What is a Demerger?
A demerger (also known as a spin-off or corporate split) is a form of corporate restructuring in which a company transfers one or more of its undertakings to a resulting company or companies. The demerged company continues to exist after the demerger, unlike in a merger where the transferor company ceases to exist.
Key Characteristics of Demerger
- • Transfer of one or more undertakings from the demerged company
- • The demerged company continues to exist after the transfer
- • Resulting company issues shares to shareholders of the demerged company
- • All assets and liabilities of the undertaking are transferred
- • Shareholders become direct owners of both companies
- • Can be done through court-approved scheme or slump sale
Reasons for Demerger
Strategic Focus
Separate businesses can focus on their core competencies without distraction from unrelated operations.
Unlock Value
Different business segments may be valued higher as separate entities than as part of a conglomerate.
Regulatory Requirements
Competition authorities may require divestment of certain businesses for M&A approvals.
Risk Isolation
Separate legal entities can isolate risks and liabilities to specific businesses.
Types of Demergers
1. Court-Approved Demerger (Scheme of Arrangement)
A demerger carried out under Sections 230-232 of the Companies Act 2013 with NCLT approval. This is the most common form for large companies and listed entities.
- • Requires shareholder and creditor approval
- • NCLT sanction is mandatory
- • Can achieve tax-neutral status
- • Most suitable for complex restructurings
2. Slump Sale Demerger
Transfer of an undertaking for a lump sum consideration without assigning specific values to individual assets and liabilities.
- • Governed by Section 180(1)(a) of Companies Act
- • Board approval with special resolution
- • No court approval typically required
- • Different tax treatment compared to court-approved demerger
3. Hive-off (Asset Transfer)
Specific assets and liabilities are transferred to a new or existing company without transferring the entire undertaking.
4. Spin-off
A type of demerger where a division becomes an independent company with shares distributed to existing shareholders.
5. Split-off
Shareholders exchange their shares in the parent company for shares in the spun-off entity, resulting in reduced shareholding in the parent.
Legal Framework
Companies Act 2013
- Sections 230-232: Power to compromise, arrange, and make arrangements including demergers
- Section 180(1)(a): Restrictions on sale of undertakings (slump sales)
- Section 110: Prohibition on variation of shareholders' rights
- Sections 66-67: Reduction of share capital (if applicable)
Income Tax Act 1961 - Tax Neutral Demerger (Section 2(19AA))
For a demerger to be tax-neutral, the following conditions must be met:
- • All assets and liabilities of the undertaking are transferred to the resulting company
- • Transfer is made to an Indian company
- • Resulting company issues shares to shareholders of the demerged company on a proportionate basis
- • Shareholders holding at least 3/4ths in value of shares in the resulting company are the same as those holding shares in the demerged company
- • Transfer is on a going concern basis
- • Resulting company holds at least 50% of book value of fixed assets for at least 3 years
- • Business of undertaking is carried on for at least 3 years
Other Regulatory Framework
SEBI Regulations
Listed companies must comply with SEBI (LODR) Regulations, including disclosure requirements and shareholder approval processes.
Competition Act
CCI approval may be required if the demerger meets combination thresholds.
FEMA
Foreign investment aspects in resulting companies require FEMA compliance.
Sectoral Regulators
RBI, IRDAI, TRAI, etc. may need to be notified depending on the industry.
Demerger Process Step-by-Step
Stage 1: Preliminary Assessment
- • Identify undertaking(s) to be demerged
- • Valuation of the undertaking
- • Structuring the demerger (court scheme vs slump sale)
- • Tax impact assessment
- • Regulatory approval requirements
Stage 2: Preparation of Resulting Company
- • Incorporate resulting company (if new entity)
- • Ensure authorized capital is sufficient
- • Appoint directors and key personnel
- • Open bank accounts
Stage 3: Valuation
- • Appoint registered valuers
- • Determine fair value of undertaking
- • Fix share exchange ratio (for court-approved demergers)
- • Obtain fairness opinion
Stage 4: Draft Scheme of Arrangement
- • Define transfer of assets and liabilities
- • Treatment of employees
- • Share issuance ratio
- • Pending litigation allocation
- • Conditions precedent
Stage 5: Board Approvals
- • Board resolution approving the scheme
- • Authorize filing with NCLT
- • Appoint valuers and advisors
Stage 6: Court Process (for Court-Approved Demerger)
See detailed section on Court Approval Process below.
Stage 7: Transfer and Compliance
- • Transfer of assets and liabilities
- • Allotment of shares to shareholders
- • Update statutory records
- • Intimate regulators and stakeholders
Court Approval Process
For a court-approved demerger, the following NCLT process must be followed:
Filing with NCLT
File petition in Form NCLT-1 with draft scheme, explanatory statement, and affidavit.
NCLT Directions
NCLT issues directions for calling meetings of shareholders and creditors.
Notice and Advertisement
Publish notice in newspapers and send individual notices to stakeholders.
Shareholder/Creditor Meetings
Approval by 3/4th majority in value of members/creditors present and voting.
Report to NCLT
Chairperson files report on voting results with NCLT.
Second Motion Hearing
NCLT considers objections and evaluates fairness of scheme.
NCLT Order
NCLT sanctions the scheme if fair and reasonable to all stakeholders.
Filing and Effectiveness
File certified copy with ROC. Scheme becomes effective on specified date.
Accounting Treatment
In the Books of Demerged Company
- • Assets and liabilities of the undertaking are removed at book values
- • Investment in resulting company is recorded
- • Reduction in share capital (if applicable)
- • Any surplus/deficit transferred to reserves
In the Books of Resulting Company
- • Assets and liabilities recorded at book values from demerged company
- • Share capital increased by issuing shares to shareholders
- • Capital reserve created for any excess of assets over consideration
Ind AS 103 (Business Combinations)
Demergers under common control are accounted for using the pooling of interests method. Assets and liabilities are recorded at carrying amounts from the demerged company's books.
Tax Implications
Tax-Neutral Demerger Benefits
When a demerger satisfies Section 2(19AA) conditions:
- • No capital gains tax on transfer of assets to resulting company
- • No capital gains in hands of shareholders on receipt of shares
- • Carry forward of losses and depreciation allowed to resulting company
- • Cost of acquisition of shares in resulting company is determined proportionately
Carry Forward of Losses (Section 72A)
Accumulated losses and unabsorbed depreciation attributable to the undertaking can be carried forward by the resulting company for the remaining period.
GST Implications
Transfer of business as a going concern is not treated as supply under GST and is not taxable. However, specific registrations may need to be transferred or cancelled.
Stamp Duty
Stamp duty is payable on transfer of immovable properties and certain other assets. Rates vary by state. Some states provide concessional rates for court-approved demergers.
Treatment of Employees
Automatic Transfer
Employees engaged in the undertaking being demerged are automatically transferred to the resulting company on the same terms and conditions of employment.
Key Considerations
- • Continuity of service for gratuity and other benefits
- • Transfer of PF and ESI records
- • ESOP/phantom stock adjustments
- • Retention of key employees
- • Communication and change management
No Compensation for Change of Employer
Since the transfer is by operation of law under a court-approved scheme, employees are not entitled to compensation merely due to the change in employer.