Akanksha Bijalwan (16018) Parthsarthi Gupta (16025) Nikita (16030) BFIA 3

Companies = Orchards
Smart apple farmers routinely saw off dead and weakened branches to keep their trees healthy. Every year, they also cut back a number of vigorous limbs - those that are blocking light from the rest of the tree or otherwise hampering its growth.

And, as the growing season progresses, they pick and discard some perfectly good apples, ensuring that the remaining fruit gets the energy needed to reach its full size and ripeness. Only through such careful, systematic priming does an orchard produce its highest possible yield.
- Dranikoff, Koller and Schneider (2002)

Combinations
Many a times, spin off is used as a precursor of equity carve outs. (15-20% of the shares in the spun off company are offered in the primary market to generate some cash inflow) Split off is sometimes also applied as a second step after an equity carve out, but has also been used independently to take a private subsidiary public.

Operational

Issues and challenges

Legal Tax
Strategic

OPERATIONAL ISSUES

Example : Tyco International

In 2007, Tyco International split into : Covidien, Tyco Electronics, and the original Tyco International. Shortly after the spin-off, then-CFO Chris Coughlin : the health care business, Covidien, had made significant strides in attracting new talent that would probably not have been attracted to the old Tyco.

In a health care company with a clearly defined strategy, employees and prospective employees could see themselves advancing professionally while remaining in health care and playing a significant role in the business.

The challenge
Coughlin : The most challenging part was to get the management teams in place and transferring the technical knowledge from some of the corporate functions that resided at the Tyco headquarters to the two new businesses.

So they set up a formal mechanism to manage the whole transition process and held reviews every month with each function.

LEGAL ISSUES

 Spin-off is considered to be a type of demerger for legal and taxation purposes.

Demerger defined in Sub-section (19AA) of Section 2 of the Income-tax Act, 1961. It means transfer, pursuant to a scheme of arrangement under Sections 391 to 394 of the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company.

Demerger is essentially a scheme of arrangement under Section 391 to 394 of the Companies Act, 1956 requiring approval by:
Majority of shareholders holding shares representing three-fourths value in meeting convened for the purpose; and Sanction of High Court.

Case study
Demerged Company: Zee Telefilms Resulting Companies: Zee News Limited, Wire and Wireless India Limited & ASC enterprise Effective Date: 22nd November 2006 Reason for demerger: Non compliance with the Indian regulations.

According to the Indian regulations, 26% total foreign equity shareholding allowed in News business 49% total foreign equity shareholding was allowed in Cable business & Direct to home (DTH) business.

 Cable and DTH business - demerged into two separate companies and part of the foreign promoter holding in the new company was transferred to Indian promoters. News business - demerged into a new company and the entire foreign promoter holding in the news company was transferred to Indian promoters and FIIs were issued Preference shares in excess of their 26% holding.

TAX ISSUES
Demerged Company Shareholders of the Demerged Company

The Resulting Company Which Emerges as a Result of Demerger.

TAX BENEFITS TO DEMERGED COMPANY

Capital Gain Tax not attracted Tax relief to Foreign Demerged Company (if following conditions are satisfied) 75% of the shareholders of demerged foreign co. continue to remain shareholders Capital gains tax not attracted in the country of its incorporation

TAX BENEFITS TO RESULTING COMPANY

Amortisation of expenditure in case of amalgamation or demerger Depreciation as apportioned The accumulated depreciation losses and unabsorbed

TAX BENEFITS TO THE SHAREHOLDERS OF DEMERGED COMPANY

Dividend - no dividend income shall arise in the hands of shareholders
Capital Gains - not regarded as Transfer for the purpose of Capital Gains.

Reliance Industries Limited

Reliance Industries Ltd. (RIL) has transferred four of its businesses > The Telecom Leg To Reliance Communication > The Coal Based Energy System To Reliance Energy > The Financial Services To Reliance Capital Ventures > The Gas Based Energy Business To Reliance Natural Resources Ltd.

Consequence of the demerger

The existing shareholders of RIL got one share each in the Resulting Companies for every share that they held in RIL.

Tax impact
As per the Income Tax Act, no tax implications on the shareholders.
o The tax implication will only arise when either the shares of RIL or the shares of the new Resulting Companies are sold.

When the shares of any of the companies are sold:

o Whether the new shares (in the Resulting Companies) are long-term assets or short-term. o Indexation of the capital gains. o Cost of acquisition of the various shares after the demerger transaction

Name of Company Reliance Industries Limited

% of Cost of Acquisition of RIL Shares

52.0%

Reliance Communication Ventures Limited

Reliance Energy Ventures Limited Reliance Capital Ventures Limited Reliance Natural Resources Limited

38.7%
7.3% 1.3% 0.7% 100.0%

The proportion in which your original cost of acquisition of RIL shares will be apportioned to the new shares.

RIL (52% of Rs. 53,400) RCVL (38.7% of Rs. 53,400) REVL (7.3% of Rs. 53,400) RCVL (1.3% of Rs. 53,400) RNRL (0.7% of Rs. 53,400) Total o o o o

Rs. 27,768 Rs. 20,666 Rs. 3,898 Rs. 694 Rs. 374 Rs. 53,400

Say, X had purchased 100 shares of RIL for Rs. 534 on January 10th 2005. Now let us say he sells the all the above shares on January 15th. since he has bought the shares on Jan 10th last year, 12 months have elapsed making them long-term capital assets. Therefore, since long-term capital gains are tax-free, if any or all of the above shares are sold on a recognized stock exchange, there would be no tax payable by X in the entire process .

Conditions prescribed for a tax neutral de-merger

All properties and liabilities transferred at book value. Liabilities which arise out of activities or operations Specific loans or borrowings General or multipurpose borrowings to extent of following amount: Total of such borrowings X Value of assets transferred in de-merger Total value of assets of such de-merged company Consideration for de-merger met by issue of resulting company shares At least 3/4th of de-merging company shareholders should become shareholders of resulting company Shares to be issued as consideration to shareholders on a proportionate basis Undertaking should be transferred on a going concern basis

Difference Between Demerger And Slump Sale

o Generally, the gains arising from a demerger are exempt from capital gains tax, while those arising from a slump sale are not. o Demerger : The resulting company must issue, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis. o Slump sale [Section 2(42C)] : Transfer of one or more undertakings as a result of the sale for a lump-sum consideration without values being assigned to independent assets and liabilities.

CASE STUDY: Issue of tax evasion

The income tax department filed its on the ground of tax evasion. Demerger to transfer its passive infrastructure assets' to a group company, no consideration was to be paid by the transferee. After the demerger, the transferee company to be merged with an independent telecommunication tower company. The court observed : The proposed demerger not a mere internal restructuring

Absence of consideration - the scheme would not qualify as an arrangement

Agreement forced and hence not satisfying condition for gift' under Transfer of Property act.

 Transferee - a shell / paper company, an intermediate vehicle for transferring PIAs with the sole purpose of tax evasion. If the PIAs were directly sold to tower company, the transaction would have attracted capital gains tax apart from levy of stamp duties and value added taxes.

Also if the scheme was approved, the transferee would claim tax holiday on the profits derived from the same block of assets, as used by the transferor to claim the tax benefits.
The transferor, under the minimum alternate tax regime artificially reduced its book profits by writing off the assets and depressing its taxable income. The transferee company would also have claimed depreciation on the PIA, thereby resulting in double deduction for tax purposes.

STRATEGIC ISSUES
FOCUSSING ON CORE COMPETENCIES/ RECAPITALISATION
Bajaj Auto

UNLOCKING SHAREHOLDER VALUE

The Reliance Demerger Cadila Healthcare Eveready Industries GE Shipping

HIVING OFF NON-CORE ASSETS

Telecom Companies