Demerger:Procedure

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 companys division/undertaking continues to be vested in it; and 2. Shares are allotted to certain of the first companys 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 entities 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 its 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.

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.
Taxation Aspects of Demerger in India

TAXATION ASPECTS OF DEMERGER The Income-tax Act, 1961 provides the tax reliefs to the demerged company, the shareholders of the demerged company, who are issued and allotted shares in the resulting company in the exchange for the shares held by them in the demerged company and the resulting company which emerges as a result of a demerger. TAX BENEFITS TO DEMERGED COMPANY: 1. Capital Gain Tax not attracted: As per section 47 (vib) of the Income Tax Act, the transfer of any capital asset by the demerged company to the resulting company will not be regarded as transfer for the purpose of capital gain. 2. Tax relief to Foreign Demerged Company: As per section 47 (vic), where a foreign company holds any shares in an Indian company and transfer the same to resulting company in the course of demerger, such transfer will not be regarded as Transfer for the purpose of capital gain, if following conditions are satisfied: 75% of the shareholders of demerged foreign company continue to remain shareholders of the resulting foreign company. Capital gains tax is not attracted on the demerged foreign company in the country of its incorporation and S. 391 to S. 394 of the Companies Act will not be applicable. TAX BENEFITS TO THE SHAREHOLDERS OF THE DEMERGED COMPANY: 1. Dividend: Section 2(22) (v) provide that no dividend income shall arise in the hands of shareholders of demerged company on demerger.

2. Capital Gains: As per section 47 (vid), any transfer or issue of shares by the resulting company to the shareholders of the demerged company, in scheme of demerger, is not regarded as Transfer for the purpose of Capital Gains. In case, the shareholders transfer these shares subsequent to the demerger, the cost of such shares will be calculated as under: Cost of acquisition of Shares in = resulting Company Net Worth of the demerged company immediately before demerger Cost of acquisition of Shares held by assessee X in the demerged company Net book value of assets transferred in demerger.

We can illustrate and substantiate the concept by means of an example of Reliance Industries Limited which is the Demerged Company and the new companies of which shares were issued are the Resulting Companies. In this case, Reliance Industries Ltd. (RIL) has transferred four of its businesses to four separate companies. The telecom leg has been transferred to Reliance Communication Ventures Ltd, the coal based energy system has been transferred to Reliance Energy Ventures Ltd, and the financial services leg has been transferred to Reliance Capital Ventures Ltd. And lastly the gas based energy business has been transferred to Reliance Natural Resources Ltd. Consequence of the demerger: The existing shareholders of RIL got one share each in the Resulting Companies for every share that they held in RIL. Tax impact of the above: As per the Income Tax Act, a transaction of demerger, per se, has no tax implications on the shareholders. In other words, when the shareholders of RIL are allotted the new shares in each of the four companies, there would be absolutely no tax implication whatsoever. The tax implication will only arise when either the shares of RIL or the shares of the new Resulting Companies are sold. Tax implications when shares are sold: When the shares of any of the companies are sold, it would give rise to capital gains tax liability. The three issues that arise are: Whether the new shares (in the Resulting Companies) are long-term assets or short-term. Indexation of the capital gains. Cost of acquisition of the various shares after the demerger transaction

a) To find out whether or not shares in the Resulting Companies are long-term or not, the holding period of the RIL shares will be included in the period of holding of the new shares. b) The indexation will start from the date of allotment of the new shares and not from the date of acquisition of RIL. Relevance of indexation is only for working out the capital gain amount if the same has to be set-off against capital loss. However, as explained further on, for most shareholders, there will be no need of this. c) To calculate capital gains when the shares are sold, a vital piece of information is the cost of acquisition. Your original cost of acquisition of RIL shares will change now on account of the demerger. Plus there will be a new cost accorded to the new shares of the Resulting Companies. The Income Tax Act specifies a complicated formula that takes into account the proportion of the net worth of RIL vis a vis the book value of the businesses transferred to arrive at the new costs of acquisition. The net results of the above calculations are summarized in the following table: Name of Company Reliance Industries Limited Reliance Communication Ventures Limited Reliance Energy Ventures Limited Reliance Capital Ventures Limited Reliance Natural Resources Limited % of Cost of Acquisition of RIL Shares 52.0% 38.7% 7.3% 1.3% 0.7% 100.0%

What the above table indicates is the proportion in which your original cost of acquisition of RIL shares will be apportioned to the new shares. It Can be understood by an example: e.g. Say, Rakesh had purchased 100 shares of RIL for Rs. 534 on January 10th 2005. Consequently, his total cost of acquisition would be Rs. 53,400. Now, post the demerger, his new costs would as in the table here. RIL (52% of Rs. 53,400) RCVL (38.7% of Rs. 53,400) REVL (7.3% of Rs. 53,400) RCVL (1.3% of Rs. 53,400) RNRL (0.7% of Rs. 53,400) Total Rs. 27,768 Rs. 20,666 Rs. 3,898 Rs. 694 Rs. 374 Rs. 53,400

For the per share cost, the above values be divided by the number of shares. For example, Rakesh's new cost of acquisition of RIL post demerger would be Rs. 27,768 divided by 100 which work out to Rs. 277.68. Now lets say he sells the all the above shares on January 15th. As explained earlier, since he has bought the shares on Jan 10th last year, 12 months have elapsed and hence the RIL shares will be long-term capital assets. Similarly, for the new shares, the period of holding RIL will be taken into account, thereby making these too long-term assets.

Therefore, since long-term capital gains are tax-free, if any or all of the above shares are sold on a recognized stock exchange, there would be absolutely no tax payable by Rakesh in the entire process. TAX BENEFITS TO RESULTING COMPANY: 1. Amortisation of expenditure in case of amalgamation or demerger (Sec. 35DD): Expenses by an Indian company incurred after 1-4-1999 for amalgamation or demerger of an undertaking, shall be amortized @ 20% each year starting from the year in which amalgamation or demerger takes place. 2. Depreciation shall be apportioned between the demerged company and the resulting company in the ratio of number of days for which the assets were used by them. 3. The accumulated losses and unabsorbed depreciation in a demerger shall be allowed to be carried forward by the resulting company 4. Benefits available for demerger are also extended to authorities or boards set up by Central or State Government.