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Introduction:
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.
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Demerger Or Hiving-Off:
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The
author can be reached at: ssagar@legalserviceindia.com /
