The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has held that a holding company cannot issue shares on behalf of its subsidiary to satisfy the statutory conditions for a tax-neutral demerger under Sections 2(19AA), 2(41A), and 72A of the Income Tax Act, 1961.

The bench of Saktijit Dey (Vice President) and Prabhash Shankar (Accountant Member) ruled that failure of the resulting company itself to issue shares to the shareholders of the demerged company disentitles it from claiming the benefit of carry forward and set-off of accumulated business losses and unabsorbed depreciation. 

The appellant/assessee was engaged in the business of vacation ownership and leisure hospitality services. During the relevant assessment year, the Assessing Officer made several additions including disallowance of prior period expenses, ESOP expenditure, and denial of carry forward and set-off of accumulated business losses and unabsorbed depreciation following a court-approved demerger scheme. 

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Both the assessee and the Revenue challenged different parts of the Commissioner (Appeals)’ order before the Tribunal.

The principal controversy related to the interpretation of the expression “resulting company” under Section 2(41A) read with Section 2(19AA) of the Income Tax Act.

Under the approved restructuring scheme: Sterling Holiday Resorts India Ltd. (SHRIL) demerged its resorts and time-share undertaking into TCISL. The remaining business of SHRIL merged into Thomas Cook (India) Ltd. (TCIL). TCIL, and not TCISL, issued shares to the shareholders of SHRIL pursuant to the demerger.

The assessee argued that both the holding company and its wholly owned subsidiary should be treated as the “resulting company” for purposes of Section 2(41A), and therefore issuance of shares by TCIL substantially complied with the statutory requirements.

The Tribunal rejected the assessee’s argument and held that the statutory language leaves no scope for such interpretation.

According to the Bench, Section 2(19AA) expressly requires the resulting company to issue its own shares to the shareholders of the demerged company. Since TCISL—the company receiving the undertaking—did not issue any shares, the mandatory condition was not fulfilled.

The Tribunal observed that a holding company and its subsidiary possess separate legal identities and one cannot discharge the statutory obligations of the other.

It emphasized that permitting the holding company to issue shares on behalf of the subsidiary would amount to rewriting the statutory provision rather than interpreting it.

The Tribunal upheld the denial of set-off of brought forward unabsorbed depreciation of ₹5.19 crore; carry forward of business losses of ₹121.66 crore; and unabsorbed depreciation of ₹113.29 crore claimed under Section 72A(4). 

While rejecting the assessee’s plea for a liberal construction of the demerger provisions, the Tribunal relied upon several Supreme Court judgments reiterating that taxing statutes must be interpreted strictly according to their plain language.

The Bench observed that courts cannot read words into a taxing statute or create an interpretation merely because it appears commercially expedient.

The Tribunal, however, granted substantial relief to the assessee on the issue of Employee Stock Option Plan (ESOP) expenditure amounting to ₹3.19 crore.

It observed that judicial precedents have consistently held ESOP discount to be an allowable business expenditure under Section 37(1) of the Act.

Relying upon decisions including Biocon Ltd., IPCA Laboratories Ltd., Nagarjuna Construction Co. Ltd., and Fortune Park Hotels Ltd., the Tribunal held that ESOP expenditure forms part of employee remuneration and cannot be treated as contingent expenditure merely because shares are issued at a discount.

Accordingly, the Assessing Officer was directed to allow the deduction. 

The assessee had also challenged disallowance of prior period expenses amounting to ₹3.11 crore.

The Tribunal found that both the Assessing Officer and the Commissioner (Appeals) had rejected the claim without adequately examining whether the liability had crystallized during the relevant assessment year.

Observing that the issue required factual verification, the Tribunal restored the matter to the Assessing Officer for fresh adjudication after examining supporting evidence to be produced by the assessee. 

The department challenged the deletion of an addition of ₹44.69 crore relating to deferred income.

The Commissioner (Appeals) had deleted the addition by following earlier Tribunal decisions rendered in the assessee’s own cases.

The Tribunal affirmed that approach, holding that an existing Tribunal decision continues to bind the authorities unless it is stayed or reversed by a higher court.

Accordingly, the department’s appeal was dismissed. 

The Mumbai ITAT partly allowed the assessee’s appeal by restoring the issue of prior period expenses for fresh examination; allowing deduction of ESOP expenditure under Section 37(1); while dismissing the challenge relating to carry forward and set-off of accumulated business losses and unabsorbed depreciation under Section 72A.

The department’s cross appeal challenging deletion of deferred income addition was dismissed in its entirety.

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