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Direct Tax Laws and International Taxation · Business Restructuring

Demerger and Resulting Company Tax Provisions Explained

Updated 11 October 2026 · Fact-checked

A demerger is a court-approved transfer of one or more undertakings of a company (the demerged company) to another company (the resulting company), usually for shares. It is tax neutral only if prescribed conditions are met. To solve questions, test the conditions, then allocate losses under section 116(6): directly relatable losses follow the undertaking, others are split by asset proportion.

Understand Demerger and Resulting Company Provisions

A demerger splits a company. One or more of its undertakings move to another company, called the resulting company. The company that gives up the undertaking is the demerged company. In return, the resulting company normally issues its shares to the shareholders of the demerged company, not to the demerged company itself.

The tax law gives relief to such a split if it is a genuine reorganisation and not a sale. The relief covers the transfer of capital assets, and it works through conditions that the scheme must satisfy. These tax neutrality conditions are not in section 116, and they are not in the text supplied here, so check the exact wording of the Act and the prescribed conditions before the exam. In general terms, they require that: all property and liabilities of the undertaking transfer at book value; the resulting company issues shares to the demerged company's shareholders in proportion to their holding; shareholders holding at least three-fourths in value of shares of the demerged company become shareholders of the resulting company; and the undertaking is transferred as a going concern.

A demerger differs from a slump sale. In a slump sale, an undertaking is sold for a lump sum consideration without values being assigned to individual assets. In a demerger, the consideration is shares issued to shareholders and the scheme is approved by the court. The tax result therefore differs: a demerger meeting the conditions is neutral, while a slump sale gives rise to capital gains in the seller's hands.

Losses are the part examiners like most. Section 116(6) says that, irrespective of anything else in the Act, the accumulated loss and unabsorbed depreciation of the demerged company are dealt with in two ways. If they are directly relatable to the undertakings transferred, they go to the resulting company, which may carry them forward and set them off. If they are not directly relatable, they are apportioned between the two companies in the proportion in which the assets of the undertakings have been retained by the demerged company and transferred to the resulting company.

Section 116(7) lets the Central Government notify conditions to ensure that the demerger is for genuine business purposes. The sub-section only gives this power. It does not state any consequence of breach, so read the question for any notified condition and apply what that condition provides.

Key rules to remember

Loss directly relatable to transferred undertaking
Accumulated loss / unabsorbed depreciation of the transferred undertaking → resulting company (section 116(6)(a))
The resulting company carries forward and sets it off under the other loss provisions of the Act.
Loss not directly relatable
Share of resulting company = Common loss × (Assets transferred ÷ Total assets of the undertakings, i.e. transferred + retained); Share of demerged company = Common loss × (Assets retained ÷ Total assets)
Section 116(6)(b) apportions in the proportion in which assets of the undertakings are retained by the demerged company and transferred to the resulting company.
Meaning of accumulated loss
Business loss (excluding speculation loss) that would have been eligible for carry forward and set off to the demerged company under section 112 had the demerger not occurred
Section 116(13)(a). Loss under other heads and speculation business loss are not covered.
Meaning of unabsorbed depreciation
Depreciation allowance that remains to be allowed and would have been allowed to the demerged company had the demerger not occurred
Section 116(13)(e).
Genuine business purpose conditions
Central Government may notify conditions to ensure the demerger is for genuine business purposes
Section 116(7). It only empowers the Government to notify conditions. Any consequence of breach depends on the notified conditions, so read the facts for any condition.

How to solve Demerger and Resulting Company Provisions questions

Use the same sequence for every demerger question, whether it asks about conditions, loss allocation or the position of the shareholders.

  1. 1Identify the demerged company, the resulting company and the undertaking transferred. Check that it is a transfer of an undertaking as a going concern, with court approval, and not a sale for cash.
  2. 2Test the tax neutrality conditions one by one against the facts: transfer of all property and liabilities at book value, issue of shares to shareholders in proportion, three-fourths shareholders continuing, going concern basis. Note any condition that fails.
  3. 3Decide the outcome. If conditions are met, the transfer is not taxed as capital gains in the demerged company. If a condition fails, say clearly that the tax relief is lost and the transfer may be treated like a normal transfer.
  4. 4Split the losses and unabsorbed depreciation. List what is directly relatable to the transferred undertaking and what is common.
  5. 5Apply section 116(6): relatable amounts go to the resulting company in full. Apportion the common amounts using the asset proportion, transferred versus retained.
  6. 6Confirm the loss is a business loss other than speculation loss, within the carry forward rules of section 112. Note that section 116(7) empowers the Central Government to notify conditions to ensure a genuine business purpose, and apply any such condition the question gives.
  7. 7State the final amounts for each company and write a one-line conclusion.

Quickest way: Two-bucket loss split

When to use it: Use when the question gives losses, depreciation and asset values and asks how much each company gets.

  1. Write two buckets: directly relatable and common.
  2. Move the whole relatable bucket to the resulting company.
  3. Compute the transferred-asset fraction: transferred ÷ (transferred + retained).
  4. Multiply the common bucket by that fraction for the resulting company and by the balance for the demerged company.
  5. Add the figures and check that the total equals the original loss.

Common mistakes in Demerger and Resulting Company Provisions

  • Treating a demerger like a slump sale

    Both involve transferring an undertaking, so students merge them.

    Fix: Ask what is received. Shares issued to shareholders with court approval points to a demerger. A lump sum for the undertaking points to a slump sale.

  • Allocating all losses by asset ratio

    Students remember the ratio rule and apply it to everything.

    Fix: Take directly relatable loss first. Only the loss not directly relatable is apportioned.

  • Using the wrong ratio base for common losses

    Students compare transferred assets with only retained assets, or use liabilities.

    Fix: The text says assets of the undertakings retained and transferred. Use transferred ÷ total of transferred and retained.

  • Carrying forward loss that is not a business loss

    Students include capital loss or speculation loss in the pool.

    Fix: Accumulated loss under section 116(13)(a) covers business loss, excluding speculation. Exclude other losses from the pool.

  • Saying shares go to the demerged company

    Confusion with an ordinary asset sale for shares.

    Fix: In a demerger, the resulting company issues shares to the shareholders of the demerged company in proportion to their holdings.

Worked examples

Example 1

X Ltd demerges its textile undertaking into Y Ltd. X Ltd has an accumulated business loss of ₹60,00,000, of which ₹24,00,000 is directly relatable to the textile undertaking. The remaining loss is common. Assets of the undertakings are: textile ₹30,00,000 (transferred) and other undertakings ₹70,00,000 (retained). How is the loss allocated?

Show the solution
  1. Directly relatable loss ₹24,00,000 goes to Y Ltd under section 116(6)(a).
  2. Common loss = ₹60,00,000 − ₹24,00,000 = ₹36,00,000.
  3. Total assets of the undertakings = ₹30,00,000 + ₹70,00,000 = ₹1,00,00,000.
  4. Y Ltd share of common loss = ₹36,00,000 × 30,00,000 ÷ 1,00,00,000 = ₹10,80,000.
  5. X Ltd share of common loss = ₹36,00,000 × 70,00,000 ÷ 1,00,00,000 = ₹25,20,000.
  6. Y Ltd total = ₹24,00,000 + ₹10,80,000 = ₹34,80,000. X Ltd = ₹25,20,000. Total = ₹60,00,000, which agrees.

Answer: Y Ltd gets ₹34,80,000 and X Ltd keeps ₹25,20,000 of the accumulated loss.

Example 2

P Ltd demerges its hotel division into Q Ltd. P Ltd has unabsorbed depreciation of ₹18,00,000, none directly relatable to the hotel division. Assets transferred are ₹2,00,00,000 and assets retained are ₹6,00,00,000. Allocate the unabsorbed depreciation.

Show the solution
  1. No amount is directly relatable, so the whole ₹18,00,000 is common and falls under section 116(6)(b).
  2. Total assets of the undertakings = ₹2,00,00,000 + ₹6,00,00,000 = ₹8,00,00,000.
  3. Q Ltd share = ₹18,00,000 × 2,00,00,000 ÷ 8,00,00,000 = ₹4,50,000.
  4. P Ltd share = ₹18,00,000 × 6,00,00,000 ÷ 8,00,00,000 = ₹13,50,000.
  5. Check: ₹4,50,000 + ₹13,50,000 = ₹18,00,000.

Answer: Q Ltd gets unabsorbed depreciation of ₹4,50,000 and P Ltd retains ₹13,50,000.

Exam tips

  • Start the answer by naming the demerged and resulting companies. It earns clarity marks and keeps your split correct.
  • Always show the two-bucket split, relatable and common, even when one bucket is nil.
  • Quote section 116(6) for the loss rule and say which clause applies. Quote 116(13) when asked about the meaning of accumulated loss.
  • For a difference between demerger and slump sale, give points on consideration, court approval, valuation of assets and tax result, and write them in a short table-like list.
  • In case-based MCQs, look for a failed condition such as shareholders below three-fourths or a transfer for cash. That usually decides the answer.

Practice questions from Business Restructuring

Demerger and Resulting Company Provisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Demerger and Resulting Company Provisions: frequently asked questions

How are losses allocated in a demerger under the Income-tax Act, 2025?

Under section 116(6), losses and unabsorbed depreciation directly relatable to the transferred undertaking go to the resulting company. Losses not directly relatable are apportioned between the demerged and resulting companies in the ratio of assets retained and transferred.

What is the difference between demerger and slump sale?

A demerger transfers an undertaking to a resulting company, which issues shares to the demerged company's shareholders, with court approval. A slump sale is a transfer for a lump sum consideration without values for individual assets. Conditions met in a demerger give tax neutrality, while a slump sale creates capital gains.

Does the resulting company get the loss without any condition?

Section 116(6) allows the carry forward and set off irrespective of other provisions of the Act, and it does not itself list holding or continuity conditions as section 116(4) does for amalgamation. Section 116(7) empowers the Central Government to notify conditions to ensure the demerger is for genuine business purposes. Read the question for any such condition and apply what it provides.

Is speculation loss carried to the resulting company?

No. The definition of accumulated loss in section 116(13)(a) covers business loss but excludes loss in a speculation business.