[Opinion] Types and Methods of Demerger

V K Subramani – [2024] 169 taxmann.com 67 (Article)

Corporate entities have to keep on evolving in order to stay relevant in the business world whether its objective is wealth maximization or profit maximization. Every organisation has to be vigilant to adopt and embrace, the changes and challenges to survive. One of the methods of optimal exploitation of resources available with the organisation is to either amalgamate with another entity or disconnect a part of its own spectrum of business. This refresher takes note of the legal provisions of the Income-tax Act, 1961 applicable for demerger besides the methods and types of demerger.

Definition of demerger

Section 2(19AA) says that demerger means transfer pursuant to a scheme of arrangement under sections 230 to 232 of the Companies Act, 2013, by a demerged company (existing) of its one or more undertakings to any resulting company in such a manner that –

• all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;
• all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger;
• the property and 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, this would not apply where the resulting company records the value of the property and liabilities of the undertaking at a value different from the value appearing in the books of account of the demerged company, immediately before the demerger, in compliance to the Indian Accounting Standards specified in Annexure to the Companies (Indian Accounting Standards) Rules, 2015.
• the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis (except where the resulting company itself is a shareholder of the demerged company).
• the shareholders holding not less than 75% in value of the shares of the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company.
• the transfer of the undertaking is on a going concern basis.
• the demerger is in accordance with the conditions, if any, notified under section 72A(5) by the Central Government in this behalf.

Explanation 1 to the section says “undertaking” shall include any part of the undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.

Explanation 2 says that the term “liabilities” referred to in (ii) above, shall include – (a) the liabilities which arise out of the activities or operations of the undertaking; (b) the specific loans or borrowings (including debentures) raised, incurred and utilized solely for the activities or operations of the undertaking; and (c) in cases, other than those referred to in clause (a) or clause (b), so much of the amounts of general or multipurpose borrowings, if any, of the demerged company as stand in the same proportion which the value of the assets transferred in a demerger bears to the total value of the assets of such demerged company immediately before the demerger.

Explanation 3 says that for the purpose of determining the value of the property, any change in value of assets consequent to their revaluation shall be ignored.

Explanation 4 says that for the purposes of this clause, the splitting up or the reconstruction of any authority or a body constituted or established under a Central, State or Provincial Act, or a local authority or a public sector company, into separate authorities or bodies or local authorities or companies, as the case may be, shall be deemed to be a demerger if such split up or reconstruction fulfils such conditions as may be notified in the Official Gazette, by the Central Government.

Explanation 5 says that for the purposes of this clause, the reconstruction or splitting up of a company, which ceased to be a public sector company as a result of transfer of its shares by the Central Government, into separate companies, shall be deemed to be a demerger, if such reconstruction or splitting up has been made to give effect to any condition attached to the said transfer of shares and also fulfils such other conditions as may be notified by the Central Government in the Official Gazette.

Explanation 6 says that for the purposes of this clause, the reconstruction or splitting up of a public sector company into separate companies shall be deemed to be a demerger, if such reconstruction or splitting up has been made to transfer any asset of the demerged company to the resulting company and the resulting company – (i) is a public sector company on the appointed day indicated in such scheme, as may be approved by the Central Government or any other body authorised under the provisions of the Companies Act, 2013 or any other law for the time being in force governing such public sector companies in this behalf; and (ii) fulfils such other conditions as may be notified by Central Government in the Official Gazette in this behalf.

Section 2(19AAA) says that “demerged company” means the company whose undertaking is transferred, pursuant to a demerger, to a resulting company.

Section 2(41A) defines the term “resulting company” as one or more companies (including a wholly owned subsidiary thereof) to which the undertaking of the demerged company is transferred in a demerger and, the resulting company in consideration of such transfer of undertaking, issues shares to the shareholders of the demerged company and includes any authority or body or local authority or public sector company or a company established, constituted or formed as a result of demerger.

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