Back Severance of the umbilical chord
S. Murlidharan
| S. Murlidharan on the tax implications of the so-called demerger of Reliance |
In the family settlement following the sibling rivalry that hogged headlines for months, the latter three companies have gone to the younger brother Anil Ambani; RIL would remain with Mukesh Ambani . Attempts are being made to sever the three companies from RIL's umbilical chord. And this attempt is being loosely termed as `demerger'.
This exercise does not pass muster under the definition of the term given in the Income-Tax Act, 1961 as well as under the one given informally by the commercial world. The term `demerger' became a buzzword during the last decade when the corporate mantra was `core competence'. When the core competence theory held sway — it is now being re-examined if not completely given up — companies dropped their unrelated activities (those that did not add synergy to its main line activity) like hot potatoes. These unrelated units were spun off into separate entities. The shareholders in the event became shareholders of both the companies — the demerged company as well as the resultant company.
In the case of RIL, the energy producer, the telecom operator and the investment outfit were not its divisions. Rather, all the three were separate companies in their own right albeit under the influence of RIL, thanks to its shareholding clout in them. Indeed these three companies are not being spun off from the divisions of RIL so as to make grade as demerger.
On the other hand, these companies have already been in existence. What is being given up is the investment of RIL in these three companies. But that by no stretch of imagination can be termed as demerger.
The exercise does not pass muster under the I-T Act either because Explanation 1 to Section 2(19AA) defining `demerger' keeps out from the loop transfer of individual assets — in this case investments — which does not constitute a business activity to the resulting company.
Another criterion prescribed by the section would also put paid to the attempts being made to give the ongoing exercise the veneer of demerger — the assets and liabilities of the undertaking being transferred by the demerged company should be recorded in the books of the resulting company at their book value.
This is not at all on cards. What is on cards is allotment of shares by the three companies to the shareholders of RIL. This is how the investments of RIL in these three companies would be realised.
Since the reorganisation exercise will not make grade as demerger under the I-T Act, the shareholders of RIL may be in for taxing times. When they sell shares of these three companies, the question that would naturally rear its head would be — what is the cost of these shares. Admittedly, the cost was incurred by RIL.
Cost to RIL cannot rub of on to its shareholders as cost to them. At least there is no provision to this effect in the I-T Act. In the event, they may have to pay tax on the entire sale proceeds if and when the shares are sold.
And if they sell these shares within a year of issue, it would be treated as short-term capital gain. The concession that is otherwise available to shareholders — the holding period in the demerged company would be included — will not be available to them because in the first place the exercise did not conform to the I-T Act definition of `demerger'.
And more important, the taxman may accost them at the very beginning by imputing value to what they have received from the three companies and taxing them because the exemption from capital gains tax for shares received from the resulting company is on only when the income-tax definition of the term `demerger' is fulfilled.
(The author is a Delhi-based chartered accountant.)
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