A demerger is a process to separate one or more units and to form a new company. A demerger is a corporate reorganization in the case when a business breaks down, either to function on their own or to liquidate or to be sold. The term ‘demerger’ is not defined under the Companies Act, 2013. However, the explanation to section 230 (1) of the Companies Act, 2013, prescribes arrangement as including a reorganization of the company’s shares capital by the consolidation of shares of different classes or by the division of shares of different levels or by both of these methods.
A demerger under the National Company Law Tribunal (Tribunal) process involves detailed steps with their associated timelines. A demerger is complete only after the Tribunal sanctions the draft scheme, and such order is filed with the registrar of companies. In the case of listed companies, specific additional steps such as intimation to stock exchange are required to be undertaken.
Partial demerger results when a part of a company is separated and transferred to a new company formed with the same shareholders allotted shares in the new company in the same proportion as held by them in the demerged company.
Demerger under a scheme of arrangement with approval by the Court
In order to affect a demerger, there must be a provision for demerger in the Memorandum of understanding of the company. The scheme of such an arrangement has to be submitted in the High Court where the head office of the principle, as well as the resulting company, is registered.
Demerger by agreement between promoters
This is a demerger that takes place by agreement between promoters. In such a demerger, the principle company may spin off its specific undertakings to the resulting new company. All the property, liabilities and issues of the principle company, transferred to this resulting company immediately before the demerger becomes the issues of the resulting company.
Demerger Under Scheme Of Arrangement
On the basis of the powers a company has in its Memorandum, it can carry out division or split of its entity in the same manner as it could accomplish amalgamation through a scheme of arrangement under the provisions of the Companies Act.
Demerger Under Voluntary Winding Up
The original company which has split into several companies after division could be wound up voluntarily pursuant to the provisions of the Companies Act.
Spin-off: In the case of the spin-off, this is a kind of dispossession strategy where the company is separated from the parent company, or it gets divided from its firm. When the companies get a spin-off, the parent company and the distribution company act separately as a corporate entity. It can be regarded as the formation of an independent company through the distribution of new shares which are existing or can be divided from the parent company.
The primary purpose of this type of divestiture is to attract the investments from outside, as after the process of demerger the business unit gets separated. It is presumed that after the spin-off the companies, they will play a meaningful role.
Split up: In this type, when a company splits into a different and independent company, the parent company ceases to exist. When the company splits into separate entities, the shares held by the parent company are exchanged for the shares in the formation of a new company. The shares are distributed depending on the situation as the parent company owns them.
The purpose of adopting this strategy is if the government mandates to curb the monopoly practices of the company, which has a various business line and the management of the company is unable to control them. The business entity can separate to focus on the core business activity.
The following are the significant steps involved in the process of the demerger of a company:
Preparation of the Scheme of Arrangement
In the process of demerger, the essential document is the scheme of arrangement in which the company binds all stakeholders. A scheme of arrangement deals with aspects such as transfer of debts, transfer of employees, the assets and liabilities of the company, the share swap ratio if applicable and many more. This scheme of arrangement is usually proposed by the directors or the liquidator of the company. It is necessary that the scheme of arrangement shall be accepted by all related stakeholders, shareholders, creditors and the employees.
Application in Court
An application should be made to the high court in order to complete the process of a demerger. Moreover, to commence the process of demerger, an application must be filed under form 33 along with the affidavit of promoters. Also, the following documents are mandatory:
- Article of Association and memorandum of the parent company.
- Audited Balance Sheets (latest)
- List of Creditors and Shareholders
- Board Resolution approving the Scheme of arrangement
- Draft of an arrangement scheme.
- Draft related to notice of Meeting, replacement or substitute and Explanatory Statements.
Obtaining a court’s order for holding a meeting of Members or Creditors
The court examines the fairness of the scheme submitted and subsequently issues a summons. The court has to ensure that the scheme is capable of being implemented.
Issuance of Notice
The authorized individuals must issue a notice twenty-one days prior to the date of the meeting along with the proposed arrangement scheme and proxy forms to the interested parties. This notice would be published in the newspaper that is well circulated through Form 38 to the parties who are interested.
A meeting should be conducted as per the guidelines by the court, and the results of the meetings should be recorded. The votes in support or against the motion should also be mentioned in the report. The report in form 39 must be submitted by the chairperson of the meeting within the appropriate time approved by the Court of law.
Petition and Sanction of the Court
A petition has to be submitted to the court for authorizing the demerger. It has to be sanctioned by three-fourth of members/creditors to file an appeal. Once the Court hears the objections, it verifies the applicability of the scheme submitted and later issues an order. The Court would then pass an order approving the demerger in the same newspaper in which the notice of the meeting was advertised.
- Balaji Telefilms: The board of directors of Balaji Telefilms have approved the demerger between the Balaji Telefilms and Balaji Motion Pictures Limited (BMPL).
- Reliance Communications: Reliance Telecom Ltd, a wholly-owned subsidiary of Reliance Communications, will demerge its operations in five circles back into Reliance Communication. The aim of the merge is to combine all Reliance Communication wireless business under one unit.
Aditya Birla Telecom Limited vs DCIT
The taxpayer in the above case is a fully owned subsidiary of Idea Cellular Limited. As per the demerger scheme, all the assets and liabilities of the taxpayer, in this case, were transferred to Idea Cellular Limited without taking anything into consideration before transferring the assets. When the taxpayers evaluated the investments in Indus, and the difference after the evaluation was complete had arisen, the same was transferred to the business restructuring reserve.
The assessing officer held that the demerger was not a good step which was taken under section 50(b) of the income tax act 1961 and that it was just calculated for a short period of capital gain and that the evaluation in the Indus was bound to happen as the part of a full consideration in relation to this case. The taxpayer argued that in case the sale consideration did not exist and that the timely profits can be gained from the value of products so that the seller can tax such a transfer.
The assessing officer then held that no demerger shall arise according to the act and that the taxpayer shall not be eligible for an exemption from paying tax which may arise out of the capital gains under section 47 of the income tax act 1961.
Under the scheme, the taxpayer had transferred all the assets and liabilities without looking into consideration, and the same was approved without any changes or amendments by the Gujarat and the Bombay high court. The tribunal has laid down that in the above case the decision was not fair and the matter was not looked into properly and that consideration in the above case does not fall within a particular provision of the act. Hence, there are no capital gains on transfer under the scheme of demerger, in the absence of consideration.
A demerger is a step taken by companies to boost the value of shareholders in the long run, but the demerged company must fulfil the objective and should maintain a clear perspective of the business to operate separately. The aim of the demerger should be apparent, and the implementation should be conducted by keeping in mind the benefits of all the stakeholders. The concept of the demerger is proved to be a great success in many companies when implemented with extensive planning.