Corporate Demerger – Corporate Restructuring, Insolvency, Liquidation & Winding-Up Important Questions
Question 1.
What is meant by Demerger? Distinguish between Demerger and Slump Sale
Answer:
- Demerger’ is a form of corporate restructuring in which the entity’s business operations are segregated into one or more components.
- It means division or separation of different undertakings of a business functioning under a common corporate control. It is in fact a corporate partition of a company in two undertakings.
- A demerger is often done to help each of the segments operate more smoothly, as they can focus on a more specific task after demerger.
- Slump sale’ is transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities.
| Demerger | Slump Sale |
| 1. Under demerger, a company transfers its undertakings to a resultant company, specifically incorporated. | Slump sale involves sale of an undertaking for lumpsum consideration without value being assigned to the individual assets and liabilities. |
| 2. Demerger scheme u/ss 230-232 requires approval of members/creditors and sanction of the Tribunal. | Slump Sale requires approval of members only. |
| 3. In demerger, separate valuation of individual assets and liabilities is mandatory. | In a slump sale, individual valuation of assets and liabilities is not carried out. |
| 4. The resulting company is created to carry on business of the transferred undertaking. | In slump sale, the buyer may not continue business of transferred undertaking. |
| 5. Demerger involves reorganization of share capital of the company. | Slump Sale does not involve any change in the share capital of the company. |
| 6. Shareholders of Demerged Company receive shares of Resulting Company. | In slump sale, the shareholders of the company do not get any direct benefit. |
| 7. Income tax benefits are applicable to a scheme of demerger, provided all tax laws are complied with. No tax benefits are provided in a slump sale transaction. | In fact, Indian Income-tax laws are regressive towards slump sale. |
Question 2.
“Demerger is not expressly defined under the Companies Act, 2013”. How does an application move before the National Company Law Tribunal (NCLT) for Demerger under the said Act?
Answer:
A demerger is corporate partition of a company into two or more undertakings, thereby retaining one undertaking with it and transferring j the other undertaking to the Resulting Company.
‘Demerger’, ‘merger’, or ‘amalgamations’ are not expressly defined under Companies Act, 2013. However, Section 230(1) gives a clue about the word demerger.
An application made to the NCLT (Tribunal) u/s 230 for sanctioning a scheme of compromise or arrangement, must specify that the nature of the transaction. The transaction includes a situation where an undertaking, assets and liabilities is proposed to be divided and transferred to two or more companies.
As per the same arrangement, a reorganization of the company’s share capital by consolidation of shares of different classes or by the division of shares into shares of different classes or both. Thus, said explanation indicates appropriateness to move the Tribunal.
Question 3.
“Accounting Standard (AS) 14 is applicable to Demerger” Comment
Answer:
Accounting Standard -14 (Accounting for Amalgamations) is applicable only in case of amalgamation, where two or more companies come together and form a combined entity. Assets, liabilities and undertakings are merged to form a bigger enterprise. AS-14 lays down the accounting and disclosure requirements in respect of amalgamations of companies.
On the other hand, demerger is a corporate partition of an existing company into two or more companies. There is a split where companies are divided into two or more companies. In a scheme of demerger, a new company created known as ‘Resulting Company’ and Original Company is ‘Demerged Company’.
AS – 14 does not apply to a scheme of demerger and it applies only to j scheme of amalgamation. In the case of Sony India Pvt. Ltd. (Sony India) j and Sony Software Centre Pvt. Ltd. (Sony Software), the Delhi High Court clarified that AS-14 is applicable only to amalgamations and not to demerger. Similar ruling was given by the Gujarat High Court in the case of Gallops Realty Pvt. Ltd.
Question 4.
“In comparison to demerger, slump sale is not generally tax-efficient.” Comment briefly with any case that had taken place.
Answer:
A demerger is a corporate partition of a company into two or more undertakings, thereby retaining one undertaking with it and transferring the other undertaking to the Resulting Company. On the other hand, a slump sale involves sale of an undertaking for lump sum consideration without values being assigned to the individual assets and liabilities. Demerger and slump sale are different forms of corporate restructuring and hence different legal provisions are applicable.
Section 2( 19AA) of the Income-tax Act, 1961 defines demerger and provides tax benefits, subject to fulfilment of certain conditions. As per Section 47, where there is a transfer of any capital asset in a demerger by Demerged Company to Resulting Company, such transfer will not be regarded as a transfer for the purpose of capital gains provided the Resulting Company is an Indian company. Thus, there is no income tax on such transactions.
However, slump sale transaction does not attract such tax benefits. As per section 50B of the Income-tax Act, 1961 any profits or gains arising from a slump sale effected in the previous year shall be chargeable to income-tax as capital gains. If an undertaking being transferred is held for more than 36 months, it shall be treated as long-term capital gains, and where the period of holding is up to 36 months, it is treated as short term capital gains. However/even in case of long-term capital assets, no indexation benefit is available for slump sale transactions, which increases the tax liability.
Hence, although slump sale is a legal transaction, but it is not a tax-efficient transaction. Example – in the year 2010, Abbott Healthcare acquired the Formulation Business from Piramal Health Care Ltd. on a slump sale basis.
Question 5.
How does reconstruction differ from demerger?
Answer:
Reconstruction is a wider term than demerger. Reconstruction includes change in capital structure or sale of entire undertaking to another company etc. In reconstruction, a new company (Transferee Company) is formed and the existing company (Transferor Company) is dissolved through the liquidation process. The entire undertaking, including properties, rights and liabilities of the Transferor Company are transferred to the Transferee Company.
The Transferee Company pays the consideration by issue and allotment of its shares to the shareholders of the Transferor Company, as per swap ratio. In this process, the old company is liquidated and is reconstructed in the form of a new company with substantially the same shareholders, same undertaking and business.
A demerger is a corporate partition of a company into two or more entities, thereby retaining one undertaking with it and transferring the other undertaking to the Resulting Company. A scheme of demerger may be carried out by NCLT approval under Section 230 of the Companies Act, 2013 or through sale of an undertaking under Section 180 of the Companies Act, 2013.
All properties and liabilities of the undertaking are transferred by the Demerged Company to the Resulting Company, based on their respective valuations. The Resulting Company issues shares to the shareholders of the Demerged Company.
Question 6.
“Demerger may take the shape of spin-off, split-off or split-up.”Discuss.
Answer:
A demerger is a corporate partition of a company into two or more entities, thereby retaining one undertaking with it and transferring the other undertaking to the Resulting Company.
Following may be the forms of demerger –
(a) Spin-off is a process through which a division or department is converted into a separate company. Shareholders of Holding Company get equity shares in the newly created Subsidiary Company. In a spin-off, the Holding company, as well as Subsidiary company, exist and carry on business separately. Examples of spin-off include Pantaloons Retail spinning off its Food Bazaar business into wholly-owned subsidiary; Air India formed Air India Engineering Services Ltd. by spinning off its engineering division etc.
(b) Split-off is a reorganization process whereby a division is transferred to another company. It also includes a scenario where few shareholders of the parent company are given shares in the division which is split-off in exchange for their shares in parent company.
(c) Split-up is a process by which a single company is divided into two or more companies, through transfer of shares. However, in a split-up, the resulting companies are not subsidiaries of each other. Shareholders of original company get the shares in all the companies created. Generally, the parent company is liquidated.
Question 7.
In a scheme of demerger, what are the tax concessions available to the Demerged Company?
Answer:
If a demerger takes places within the meaning of section 2(19AA) of the Income-tax Act, the following tax concessions shall be available to:
- Demerged company,
- Shareholders of demerged company, and
- Resulting company
Tax concessions to the Demerged Company:
i. Capital gains not attracted:
As per Section 47(vi)(h) of the Income-tax Act, 1961, where there is a transfer of any capital asset in a demerger by demerged company to resulting company, such transfer will not be regarded as a transfer for the purpose of capital gains provided the resulting company is an Indian company.
ii. Tax relief to a foreign demerged company:
According to Section 47(vi)(c) of the Income-tax Act, 1961, where a foreign company holds any share in an Indian Company and transfers the same during the course of a demerger to the resulting foreign company, such transaction will not be regarded as a transfer for the purpose of capital gains under Section 45.
if the following conditions are satisfied:
the shareholders holding not less than 3 /4th in value of the shares of the demerged foreign company continue to remain shareholders of the resulting foreign company, and such transfer does not attract tax on capital gains in the country in which the demerged foreign company is incorporated.
Question 8.
State the salient features of Reconstruction that differs with Demerger.
Answer:
Reconstruction means an act of constructing again, repairing, restoring to former condition or appearance. Generally, the term reconstruction means a transfer of an undertaking or business of a company to another company, specially formed for the purpose.
The old company goes into liquidation and its shareholders are issued and allotted shares in the new company. Under reconstruction, the new company may have different capital structure or different objects, as compared to old company.
However, an essential feature of reconstruction is that the new company’s membership is substantially the same as that of the old company.
Demerger means separation of an undertaking or substantial part of undertaking of Transferor company in favour of Resulting company through process of compromise or arrangement in terms of sections 230-232 of the Companies Act, 2013 approved by NCLT.
All the properties and liabilities attributable to the relevant undertaking are transferred to the Resulting company. Valuation report by a registered valuer is necessary for demerger. Hence, the concepts of reconstruction and demerger are different.
Question 9.
“A scheme of demerger can avail income tax benefits if they satisfy certain conditions.” Discuss.
Answer:
The term Demerger is defined under section 2(19AA) of the Income-tax Act, 1961.
As per this section, a demerger transaction must satisfy the following conditions:
1. Demerger must be by way of a transfer by the demerged company to a resulting company of one or more undertakings belonging to the demerged company
2. Such transfer must be as per scheme of arrangement u/ss 230-232 of Companies Act, 2013
3. All properties and related liabilities of the undertaking transferred immediately before the demerger must become properties and liabilities of the resulting company by virtue of demerger
4. Properties and liabilities must be transferred at values appearing in the books of account of- the demerged company immediately before the demerger. Revaluation of assets must be ignored
5. The consideration to be paid by the resulting company shall be paid to the shareholders of the demerged company and not to the demerged company. Such consideration must be in the form of shares of the resulting company and not in cash or otherwise
6. The shareholders holding not less than 3/4th in value of the shares in the demerged company must become the shareholders of the resulting company by virtue of demerger.
7. The transfer of the undertaking should be on a going concern basis.
8. An outright sale of undertaking is specifically excluded from the concept of demerger under the Income-tax Act. An outright sale of I undertaking can be a slump sale but never a demerger.
Question 10.
What are the types of Demerger?
Answer:
Basically, there are two types of Demerger –
- Partial Demerger – When a division or department of a company is separated and transferred to one or more companies, it is known as partial demerger. In a partial demerger, the Demerged Company continues to maintain its separate legal identity and the new Resulting Company carries on the separated business and undertaking.
- Complete or Total Demerger – In a complete demerger, the whole of the business/undertaking of the Demerged company is transferred to j one or more Resulting companies formed for this purpose. Here, the j Demerged company is dissolved and does not exist after the demerger.
Question 3.
Distinguish between Demerger as per Companies Act, 2013 and Demerger as per Income-tax Act, 1961.
Answer:
| Demerger as per Companies Act | Demerger as per Income-tax Act |
| 1. Demerger can be achieved either as a part of arrangement u/s 230 or by sale of an undertaking under Section 180(1)(a). | Demerger must be only through scheme of arrangement under sections 230-232 of the Companies Act and not otherwise. |
| 2. The Scheme may require payment of consideration to demerged company or to shareholders of the demerged company. | The consideration cannot be paid to the demerged company but only to the shareholders of the demerged company. |
| 3. It is not necessary that all the properties and all the related liabilities need to be transferred to the resulting company. | It is necessary that all the properties and all related liabilities must be transferred to the resulting company. |
| 4. Properties, liabilities transferred could be at values agreed & revaluation values could also be part of values transferred | Properties, liabilities shall be transferred only at book values appearing in the books of account in the demerged company. |
| 5. The resulting company may or may not consist of shareholders of the demerged company. | The resulting company must have as shareholders persons holding not less than 3/4th in value of the shares in the transferor/demerged company. |
| 6. Transfer need not be of a running concern i.e., undertaking transferred need not be carrying on business at the time of transfer. | The transfer must be of a running concern as a transfer must be on a going-concern basis. |
Question 4.
What are the ways of carrying out a scheme Demerger?
Answer:
(a) Demerger by agreement – A demerger may be carried out by an agreement (between promoters) where the demerged company spins off its specific undertaking to a resulting company, formed with another name in such manner that:
All properties of undertaking, being transferred by the Demerged company, immediately before the demerger, becomes property of the resulting company by virtue of the demerger;
All liabilities of undertaking, being transferred by the Demerged company, immediately before the demerger, become the liabilities of resulting company by virtue of the demerger;
The resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerger company on a proportionate basis.
(b) Demerger under scheme of arrangement – A company can carry out a demerger by division of its undertaking in the same manner as it can accomplish compromise or arrangement. Hence, a scheme of demerger can be carried out through sanction by the Tribunal, under provisions of Companies Act, 2013 and based on provisions/powers in Memorandum of Association of the demerged company.
(c) Demerger and Voluntary Winding Up – A company which has split into several companies after division can be wound up voluntarily pursuant applicable provisions of the Companies Act, 2013 and Insolvency and Bankruptcy Code, 2016.
Question 5.
Discuss the concept of Appointed Date and Effective Date in a scheme of Demerger. Give reference of a case law to support your answer.
Answer:
Appointed date means the date for identification of assets and liabilities of existing company for transfer to new company. The ‘appointed date’ (i.e. cut-off date) is used for identification and quantification of the assets and liabilities of the existing (demerged) company and new (resulting) company consequent to the proposed spin-off. This identification is done on the basis of the audited balance sheet of the existing company for the financial year.
In the case of (HCLI Hewlett- Packard Ltd., the Central Government had raised the objection in approving of the scheme of arrangement for spinoff the company’s division with new company that the ‘appointed date under the scheme of demerger was falling prior to incorporation of new company.
The Court overruled the objection by distinguishing the ‘appointed date’ from ‘effective date’. This appointed date is relevant for fixation of the valuation/share exchange rate which the company would offer to the) existing shareholders after bifurcation and spinning off the divisions.
All assets are to be transferred to the new company as on the ‘appointed date’. The appointed date is different from the effective date. An Effective date is a date on which all consents and approvals required under the scheme of demerger were to be obtained and the transfer effected. Hence, objection of Central Govt, that the appointed date under the scheme is falling prior to incorporation of a new company is not sustainable, and the scheme approved.
Question 6.
In a scheme of demerger, what are the tax concessions available to | the shareholders of the Demerged Company?
If a demerger takes places within the meaning of section 2(19AA) of the Income-tax Act, the following tax concessions shall be available to:
- Demerged company
- Shareholders of demerged company, and
- Resulting company.
Tax reliefs to the shareholders of the Demerged Company:
Through demerger, existing shareholders of demerged company will get shares in resulting company. As per Section 47(vi)(d), any transfer or issue of shares by resulting company in a scheme of demerger to the shareholders of the demerged company is not regarded as a transfer if the transferor issue is made in consideration of demerger of the undertaking.
The cost of acquisition of shares in the resulting company shall be the amount which bears to the cost of acquisition of shares held by the assessee in the demerged company the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged company immediately before such demerger.
Period of holding – For computing capital gains, the period of holding shall include duration of resulting company as well as the duration of shareholding of the demerged company.
Question 7.
In a scheme of demerger, what are the tax concessions available to the shareholders of the Demerged Company?
Answer:
If a demerger takes places within the meaning of section 2(19AA) of the Income-tax Act, the following tax concessions shall be available to:
- Demerged company,
- Shareholders of demerged company, and
- Resulting company
Tax reliefs to the Resulting Company:
Expenditure on acquisition of patent or copy-rights – Pursuant to a scheme of demerger, if the demerged company transfers its patents or copy-rights to the resulting Indian company, the deduction u/s 35A shall be applicable to the resulting company, for the balance number of years.
Depreciation u/s 32 – The aggregate deduction against depreciation of tangible and intangible assets is allowable to the demerged company and the resulting company in the ratio of the number of days for which the assets were used by them.
Expenditure on know-how-The Resulting company would be entitled to claim deduction in respect of expenditure on know-how u/s 35AB for the residual period.
Amortization of Preliminary Expenses – The resulting company would be entitled to claim deduction in respect of preliminary expenses, not written off, under Section 35D(5A) for the residual period.
Treatment of Bad Debts – If the debts of demerged company have been taken over by the resulting company and subsequently such debt becomes bad, the same shall be allowed as deduction to the resulting company. (CIT v. Veerbhadra Rao)
Amortization of expenditure in case of Demerger – Where an assessee, being an Indian company, incurs any expenditure (on or after 1 st April 1999), wholly and exclusively for the purposes of demerger of an undertaking, the assessee shall be allowed a deduction of an amount of 1 / 5th of such expenditure for each of the five years, post the year in which demerger takes place.
Carry forward and set off of business losses and unabsorbed depreciation of demerged company. Pursuant to a scheme of demerger, the resulting company would be allowed to carry forward and set off accumulated losses and unabsorbed depreciation, only if these are related to the undertaking proposed to be transferred.