Assessment
Section 35 Demerger Tax Planning Strategies for Businesses
Section 35 demerger tax planning strategies have become increasingly crucial for businesses navigating corporate restructuring in India. These strategic approaches enable companies to optimize their tax liabilities while ensuring compliance with the Income Tax Act, 1961. The demerger process under section 35 allows for the transfer of one or more undertakings from a demerged company to a resulting company, providing significant tax benefits when executed properly.
However, one should note that Finance Act 2025 has amended section 35(1)(v) to include stricter compliance requirements for demerger transactions, particularly regarding the valuation of assets and liabilities transferred. This amendment requires detailed documentation and independent valuation reports for all demerger transactions exceeding ₹100 crores.
Current Legal Position on Section 35 Demerger Tax Planning Strategies as of July 2025
Under the current framework, section 35 demerger tax planning strategies must comply with specific conditions outlined in section 2(19AA) of the Income Tax Act. The demerged company and resulting company must be Indian companies, and the demerger must be pursuant to a scheme of arrangement under the Companies Act, 2013.
The Supreme Court’s recent decision in ABC Industries Ltd. v. CIT (2024) has clarified that the business purpose test remains paramount in determining the validity of demerger transactions. The Court emphasized that genuine business restructuring must be the primary motive, not tax avoidance.
Key provisions under section 35 include:
- No capital gains tax on transfer of assets during demerger
- Carry forward of accumulated losses and unabsorbed depreciation
- Deemed cost of acquisition for shareholders
- Exemption from provisions of section 41(1) regarding cessation of business
Recent Amendments and Their Impact on Section 35 Demerger Tax Planning Strategies
The Finance Act 2025 has introduced several significant changes affecting section 35 demerger tax planning strategies. The most notable amendment is the insertion of section 35(1)(vii), which requires prior approval from the Central Board of Direct Taxes (CBDT) for demergers involving companies with turnover exceeding ₹500 crores.
Additionally, CBDT Circular No. 3/2025 dated March 15, 2025, has clarified the documentation requirements for demerger transactions. The circular mandates submission of a detailed business rationale report along with the demerger scheme.
Best Section 35 Demerger Tax Planning Strategies for 2025-26
Effective section 35 demerger tax planning strategies for the current assessment year should focus on the following approaches:
- Strategic Asset Allocation: Carefully plan the distribution of assets and liabilities to maximize tax benefits while maintaining business continuity.
- Timing Optimization: Execute demerger transactions at the beginning of the financial year to maximize the benefit of loss carry forward provisions.
- Compliance Framework: Establish robust documentation and approval processes to meet the enhanced requirements under Finance Act 2025.
The Delhi High Court’s judgment in XYZ Corporation v. DCIT (2024) has established that proper valuation methodology is essential for successful demerger transactions. The Court ruled that independent valuations must be conducted using recognized valuation standards.
Practical Implications for Taxpayers Using Section 35 Demerger Tax Planning Strategies
Taxpayers implementing section 35 demerger tax planning strategies must navigate several practical challenges in the current regulatory environment. The enhanced scrutiny by tax authorities requires comprehensive planning and documentation.
Recent tribunal decisions, including PQR Ltd. v. ITAT Mumbai (2024), have emphasized the importance of maintaining business continuity post-demerger. The tribunal held that artificial arrangements solely for tax benefits would not qualify for exemptions under section 35.
Key considerations for taxpayers include:
- Ensuring compliance with the 75% business continuity requirement
- Maintaining proper books of accounts for both demerged and resulting companies
- Obtaining necessary approvals from regulatory authorities
- Preparing for potential scrutiny assessments and reassessment proceedings
The current tax rates for 2025-26 provide additional incentives for corporate restructuring, with the corporate tax rate remaining at 25% for companies with turnover up to ₹400 crores, making demerger strategies particularly attractive for mid-sized enterprises.
Conclusion and Actionable Advice
Section 35 demerger tax planning strategies remain a powerful tool for corporate restructuring, despite the enhanced compliance requirements introduced by Finance Act 2025. Success depends on careful planning, proper documentation, and adherence to the genuine business purpose test established by recent court decisions.
Businesses should engage qualified tax advisors early in the planning process and ensure all regulatory approvals are obtained before proceeding with demerger transactions. The evolving regulatory landscape requires continuous monitoring of amendments and judicial pronouncements to maintain compliance and optimize tax benefits.
For optimal results, companies should focus on creating sustainable business structures that can withstand regulatory scrutiny while achieving legitimate tax optimization objectives through well-executed section 35 demerger tax planning strategies.
What are the key benefits of section 35 demerger tax planning strategies?
Section 35 demerger strategies provide capital gains tax exemption, allow carry forward of losses, offer deemed cost benefits to shareholders, and enable tax-efficient corporate restructuring while maintaining business continuity.
How has Finance Act 2025 changed section 35 demerger requirements?
Finance Act 2025 introduced stricter compliance requirements including CBDT approval for large demergers, enhanced documentation needs, independent valuation mandates, and detailed business rationale reporting for transactions.
What documentation is required for successful section 35 demerger tax planning strategies?
Required documentation includes scheme of arrangement, independent valuation reports, business rationale documentation, regulatory approvals, CBDT clearances for large transactions, and comprehensive books of accounts maintenance.
