When a company transfers its undertaking, properties and liabilities to one or more existing undertaking or new undertaking it is precisely known as Demerger. Interestingly, companies act no where defines or talks about the Merger or Amalgamation or Demerger, rather section 230 of the companies act, 2013 defines it as the compromise or arrangement between company and its creditors or members.
However, section 2 (19AA) of the income tax defines demerger when all the property and liabilities of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property and liabilities of the resulting company by virtue of the demerger. The property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger, however, a 2019 amendment has allowed that valuation can be different provided it has been in compliance of the Indian Accounting Standards.
Let’s understand it from the simple perspective;
A company is owned by its shareholders so in reality they are the owners of Company, so when a company decides that it is going to demerge its existing business into another entity which may be an existing entity or new entity, now this is an event which will result into division of the company’s assets(Fixed and Current), liabilities and ownership of existing shareholder, therefore, any demerger is going to be an arrangement between company and its shareholder/members, an arrangement which defines that how after demerger the rights and interests of shareholders as well as companies will be secured.
Real Case Example
HUL (Hindustan Unilever Limited) is the holding company of Kwality Wall’s India Limited and Kwality is the wholly owned subsidiary of Hindustan Uniliver Limited. HUL decided to demerged the Ice cream and frozen goods undertaking from HUL.
Demerger of Holding and Subsidiary
When a Company demerged its wholly owned subsidiary and demerger results into two independent entities as going concern it is known as demerger. For instance; HUL decided to demerged its wholly owned subsidiary Kwality it is an example of a demerger. So, the company which is demerging its undertaking is known as “Demerged Company” and the Company into which it is demerging its undertaking is known as “Resulting Company”.
Why Demerger
A demerger is a business strategy and the reason for demerger can vary based upon the circumstances and long-term strategy of each Company. If I have to list few common and compelling reason of the demerger, so following are the reasons of demerger in my opinion and understanding;
A. Unlocking the shareholder value
The Large conglomerates often contain unrelated or underperforming units and by demerging, each business becomes a focused, standalone entity, wherein, investors can independently value the business which may lead to higher valuation. It is popular among listed companies (Example Reliance demerger, Hul and Kwality demerger). In case of listed Company, the resulted company post demerger shall be listed on the stock exchange i.e. NSE and BSE. For instance; HUL is already listed on the NSE/BSE and post demerger, Kwality India will be also listed on the stock exchange. HUL and Kwality has clearly specified in their demerger scheme document “the Demerger would create a leading listed ice cream company in India”.
B. Focus on Core Competence
Companies demerge non-core or legacy units that no longer align with their long-term goals and after demerger each entity can follow its own strategy, management, and capital allocation policies.
C. Investment Strategy
Investors or private equity funds may want to invest only in a particular business vertical and Demerger isolates that vertical which is easier for: Investment, Joint ventures and Sale or strategic partnerships.
D. Family-owned or Promoter Settlement
In family run Indian businesses, different promoter groups want control of different business units and demerger allows fair division of business assets. In Indian corporate law history, we have witnessed multiple examples, where, an existing large business was divided among brothers post a long-standing family disputes and demerger is a common strategy in such cases.
E. Operational Efficiency
To attain the independent operational efficiency owing to the fact that demerged entity has an absolutely independent factory, operational team, logistics and process and demerger of the said undertaking shall result into two focused entities with separate businesses. HUL in their demerger scheme has stated that HUL is globally demerging the Kwality business from HUL in view of its different operating model, including differentiated infrastructure for supply and distribution, capital allocation needs, distinct channel landscape and go-to-market strategy, wherein, HUL has sighted it as the prime reason for demerger in India.
F. Preparing for Sale or Divestment
Now with the rise of strong fund houses in India, good GDP growth and rising competition, it has seen that companies tend to demerge their entity so as to attain good valuation and to sell it as an independent asset, as demerger makes the sale, Cleaner, legally clearer and less risky.
G. Tax Efficiency
A demerger structured as a tax-neutral demerger offers benefits if demerger is done in Compliance with Section 2(19AA) of the Income-tax Act.Asno capital gains tax for the demerged or resulting company, no tax for shareholders and carry forward of accumulated losses in some cases which makes restructuring financially efficient.
Procedure under Law
Demerger is done as per the provision of Companies Act (230-232), Income Tax act and special laws as may applicably base upon the circumstances. For instance, SEBI Regulations or Industry Specific Regulations, if any. Every Demerger requires tribunal permission; however, slump sale doesn’t require NCLT permission but in that case Income tax benefit for demerger won’t be available for slump sale. Every demerger scheme shall be approved by the shareholders and creditors as well as interested/affected parties. However, each party who has an opportunity to raise question or objection to any such scheme must raise their objection within defined timeline, which is generally 30 days, otherwise, it will be considered as that department be it Registrar, Regional Director, Income Tax, Liquidator, Sector specific department has no objection to the demerger and Tribunal will conclude it as the acceptance to Demerger.
-Dixit Mehta, Ductus Legal
DUCTUS EDGE 