[Aayush Agarwal is a 3rd year student at Gujarat National Law University, Gandhinagar and Taher Hussain is a 4thyear student at Maharashtra National Law University, Mumbai]
On July 21, 2025, the Select Committee on the Income Tax Bill, 2025, presented its Report (‘the Report’) before the Parliament, analysing various provisions of the new bill and suggesting appropriate changes to it. One of the clarifications provided in the Report by the representatives of the Ministry of Corporate Affairs (‘MCA’), concerning the definition of ‘demerger’ brought to the fore a lesser-known anomaly in the Income Tax Act, 1961 (‘the Act’).
This post seeks to provide a background to the issue of exclusion of the fast-track mechanism from the definition of ‘demerger’ as provided in the Act, present a case for the tax-neutrality of fast-track demergers (‘FTDs’) irrespective of the above exclusion, and discuss the implications arising from such an approach. Finally, the authors suggest certain solutions for the aforementioned issues.
Background
FTDs were introduced with the scheme of fast-track mergers under the Companies Act 2013 (‘2013 Act’) on the recommendation of the JJ Irani Committee Report. Unlike the conventional restructuring route, which is often lengthy and complex, certain classes of companies under this route can effect restructuring without approaching the National Company Law Tribunal (‘NCLT’), requiring only the approval of the Central Government/Regional Director (‘CG’ and ‘RD’). The intent behind this move was to facilitate ease of doing business and promote investments for small companies and wholly-owned subsidiaries. This route is regulated under section 233 of the 2013 Act.
The issue becomes relevant as certain clauses of section 47 of the Act confer tax benefits to approved schemes of demerger. The definition of ‘demerger’ under section 2(19AA) is applicable to the schemes of arrangement under sections 391 to 394 of the Companies Act, 1956 (corresponding to sections 230 to 232 of the 2013 Act). In this context, on a strict construction of these provisions, FTDs would be excluded from such benefits as section 233 is not encompassed within the referenced scheme provisions.
Tax Neutrality of FTDs under Section 47
Irrespective of the above, it is pertinent to emphasize that such a restrictive view of section 47 would lead to absurd consequences, which would restrain the tax authorities from relying on it.
Traditionally, exemption provisions have been construed with regard to their underlying object and purpose, so as to ensure that the intended tax benefits are conferred in the manner envisaged by the legislature. A landmark ruling in this was K.P. Varghese v. ITO, where the Apex Court, in the context of deciding a tax provision, held that the courts are entitled to “modify the language used by the legislature or even ‘do some violence’ to it” if a literal interpretation leads to an absurd or unjust result. In 2018, a Constitution Bench in CC v. Dilip Kumar departed from this approach, ruling that ambiguity in an exemption provision must be interpreted in favour of the Revenue. However, this view was distinguished from the approach to be taken for beneficial exemption provisions in Govt. of Kerala v. Mother Superior, holding that the latter should still be interpreted liberally so as to give effect to their intended purpose.
Against the backdrop of the above rulings, if FTDs are said to be excluded from the ambit of section 47, it would result in a scheme of demerger to qualify for benefits under section 2(19AA), if it followed the elaborate procedure of section 232, but lose out on it, if the assessee adopts the simpler and time-efficient procedure of section 233. Such an illogical result clearly calls for a purposive reading of the provision, including FTDs within the scope of tax benefits.
Further, this provision could be interpreted through section 8(1) of the General Clauses Act, 1897, which deals with the construction of references to repealed enactments. It states that references in any law or document to a repealed provision shall, unless a different intention appears, be read as references to the re-enacted provision.
Sections 233(5) (if CG has any objections) and 233(14) (alternate option for companies given in 233) itself provide for applying to the NCLT under section 232 for approval of the scheme. Thus, it is evident that section 233 routes through section 232 and cannot be read in isolation, and there can be no ‘different intention’ or any ‘different intended purpose’ that can be inferred from the text of the provision. Therefore, section 233 should be interpreted under the same scheme as sections 230-232 and should be allowed a benefit under section 47 of the IT Act and construed liberally.
Implications of Clarifications in the Report
In light of the Bill having attained Presidential assent and subsequently having been notified by the Central Government, it becomes pivotal at the current juncture to analyse the implications arising from the aforementioned exclusion, especially since there has been no clarity on this issue by the Courts or the Legislature.
Set-Off of Accumulated Losses
Section 72A of the IT Act deals with carry-forward and setting-off of accumulated losses for mergers, demergers, and business reorganizations. Specifically, sub-section (4) states that the accumulated losses and allowance for unabsorbed depreciation of the demerged company shall be allowed to be carried forward and set-off in the hands of the resulting company. This allows the resulting company to adjust the losses incurred by it, being under the demerged company, against the gains it makes after the demerger. However, if FTDs are excluded from the scope of section 2(19AA), such benefits of carrying forward of losses and unabsorbed depreciation shall be lost by the resulting company. This may lead to the imposition of immense financial burdens on the resulting company in the form of higher effective tax rates, undermining the financial viability of the fast-track mechanism and potentially discouraging future capital allocationand investment decisions.
Nullification of Purpose of Fast-Track Mechanism
The imposition of taxation on FTDs would effectively negate the benefits originally envisaged for the corporate sector. First, it would become impractical for parties to employ FTDs, due to the extensive liquidity burdens placed on them, especially since the targeted beneficiaries of the fast-track mechanism were start-ups and MSMEs. Secondly, subjecting such transactions to taxation would compel parties to opt for the slower and cumbersome NCLT route, entailing additional months of legal proceedings, associated NCLT filing fees, and potential expenses for statutory publication and hearing-related costs. The cumulative of these consequences would render the fast-track mechanism redundant.
Paradoxical Scenarios
The view taken by the Ministry may lead to inconsistent legal scenarios. Regional Directors under section 233(5) of the 2013 Act have the power to refer an application for demerger to the NCLT if it is of the opinion that the scheme is not in line with the public policy or prejudiced creditors’ interests, thereby triggering the conventional route under section 232.
This regulatory mechanism creates an inherently paradoxical situation, where parties initially denied the benefit may subsequently obtain such a benefit through the very process designed to scrutinize their eligibility. Such procedural inconsistency serves neither the investors’ nor the Revenue’s interests.
Possible Way Forward
The reasoning stated in the Report of excluding section 233 was that fast-track demergers were to take place in the absence of a court-monitored process, which raised risks of tax avoidance by the involved parties. In light of such risks, it was not deemed feasible to allow tax-neutrality to fast-track demergers.
A possible solution to this may be to add a procedural safeguard in the form of introducing a court-appointed valuer in the loop. Under section 233, RD has to form an opinion following the review from the official liquidator and Registrar of Companies. Here, though a view can be taken that the official liquidator has already carried out a valuation, the court-appointed liquidator will keep it in check, and further, NCLT could also act in a supervisory capacity in all these schemes so as to intervene and ask for the details whenever it deems fit. The appointed valuer in this shall not only give his views to the RD but also report to NCLT. This way, NCLT is kept in the loop, though not substantively, eliminating the pitstop.
But this would again pose challenges, as there is no such existing mechanism for continuous judicial oversight, and such oversight would undermine the time and cost efficiencies that the provision was meant to achieve.
Another possible solution to this could be for the company to submit an independent valuer’s report to the RD along with the application, similar to the requirement under section 230(2)(v), which mandates its disclosure to the NCLT. This way, theReport’s argument that the valuation may be altered and may lead to tax avoidance diminishes to a major extent, as the RD (who already consults the official liquidator) could rely on it to ensure objectivity in valuation. Additionally, the MCA could also issue guidelines directing RDs to flag such schemes exceeding certain thresholds or affecting public policy.
Conclusion
Considering the MCA’s efforts to broaden the scope of section 233 of the 2013 Act and following the mature jurisdictions’ efforts, the exclusion of fast-track demergers from the ambit of tax neutrality represents a significant policy misalignment in the view of the authors. While the government’s concern over potential tax avoidance is valid, a blanket denial of benefits undermines the very rationale of introducing section 233. Unless addressed, the current stance risks rendering the fast-track route redundant, disincentivising MSMEs and start-ups from pursuing efficient restructuring. A nuanced legislative or judicial intervention is therefore essential to restore coherence between the demergers scheme and tax policy.
– Aayush Agarwal & Taher Hussain