee-company or the amalgamated company, as the case may be, shall be the written down value of the block of assets as in the case of the transferor-company or the amalgamating company for the immediately preceding previous year as reduced by the amount of depreciation actually allowed in relation to the said preceding previous year.

PLEASE NOTE THAT

1. Provisions of Sections 47(iv)/(v) are not applicable in case of transfer of Capital Assets made after February 29,1988 as Stock-in -Transfer;
2. The provisions of Sections 47(iv) and (v) are applicable only to immediate subsidiary of a holding company.

3. Withdrawal of exemption given by Section 47(iv)/(v)

any transfer of Capital Assets by a Holding Company to its WOS or vice-versa will not be considered transfer and exemption under Section 47(iv)/(v) will not be available if;

1. if at any time before expiry of eight years from the date of transfer of a Capital Asset between holding company and its WOS, such Capital Asset is converted by the transferee company into (or is treated by it as) Stock-in-trade of its business.
2. The holding company ceases to hold the whole of Share Capital of the WOS before the expiry of periods of eight years from the date of transfer of Capital Asset;
3. The holding/subsidiary company transfers a Capital Asset as Stock-in-trade after February 29,1988. in such case the transfer shall be regarded as "transfer" and shall be taxed according to the provisions of Section 45 of the Income Tax Act,1961.

WITHDRAWAL OF EXEMPTION IN CERTAIN CASES

SECTION 47A OF INCOME TAX ACT,1961

(1) Where at any time before the expiry of a period of eight years from the date of the transfer of a capital asset referred to in clause (iv) or, as the case may be, clause (v) of section 47,—

(i) such capital asset is converted by the transferee company into, or is treated by it as, stock-in-trade of its business; or

(ii) the parent company or its nominees or, as the case may be, the holding company ceases or cease to hold the whole of the share capital of the subsidiary company, the amount of profits or gains arising from the transfer of such capital asset not charged under section 45 by virtue of the provisions contained in clause (iv) or, as the case may be, clause (v) of section 47 shall, notwithstanding anything contained in the said clauses, be deemed to be income chargeable under the head "Capital gains" of the previous year in which such transfer took place.

(2) Where at any time, before the expiry of a period of three years from the date of the transfer of a capital asset referred to in clause (xi) of section 47, any of the shares allotted to the transferor in exchange of a membership in a recognised stock exchange are transferred, the amount of profits and gains not charged under section 45 by virtue of the provisions contained in clause (xi) of section 47 shall, notwithstanding anything contained in the said clause, be deemed to be the income chargeable under the head "Capital gains" of the previous year in which such shares are transferred.

(3) Where any of the conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 are not complied with, the amount of profits or gains arising from the transfer of such capital asset or intangible asset not charged under section 45 by virtue of conditions laid down in the proviso to clause (xiii) or the proviso to clause (xiv) of section 47 shall be deemed to be the profits and gains chargeable to tax of the successor company for the previous year in which the requirements of the proviso to clause (xiii) or the proviso to clause (xiv), as the case may be, are not complied with.

(4) Where any of the conditions laid down in the proviso to clause (xiiib) of section 47 are not complied with, the amount of profits or gains arising from the transfer of such capital asset or intangible assets or share or shares not charged under section 45 by virtue of conditions laid down in the said proviso shall be deemed to be the profits and gains chargeable to tax of the successor limited liability partnership or the shareholder of the predecessor company, as the case may be, for the previous year in which the requirements of the said proviso are not complied with.

COST WITH REFERENCE TO CERTAIN MODES OF ACQUISITION

SECTION 49(3) OF INCOME TAX ACT, 1961

Notwithstanding anything contained in sub-section (1), where the capital gain arising from the transfer of a capital asset referred to in clause (iv) or, as the case may be, clause (v) of section 47 is deemed to be income chargeable under the head "Capital gains" by virtue of the provisions contained in section 47A, the cost of acquisition of such asset to the transferee-company shall be the cost for which such asset was acquired by it.

4. CONSEQUENCES of withdrawal of exemption

On non-compliance of provisions mentioned above and according to the provisions of Section 47A of the Income Tax Act,1961, the cost of Capital Assets transferred in the hand of transferor at the time of transfer will be considered as Cost of Acquisition for calculation of Capital Gain under Section 45.

LET’S CONSIDER THROUGH AN EXAMPLE

S Ltd., is WOS of A Ltd. (both Indian companies and maintain book of accounts on the basis of financial year). On April 10, 1984 (relevant to AY 1985-86), S Ltd., transfers a Capital Asset (i.e., Shares acquired on April 6, 1981 for Rs. 50,000 FMV as on April 1,2001 is Rs. 60,000) to A Ltd., for Rs. 1,50,000/-. A ltd., sells the asset on May 10,2020 for Rs. 3,40,000/-. Determine the assessable profits of S Ltd., and A Ltd., under below mentioned circumstances:

1. Before the sale of asset, A Ltd, has not converted it into Stock-in Trade and it does not cease to hold all shares of S Ltd.;
2. A Ltd. Has converted the Capital Asset into Stock-in trade before its sale on May 1,2020(date of conversion June 10, 1987 FMV Rs. 3,10,000/-);
3. Though A Ltd., does not convert Capital Asset into Stock-in -trade but it ceases to hold entire (100%) share capital of S Ltd., on June 10,1988, when 5% of shareholding of S Ltd., has been transferred to Public.

SOLUTION

1. Under Situation (i)

The transfer of Capital Asset between S Ltd., and A Ltd., will not be considered as a transfer, since it is a transfer between holding company and its WOS and exempted under provisions of Section 47(v) of the IT Act,1961 and hence nothing is chargeable in the hand of A Ltd., as well as S Ltd.

However, on sale of Capital Assets by A Ltd., the Capital Gain will be calculated as;

Sale Consideration Rs. 3,40,000

Less: Indexed Cost of Acquisition: Rs. 1,80,600

[Rs. 60,000*301/100] ===========

Long Term Capital Gain Rs. 1,59,400

============

2. Under Situation (ii)

The profit will be determined as follows

Taxability in case of S ltd

Since A Ltd., has converted Capital Asset transferred within a period of eight years into Stock-in trade of its business, then exemption of provisions of Section 47(v) are not available and hence;

Rs. 1,00,000[ Rs. 1,50,000(Value of asset at the time of transfer -Rs. 50,000(purchase price of asset)] will be treated as Long Term Capital Gain in the hand of S Ltd., by virtue of the provisions of Section 47A of the Income Tax Act, 1961 for AY 1985-86.

Please note that

1. Provisions of Indexation will be available only from AY 1993-94 onwards.
2. If assessment of S Ltd., has completed then AO has power to reopen assessment for this purpose under Section 155(7B) at any time before 4 years from the end of previous year in which Capital Asset is converted into Stock-in-trade (i.e., up to March 31, 1992)

Taxability in hand of A Ltd.

1. As Business Income

Sale Consideration of Shares Rs.3,40,000
Less: Value of Stock-in -trade at the time of sale Rs. 3,10,000
============
As business income u/s 28(i) for AY 2020-21 Rs. 30,000
=============

2. As Capital Gain

Full value of consideration received (FMV Rs.3,10,000
On the date of conversion of Capital Asset
Into Stock-in-trade)
Less: Indexed Cost of Acquisition Rs. 1,80,000
(Rs. 1,50,000*150/125)
============
Long Term Capital Gain for AY 2020-21 Rs. 1,30,000
==============

3. Under Situation (iii) Chargeable Profit will be determined as follows

In hand of S Ltd. Since A Ltd., has transferred Capital Assets before expiry of eight years from the date of transfer of Capital Asset and hence the exemption provided in provisions of Section 47(v) are not available and

Rs. 1,00,000[ Rs. 1,50,000(Value of asset at the time of transfer -Rs. 50,000(purchase price of asset)] will be treated as Long Term Capital Gain in the hand of S Ltd., by virtue of the provisions of Section 47A of the Income Tax Act, 1961 for AY 1985-86.

Please note that

• provisions of Indexation will be available only from AY 1993-94 onwards.
• If assessment of S Ltd., has completed then AO has power to reopen assessment for this purpose under Section 155(7B) at any time before 4 years from the end of previous year in which Capital Asset is converted into Stock-in-trade (i.e., up to March 31, 1992)

In hand of A Ltd. -Capital Gain will be determined as follows

Full value of consideration received Rs.3,40,000
Less: Indexed Cost of Acquisition Rs. 4,51,500
(Rs. 1,50,000*301/100)
============
Long Term Capital Loss for AY 2020-21 Rs. (-1,11,500)
=============

CONCLUSION

From above discussion it is clear that any transfer from a wholly owned subsidiary to holding or vice-versa of Capital Assets will not be considered as transfer and exempted under provisions of Sections 47(iv)& (v) of the Income Tax Act, 1961. The above exemption is available only on fulfilment of specified conditions.

DISCLAIMER: the article produced here is only for knowledge and information of readers. the views expressed here are the personal views of the author and same should not be considered as professional advice. In case of necessity do consult with professionals for more clarity and understanding on subject matter.