Clause (1B) [Explanation to Section 10(2)(vi)(c) of 1922 Act]: Amalgamation under Income Tax – A Comprehensive Guide

Amalgamation, a common corporate restructuring tool, has specific implications under Indian Income Tax Law. Understanding these implications is crucial for businesses undergoing such processes. This article provides a detailed exploration of Clause (1B) [Explanation to Section 10(2)(vi)(c) of the Indian Income Tax Act, 1922 (as applicable)], focusing on its relevance to amalgamation, along with relevant provisions of the current Income-tax Act, 1961.

Introduction to Amalgamation and Income Tax Implications

Amalgamation, in simple terms, is the merging of two or more companies into a single entity. It can take various forms, but the fundamental outcome is the consolidation of businesses. Under Income Tax law, amalgamation can have significant consequences regarding capital gains, depreciation, and other tax liabilities. Understanding these consequences is essential for proper tax planning and compliance.

Historical Context: Section 10(2)(vi)(c) and Clause (1B)

While the Income Tax Act, 1922 is no longer in effect, its provisions, specifically Section 10(2)(vi)(c) read with Clause (1B) of its Explanation, laid the groundwork for understanding the treatment of depreciation in cases of succession to a business, including amalgamation. Clause (1B) clarified certain aspects relating to the computation of depreciation in such scenarios. It essentially addressed situations where a company ("predecessor") transferred its assets to another company ("successor") as part of an amalgamation.

Understanding the Original Provision: Section 10(2)(vi)(c) of the 1922 Act

Section 10(2)(vi)(c) of the Income Tax Act, 1922, dealt with the allowance of depreciation to an assessee in respect of buildings, machinery, plant, or furniture owned by them and used for the purposes of their business or profession. The ‘Explanation’ to this sub-section contained various clauses that clarified different aspects of depreciation.

Clause (1B) of the Explanation to Section 10(2)(vi)(c) specifically addressed situations where a business or profession was succeeded to by another person, including in the case of an amalgamation. It essentially ensured that the aggregate depreciation allowed to both the predecessor and the successor should not exceed the actual cost of the asset to the predecessor.

Key Aspects of Clause (1B):

• Succession to Business: Applied specifically when a business or profession was succeeded to by another person. Amalgamation was one such form of succession.
• Depreciation Limitation: Stipulated that the total depreciation allowed to both the predecessor (amalgamating company) and the successor (amalgamated company) could not exceed the original cost of the asset to the predecessor.
• Continuity of Depreciation: Allowed the successor to continue claiming depreciation on the assets acquired from the predecessor, subject to the overall cost limitation.

Relevance Under the Income-tax Act, 1961

While the Income Tax Act, 1922 is repealed, the principles established in Section 10(2)(vi)(c) and Clause (1B) of its Explanation are reflected in the current Income-tax Act, 1961, particularly in the provisions related to depreciation and business reorganization. The core concept of limiting depreciation to the actual cost and the principle of continuity in depreciation claims following a succession or amalgamation are retained.

Current Provisions: Depreciation under the Income-tax Act, 1961

The current provisions regarding depreciation are primarily found in Section 32 of the Income-tax Act, 1961, and the Income Tax Rules. Section 32 allows depreciation on tangible assets (buildings, machinery, plant, and furniture) and intangible assets (know-how, patents, copyrights, trademarks, licenses, franchises, or any other business or commercial rights of similar nature) owned by the assessee and used for the purposes of the business or profession.

Amalgamation and Depreciation under the 1961 Act

In the context of amalgamation, the following points are relevant under the current Income-tax Act, 1961:

• Carry Forward of Depreciation: Section 32(1)(ii) allows for the carry forward of unabsorbed depreciation. In an amalgamation, the amalgamated company may be able to carry forward the unabsorbed depreciation of the amalgamating company, subject to certain conditions specified in Section 72A of the Act (discussed further below).

• Depreciation on Transferred Assets: The amalgamated company is entitled to claim depreciation on the assets it receives from the amalgamating company. However, the aggregate depreciation claimed by both companies (amalgamating and amalgamated) is generally limited to the original cost of the asset to the amalgamating company, mirroring the principle in Clause (1B) of the Explanation to Section 10(2)(vi)(c) of the 1922 Act.

• Written Down Value (WDV): The WDV of the assets transferred in the amalgamation becomes the basis for calculating depreciation in the hands of the amalgamated company.

Section 72A: Carry Forward and Set Off of Accumulated Loss and Unabsorbed Depreciation Allowance in Amalgamation

Section 72A is a crucial provision dealing with the carry forward and set off of accumulated losses and unabsorbed depreciation allowance in cases of amalgamation. It provides certain conditions that, if satisfied, allow the amalgamated company to utilize the losses and depreciation of the amalgamating company.

Key Conditions under Section 72A:

• Industrial Undertaking or Ship: The amalgamating company must be engaged in the business of industrial undertaking or ship. Relaxations exist for certain sectors.
• Continuity of Business: The amalgamated company should continue the business of the amalgamating company for a minimum period of five years.
• No Change in Ownership: There should be no substantial change in the ownership of the amalgamated company within two years from the date of amalgamation.
• Prescribed Conditions: The amalgamation must be in the public interest, and other prescribed conditions as laid down in the section and the rules must be satisfied. These often relate to operational efficiencies and business restructuring.
• Approval of Specified Authority: The amalgamation may require approval from a specified authority (often the National Company Law Tribunal – NCLT), depending on the specific circumstances.

Impact of Satisfying Section 72A:

If all the conditions of Section 72A are met, the amalgamated company can carry forward and set off the accumulated losses and unabsorbed depreciation of the amalgamating company against its own profits. This can provide significant tax benefits to the amalgamated entity.

Capital Gains Implications in Amalgamation

Generally, an amalgamation that meets specific conditions is exempt from capital gains tax. Section 47 of the Income-tax Act, 1961, provides a list of transactions that are not regarded as transfers for the purpose of capital gains. Clause (vi) of Section 47 exempts transfers in an amalgamation if the following conditions are satisfied:

• Transfer of Capital Asset: The transfer must be of a capital asset.
• Amalgamating Company: The transferor must be the amalgamating company.
• Amalgamated Company: The transferee must be the amalgamated company.
• Indian Company: The amalgamated company must be an Indian company.
• Conditions of Amalgamation: The amalgamation must satisfy certain conditions as prescribed by the Central Government.

Similarly, Clause (vii) of Section 47 exempts the issue of shares by the amalgamated company to the shareholders of the amalgamating company in consideration of the amalgamation.

Other Relevant Considerations

• Stamp Duty: Amalgamation also involves stamp duty implications, which vary from state to state.

• Goods and Services Tax (GST): The transfer of assets and liabilities in an amalgamation may also have implications under GST.

• Regulatory Approvals: Amalgamation requires various regulatory approvals, including those from the Registrar of Companies, SEBI (if listed companies are involved), and other relevant authorities.

Case Laws and Judicial Interpretations

Various court decisions have further clarified the tax implications of amalgamation. These rulings often address specific issues, such as the interpretation of Section 72A, the valuation of assets, and the applicability of exemptions. Referencing relevant case laws is crucial for a comprehensive understanding of the legal principles.

Example Scenario Illustrating Depreciation in Amalgamation

Let's consider a simplified example:

Company A (Amalgamating Company) has a machine with an original cost of ₹100 lakhs and a WDV of ₹40 lakhs. Company B (Amalgamated Company) absorbs Company A.

• Depreciation Claimable by Company B: Company B can claim depreciation on the machine based on the WDV of ₹40 lakhs. The rate of depreciation will be as per the applicable rate for that type of machinery under the Income Tax Rules.

• Total Depreciation Limitation: The total depreciation claimed by both Company A (before amalgamation) and Company B (after amalgamation) cannot exceed ₹100 lakhs (the original cost of the machine).

• Section 72A Application: If Company B satisfies the conditions of Section 72A, it can carry forward and set off any unabsorbed depreciation of Company A, subject to the limitations prescribed in that section.

Conclusion

Amalgamation is a complex process with significant implications under Indian Income Tax law. While the Income Tax Act, 1922 is no longer in force, the principles underlying Clause (1B) [Explanation to Section 10(2)(vi)(c)] – particularly the limitation of depreciation to the original cost and the concept of continuity in depreciation – remain relevant under the current Income-tax Act, 1961. Understanding the provisions of Section 32 (depreciation) and Section 72A (carry forward of losses and depreciation) is crucial. Businesses contemplating or undergoing amalgamation should carefully analyze the tax implications and seek professional advice to ensure compliance and optimize their tax position. Careful attention to detail in complying with the conditions outlined in these sections is paramount to avail the benefits offered by the Income Tax Act.