Demerger & Business Transfer

A demerger (also referred to as a scheme of arrangement involving division of a company) is effected under Sections 230 to 232 of the Companies Act 2013 through a court-monitored process before the National Company Law Tribunal (NCLT). The process involves filing a petition with the NCLT for calling a meeting of creditors and members, obtaining approvals by a majority of persons representing three-fourths in value of creditors or members present and voting, and securing NCLT sanction of the scheme. The scheme must be filed with the Registrar of Companies in Form INC-28 within 30 days of the NCLT order under Section 232(8) and must also be filed with the stock exchange if either company is listed, following SEBI Circular SEBI/HO/CFD/DIL1/CIR/P/2021/0000000665. Creditors whose debts exceed ₹1 lakh are entitled to receive notice of the scheme under Section 230(3), and the NCLT scrutinises whether the scheme is fair and reasonable to all stakeholders before sanction.

A demerger can be structured as a tax-neutral transaction under Section 2(19AA) of the Income Tax Act 1961 if it satisfies all four conditions: the resulting company must issue shares to the shareholders of the demerged company on a proportionate basis, all properties and liabilities attributable to the undertaking being demerged must transfer to the resulting company, the demerged company must retain at least 75% of its book value of assets, and the resulting company must be an Indian company. When these conditions are met, the transfer of assets from the demerged company to the resulting company is not treated as a transfer for capital gains purposes under Section 47(vib) of the Income Tax Act 1961, and the resulting company takes over the written-down value of depreciable assets. The shareholders of the demerged company who receive shares in the resulting company are not taxed at the time of receipt under Section 47(vid), and their cost of acquisition is determined by apportioning their original cost between the two companies under Section 49(2C). If the conditions of Section 2(19AA) are not satisfied, the transfer is taxable as a capital gain in the hands of the demerged company.

In a tax-neutral demerger under Section 2(19AA) of the Income Tax Act 1961, the unabsorbed depreciation and business losses attributable to the demerged undertaking can be carried forward by the resulting company under Section 72A(4) of the Income Tax Act 1961. The losses must be directly relatable to the demerged undertaking — losses of the demerged company as a whole cannot be transferred unless they are specifically attributable to the undertaking being demerged, which often requires detailed allocation on a reasonable basis. The resulting company can set off these losses against its profits under the normal eight-year carry-forward rule applicable to non-specified business losses under Section 72, or the carry-forward period for unabsorbed depreciation which has no time limit under Section 32(2). The demerged company retains any losses not attributable to the demerged undertaking. This benefit of loss transfer is one of the primary tax motivations for structuring a demerger rather than a slump sale.

Stamp duty on the transfer of assets pursuant to an NCLT-sanctioned demerger scheme is levied under the relevant State Stamp Acts on the instrument of transfer of immovable property and other assets located in each state. Most states do not have a specific exemption for demergers, meaning stamp duty on property transfers can be substantial — for instance, Maharashtra levies stamp duty at applicable rates under the Maharashtra Stamp Act 1958. However, several states have issued notifications granting partial or full stamp duty relief for corporate restructurings sanctioned by the NCLT, and this must be verified state-by-state. The NCLT order itself is not a chargeable instrument, but the actual conveyances and transfer documents executed pursuant to the scheme are. Advance planning for stamp duty liability across all states where assets are located is essential, as it can materially affect the economics of the demerger.

If the demerged or resulting company is listed on a recognised stock exchange, the scheme must be filed with the stock exchanges and SEBI at least 30 days before filing the petition with the NCLT, as required under SEBI Circular SEBI/HO/CFD/DIL1/CIR/P/2021/0000000665 dated August 19, 2021. SEBI has the power to raise objections to the scheme if it is detrimental to the interests of public shareholders, and the NCLT must consider SEBI's report before sanctioning the scheme under the second proviso to Section 230(5) of the Companies Act 2013. If the resulting company is to be listed as a fresh entity, it must comply with SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 — specifically Regulations 37 and 94 — and obtain NCLT approval as well as stock exchange in-principle approval for listing. The listed entity must also ensure compliance with SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011 where post-demerger shareholding patterns trigger open offer obligations, particularly if the promoter's holding in the resulting company crosses the creeping acquisition threshold.