R. Kumar, B.Com. MBA (Finance)
The term ‘demerger’ simply means one company transferring one or more of its business operations into another company(s). The company that transfers such business operation is known as the “demerged” company, while the company to which the business is transferred is known as the “resulting” company. Demerger is an opposite of merger a statutory disintegration or sepration of two or more companies by the transfer of the properties to one surviving company.
Meaning and definition of Demerger:-
The term ‘demerger’ is derived from the verb ‘demerge’ meaning “separate a business from another particularly to dissolve an earlier merger” and the term ‘demerger’ is defined as “the sepratation of a larger company into two or more smaller organisation”. Demerger is a process of reorganising a corporate structure whereby the capital stock of a division or a subsidiary of a corporation or of a newly affliated company is transferred to the stock holders of the perent corporation without an exchange of any part of the stock of the latter.
As per Black’s Law Dictionary, Eighth edition defines the word “spin-off” to mean:
“1. A corporate divesture in which a division of a corporation becomes an independet company and stock of the new company is distributed to the corporation’s shareholders;
2. The company created by this divesture.”
‘Demerger’ is often used to describe division or separation of different undertakings of a business, functioning hitherto under a common corporate umbrella. “A scheme of Demerger is in effect a corporate partition of a company into two undertakings, thereby retaining one undertaking with it and by transferring the other undertaking to the resulting company. It is a scheme of business reorganization” Justice N.V. Balasubramaniam J in Lucas TVS Ltd. in[Re. CP No. 588 and 589 of 2000 (Mad-Unreported)].
Sec. 2(19AA) of the Act defines the term demerger. “Demerger” in relation to companies, means the transfer, pursuant to a scheme of arrangement, by a demerged company of its one or more undertakings to any resulting company in such a manner that:
- All the assets and the liabilities of the undertaking are transferred from the De-merged company to the resulting company.
- The transfer is effected on a going concern basis and at book value.
- Shareholders holding not less than 75 per cent in value of the shares in the De-merged company become shareholders of the resulting company or companies by virtue of the De-merger.
- In consideration of the De-merger, the resulting company issues its shares to the shareholders of the De-merged company on a proportionate basis. When a transaction satisfies the above conditions, the following tax provisions are applicable.
- Tax benefits and concessions available to any undertaking should be available to the said undertaking on its transfer to the resulting company.
- Accumulated losses and unabsorbed depreciation can be carried forward from the De-merged company to the resulting company.
- Neither the companies nor the shareholders are subject capital gains tax.
- Expenses incurred wholly for the purpose of De-merger are allowed as a deduction in five annual installments of 20 per cent each.
Bajaj Auto Ltd (BAL) has been demerged. Consequently, shareholders of the erstwhile Bajaj Auto Ltd. received shares of the demerged new companies as per the provisions of the demerger. In this case, Bajaj Auto Ltd. has been demerged into resulting companies the same are as follows:
(a) Bajaj Auto Ltd. to focus on the auto business,
(b) Bajaj Finserv Ltd (BFSL) to focus on wind energy generation, insurance, consumer finance etc, and
(c) Bajaj Holdings & Investment Ltd (BHIL) to focus on investments and new business opportunities.
Simultaneously, the name of the erstwhile Bajaj Auto Ltd. has been changed to Bajaj Holdings & Investment Ltd, and the name of the erstwhile Bajaj Holding & Investment Ltd., i.e the company to which the auto business has been transferred, has been changed to Bajaj Auto Ltd.The record date for the demerger is March 25, 2008.
> Consequence of the demerger :- The existing shareholders of Bajaj Auto Ltd. will get one share each in the resulting companies for every share that they held in Bajaj Auto Ltd.
> Tax impact of the demerger:- As per the Income Tax Act, a transaction of demerger per se has no tax implication on the shareholders.
Hence, when the shareholders of Bajaj Auto Ltd. are allotted the new shares in each of the three companies, there would be absolutely no tax implication whatsoever.
The tax implication will only arise when either the shares of Bajaj Auto Ltd. (now BHIL) 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:
1. Whether the new shares (in the resulting companies) are long-term assets or short-term: To find out whether or not shares in the Resulting Companies are long-term or not, the holding period of the original Bajaj Auto Ltd. shares will be included in the period of holding of the new shares
2. Indexation of the capital gains: The indexation will start from the date of allotment of the new shares and not from the date of acquisition of the original Bajaj Auto Ltd. 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
3. Cost of acquisition of various shares after the demerger transaction: 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 Bajaj Auto Ltd. 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 formula that takes into account the proportion of the net worth of Bajaj Auto Ltd. vis-à-vis the book value of the businesses transferred to arrive at the new costs of acquisition.
Bajaj have summarised the net results of the above calculations as per the following table.
Name of company
% of cost of BAL shares
|Bajaj Holding & Investments Ltd.||
|Bajaj Auto Ltd.||
|Bajaj FinServe Ltd.||
The above table indicates the proportion in which your original cost of acquisition of Bajaj Auto shares will be apportioned to the new shares.
Now let’s understand all of the above in terms of an example
Say, Anand had purchased 10 shares of Bajaj Auto for Rs 3,100 on January 10, 2007. Consequently, his total cost of acquisition would be Rs 31,000. Now, post the demerger, his new costs would be as below:
|Bajaj Holding Investment Ltd. (56.5% of Rs. 31,000)||Rs. 17,515|
|Bajaj Auto Ltd. (22.1% of Rs. 31,000)||Rs. 6,851|
|Bajaj FinServe Ltd. (21.4% of Rs.31,000)||Rs. 6,634|
For the per share cost, just divide the above values by the number of shares. For example, Anand’s new cost of acquisition of Bajaj Auto (actually BHIL on account of the change in name) post demerger would be Rs 17,515 divided by 10, which works out to Rs 1,751.50. Ditto for other shares.
Now, let’s say he sells all the above shares on May 15, 2008. Since he has bought the shares on January 10 last year, over 12 months have elapsed and hence the shares will be long-term capital assets. Similarly, for the new shares, the period of holding of the original Bajaj Auto shares (now BHIL) will be taken into account, thereby making these long-term assets, too.
Therefore, since long-term capital gains are tax-free, if any or all of the above shares are sold on a recognised stock exchange, there would be absolutely no tax payable by Anand in the entire process. Were Anand to sell any of the share(s) within one year of the purchase of the original Bajaj Auto shares, he would be liable to pay 15% short-term capital gains tax. The cost of acquisition would continue to be in the proportions explained above.
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