Background
Consider a case where there is a textile manufacturing company with surplus real estate (say, Company A). In this context, consider that Company A intends to develop the surplus real estate as a commercial or a residential real estate project, the risk profile, and rewards of which are completely disjointed as compared to the textile manufacturing business. Therefore, commercially, it wants to segregate the surplus real estate into a separate company, owing to the fact that the development of real estate commercially in a separate entity would lead to a focused approach on developing the said real estate, the separate entity could also scout for various strategic and financial investors, and the risks from development of real estate are ringfenced vis-à-vis Company A.
Key Issue under Consideration:
The key question is whether the segregation is intended to be in a parallel company, i.e., a company that has a mirror image shareholding as that of Company A, or whether the segregation is intended to be in a subsidiary of Company A?
- Parallel Company Structure: In the case of a parallel company, while the risk profile of the real estate business would be completely delinked from Company A, given the nascent stage of the real estate business, it may require funding from Company A, as well as the strength of Company A’s balance-sheet for seeking fund-based and non-fund-based banking limits. Therefore, a parallel structure may create a complicated structure in terms of cross-funding, and cross-guarantees, which could be tricky to unwind at a later stage, as well as from a valuation standpoint, it may create complications, if an investor entry is sought.
- Tax Leakages in Parallel Structure: Further, from an execution standpoint, the only option could be the sale of surplus real estate by Company A to a parallel company, which would result in capital gains tax implications on Company A, and funding issues for the parallel transferee company to fund the acquisition of the said surplus real estate. The other option could be to simply “demerge” the surplus real estate in a cash-neutral manner; however, given that the real estate assets, per se, without any business activity, would not qualify as an “Undertaking”, the said demerger could be considered as a non-tax neutral demerger, leading to capital gains implications in the hands of Company A, and deemed dividend implications in the hands of the shareholders of Company A.
- Subsidiary Structure: To address the above issues, one could look at a subsidiary structure, where Company A could transfer surplus real estate to a wholly owned subsidiary (say, WOS), and therefore, the WOS could get the funding and balance strength of Company A. However, while the initial transfer of assets, by way of a sale, would be tax exempt u/s 47(iv) of the Income-tax Act, 1961 (“ITA”), being a transfer of a capital asset from holding company to its wholly-owned subsidiary company, if the 100% shareholding is diluted, say, as a result of the entry of an investor in WOS before completion of 8 years from the date of transfer, then the initial transfer would be subject to capital gains tax in the hands of Company.
Problem Statement: Therefore, in the above context, is there any merit in exploring the concept of “Corporate Gift” of surplus real estate by Company A to its WOS?
Mechanics of Corporate Gift: In terms of the mechanics, a corporate gift would effectively result in the transfer of surplus assets by Company A to its WOS, without any consideration payable by WOS to Company A. The following paragraphs analyze key tax, regulatory, and accounting considerations in this regard:
Key Considerations:
- Tax Implications in the hands of Company A i.e., the Transferor Company: Section 47(iii) of the ITA provides that any “gift” of a capital asset is not considered as a “transfer” for the purposes of section 45 of the ITA, and therefore, there should not be any tax implications in the hands of Company A. Further, by claiming this exemption, and not the exemption u/s 47(iv) (i.e., holding company to WOS), there should be no requirement of maintaining 100% shareholding for 8 years, and investor entry could be facilitated. In various judicial precedents, the concept of “corporate gift” in the context of exemption 47(iii) read with Transfer of Property Act, 1882 has been held to be valid.
- Tax Implications in the hands of WOS i.e., the Transferee Company: While section 56(2)(x) of the ITA applies to the transfer of assets (including immovable properties, shares, securities, etc.) in the hands of the transferee company, it does not apply to the receipt of properties from a 100% Holding Company, which is the case here. Also, if the WOS were to record the immovable properties as “stock in trade” and not a capital asset, then one could argue that the deemed income provisions u/s 56(2)(x) may not apply to the transferee company (i.e., the WOS).
- IndAS Implications: If Company A is an IndAS Company, then the book value of real estate assets transferred would be reduced, and be added as a cost of investment in WOS in the books of Company A, effectively, not leading to a truncated balance sheet, which could otherwise happen in case of a demerger. In the books of the WOS, the book value of real estate assets would be recorded at the net book value, with a corresponding credit to a deemed share capital contribution by the holding company, reflected as Other Equity in the books of the WOS.
- Stamp Duty Implications: In the case of Maharashtra, if the real estate is merely transferred through a conveyance deed, then 5% of the reckoner value would be payable as stamp duty at the time of transfer. However, if the real estate is transferred vide a Scheme of Arrangement u/s 230-232 of the Companies Act, 2013, given that the maximum stamp duty is restricted to 10% of the “value of consideration”, and since there is no consideration, there could be a possibility of NIL stamp duty at the time of transfer of such real estate. However, a Scheme of Arrangement would require NCLT approval and approval from other regulatory authorities, and would also require an overall timeline of 7 months for execution (plus 3 months, if Company A is a listed company that requires SEBI/ BSE/ NSE approval).
Summing Up: While corporate gifts are valid under the Companies Act, 2013 and Transfer of Property Act, 1882, it would generally result in tax implications in the hands of the transferee company or entity, with the advent of section 56(2)(x) of the Act. However, in certain circumstances, say, the transfer of capital assets to a wholly owned subsidiary or vice versa, the route of corporate gifts could still be explored, and consequently, the concept of corporate gifts may not be completely bygone.