The Companies Act does not define "Demerger".

However, the Income Tax Act has a

definition of "Demerger","Demerged Company" and "Resulting Company".These are
defined by Section 2(19AA), Section 2(19AAA), and Section 2(41A) respectively. The
applicable provisions are Sections 390 to 396A of the Companies Act. Under the
Companies Act, Demerger would amount to "reconstruction".

The procedure is as follows:

1. Incorporate the company which will be the Resulting Company.

2. Frame a scheme of Demerger
3. File a Judges Summons in the High Court praying for an Order convening
separate meetings of the Creditors, Share-holders, or any class of them. Each such
Judges summons must be supported by an
Affidavit and a copy of the Scheme must be annexed to the Affidavit. If all the
Creditors agree to the Scheme, the meeting may be dispensed with. In the case of
a Demerger, it would not be possible to dispense with a meeting of the share-
holders, since under Section 293 (1)(a) of the Companies Act, a general meeting
of the share-holders would be essential before any such Demerger can take place.
4. Notice of the meeting must be given to the Creditors and /or members and sent
individually to each Share-holder/Creditor. Each notice must be accompanied by a
copy of the scheme, explanatory statement as required by Section 393 of the
Companies Act and a proxy form.
5. The notice of meeting must be advertised in such newspapers and in such manner
as the judge may direct. The Advertisement must take place at least 21 clear days
before the date of the meeting,i.e. 21 days notice must be given excluding the date
of advertising of the notice and the date of the meeting.
6. The Chairman of the meeting or other person directed to issue the Advertisement
and notices must file an Affidavit not less than 7 days before the date of the
meeting showing that the directions reg: issue of notices and advertisements have
been duly complied with.
7. On the date of the meeting, the decisions of the meetings must be ascertained only
be taking a poll.
8. The Chairman of each meeting must file a report in the Court within that time
fixed by the Judge or where no time has been fixed, within 7 days after the
conclusion of the meeting. The report must state accurately the number of
creditors or class of creditors or number of members or class of members as the
case may be who were present and who voted at the meeting either in person or
by proxy, their individual values and the way they voted. The report shall be in
Form 39 annexed to the Companies (Court) Rules,1959.
9. Where the proposed Demerger is approved by the various meetings with or
without modification, the company must present the petition to the Court, for
confirmation of the Demerger within 7 days of the filing of the Chairman's
Report.
10. The Court shall fix a date for hearing of the Petition and direct advertising in the
same newspapers in which the notices of the meetings were advertised or in such
 other papers as the Court might direct. The notice must be given not less than 10
days before the date of the hearing.
11. If the Court sanctions the Demerger, it may give such directions as it considers
necessary for the proper working of the Demerger.The certified copy of the Order
must be filed within 14 days from the date of the Order or such other time, as may
be fixed by the Court.
12. Applications for Orders in connection with the Demerger or for any variation, etc.
shall be made under Section 394 by Judges Summons supported by an Affidavit
for directions as to the proceedings to be taken. Notice of the summons shall be
given in such manner and to such person as the Court may direct. On hearing the
Summons, the Court may make such Order or Directions as may be necessary.
13. The Company or any Creditor or Member thereof may at any time after the
passing of the Order sanctioning Demerger, apply to the Court for determination
of any question relating to the working of the compromise or arrangement.
Notices and Advertisements shall be as the Court may direct. The Court may pass
such Orders, give such Directions as it may think necessary.
There is a common misconception amongst the corporate world that demerger and hiving-off are
similar as far as the Indian corporate scenario is concerned, and hence, undertaking corporate
restructuring using any one of the two modes for investment purposes, for raising capital or for
increasing profits through cost-reduction, does not make any difference. This article takes this
view as its starting point and dispels the notion by undertaking analysis of "hiving off" and
"demerger" concepts, both from the legal and taxation perspectives. The article further draws on
the various provisions of Indian company law, Indian tax law and judicial decisions to conclude
that these two concepts are significantly different on various points such as how the consideration
is to be paid and proportioned, how the assets would be valued, how the depreciation will be
carried forward to the investing partner and what would be the cost of assets in the hands of the
investor, depending on whether the transaction is a demerger, or hiving-off. The article
recommends that corporations, both as sellers or as foreign direct investors, ought to be aware of
the implication of both strategies, as choosing one over the other may have considerable financial
advantages as well as undertaking the correct required procedural compliances.

Demerger
The expression ‘Demerger’ is not expressly defined in the Companies Act, 1956. However, it is
covered under the expression arrangement, as defined in clause (b) of Section 390 of Companies
Act.
Division of a company takes place when
1. Part of its undertaking is transferred to a newly formed company or an existing company and
the remainder of the first company’s division/undertaking continues to be vested in it; and
2. Shares are allotted to certain of the first company’s shareholders.

A demerger is a form of restructure in which owners of interests in the head entity (for example,
shareholders or unit-holders) gain direct ownership in an entity that they formerly owned
indirectly (the ‘demerged entity’). Underlying ownership of the companies and/or trusts that
formed part of the group does not change. The company or trust that ceases to own the entity is
known as the ‘demerging entity’.

The entity that emerge have its own board of directors and, if listed on a stock exchange, have
separate listings. The purpose of demerger is to revive a company's flagging commercial fortunes,
or simply to lift its share price.

Mode Of Demerger:
Under the scheme of arrangement with approval of the court U/s 391 of the Companies Act.

Procedure For Demerger:

1. Demerger forms part of the scheme of arrangement or compromise within the ambit of Section
390, 391, 392, 393, 394 besides Sec 394A

2. Demerger is most likely to attract the other provisions of the companies Act, envisaging
reduction of Share capital comprising Sec. 100 to 105

3. The company is required to pass a special resolution which is subject to the confirmation by the
court by making an application.
4. The notice to the shareholders convening the meeting for the approval will usually consist of
the following detail:
(a) Full Details of the scheme
(b) Effect of the scheme on shareholders, creditors employee
(c) Details of the valuation Report

5. An application has to be made for approval of the High Court for the scheme of arrangement

6. It is necessary that the Articles of Association should have the provision of reduction of it’s
Share Capital in any way, and its MOA should provide for demerger, Division or split of the
Company in any way. Demerger thus, resulting into reduction of Companies share capital would
also require the Co. to amend its MOA.

Tax Aspect:
Definition of demerger U/s Section 2(19AA) of the Income Tax Act:
The definition of 'demerger' as given under Section 2(19AA) of the Income Tax Act is unduly
restrictive, and subject to various conditions. Some of the conditions mentioned are:
1. The first condition is that all the property of the undertaking should become the property of the
resulting company.
2. Conditions of Sec 391 to Sec.394 should be satisfied.
3. Similarly, all the liabilities relating to the undertaking immediately before the demerger should
become the liabilities of the resulting company.

4. Explanation 2 provides that not only identified liabilities should be transferred to the resulting
company, but also general borrowings in the ratio of the value of the assets transferred to the total
value of the assets of the demerged company.
5. Assets and liabilities have to be transferred at book value.

Compliance With SEBI Regulations

The SEBI (Disclosure and Investor Protection) Guidelines do provide certain disclosures needed
for protecting the investors. No specific guidelines are presently there. However, in SEBI Press
Release 311-2003 dated December 17, 2003, it has been proposed by SEBI to enforce appropriate
disclosures in case of demerger as in the case of amalgamation.

Hiving Off The Business/Sale Of Undertaking

The term ‘Undertaking’ as interpreted in the present context means a unit, a project or a business
as a going concern. It does not include individual assets and liabilities or any combination thereof
not constituting a business activity.

Under a sale as a going concern, the rights, liabilities and obligations of all the affected parties
(eg. debtors, creditors, employees etc.) are protected. It provides for the continuation of the
running of the undertaking without any interruption.

Precautions to be taken by buyer: in a going concern principle the buyer inherits both benefits and
liabilities from the ongoing contracts that may arise at a later date even with respect to past
transactions. There should be clear provisions in the sale agreements fixing the responsibilities of
the parties in this behalf

Legal Aspects Of Hiving Off:

Memorandum of Association:
Transferor Company: The MOA of the company shall contain a provision empowering the
company “to sell or dispose off the whole or any part of the undertaking, or of any of the
undertaking of the company”. If there is no provision in that regard, then the MOA can be
amended under section 17 of the Companies Act by passing a special resolution.

Transferee Company: The objects clause of the transferee company shall also contain such a
provision for carrying on the business that it seeks to acquire. However it is not necessary that the
objects of the two companies should be in unison.

Consent of the Creditors:

The company needs to take consent of high value creditors in writing, if the assets on which the
loans were raised are transferred (as a part of the industrial undertaking). Only then the loans can
be transferred or the assets can be released from the charge.

Mode of payment of consideration:

The consideration for the transfer of the business/undertaking can take any one of the following
forms:
# Shares;
# Shares and Bonds;
# Cash.

Tax Implications
Capital Gains in the hands of transferor:
The provisions of Section 50B of the Income Tax Act, 1961 provide for the computation of
Capital Gains in case of slump sale.

If the undertaking or division has been held by the transferee for more than 36 months: Any
profits or gains arising from the slump sale effected in the previous year shall be chargeable as
long term capital gains and shall be deemed to be the income of the previous year in which the
transfer took place.

If the undertaking has been owned and held by the transferor for not more than a period of 36
months, the capital gain arising out of such a slump sale shall be treated as short term capital
gains.

Accumulated loss/Depreciation:
In case of slump sale the unabsorbed depreciation or losses can be carried forward only in the
hands of the transferor and unlike in the hands of the transferee in case of demerger.

Depreciation post slump sale:

The purchaser can claim depreciation on the basis of fair apportionment of total consideration as
described earlier.

Demerger Vs. Hiving - Off

1. Consideration:
In case of Hiving- off, the payment of a lump sum sale consideration is required in respect of
transfer of an undertaking by slump sale in demerger the resulting Co. issues, in consideration of
the demerger, it shares to the shareholder of the demerged Co. on a proportionate basis
2. Valuation Of Asset:
In Hiving- off values are not assigned to individual assets and liabilities of the undertaking,
whereas in case of demerger, the assets and liabilities of the demerged Co. are transferred at the
value appearing at the books of accounts immediately before the demerger to the resulting Co.

3. Carry Forward Of Depreciation:

In Hiving- off unabsorbed depreciation/loss can be carried forward only by a transferor Co,
whereas in the case of demerger, the resulting Co. avails the benefit of such depreciation/loss.

4. Cost of Assets in Hands of the Transferee:

In a slump sale, to determine the actual cost of assets transferred, the lump sum consideration
received is apportioned in fair and reasonable manner among the assets, whereas in the case of
demerger the assets are valued at the book value as appearing in the books of transferor.