Merger and Demerger of a Company

Introduction

Developed Businesses are frequently exposed to experiment with different tactics in the dynamic business environment in an effort to improve their competitiveness, spur growth, and streamline operations. Mergers and demergers are two corporate restructuring techniques that are frequently used. A merger entails the combination of two or more

In today’s cutthroat economic environment, companies and organizations are constantly searching for methods to reduce expenses and boost earnings. During this process, businesses are frequently combined, merged, demerged, or transformed into limited liability partnerships (LLPs) or partnership firms in order to take advantage of economies of scale, gain market share, enhance their operations, and generally organize their affairs. Conversely, among other advantages, acquisitions offer a way to increase market share, diversify, create synergy, and improve technology.

A merger involves combining multiple firms into one, while a demerger involves dividing a company into separate entities. This article covers the ideas of merger and demerger, looks at their potential advantages and disadvantages, and looks at some legal precedents to shed light on their consequences.

Legal framework

The Companies Act, 2013 (“the Act”) and the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 govern mergers and demergers in India. This structured framework for corporate restructuring, including mergers, amalgamations, and demergers, is provided under the Act. It establishes the rules, guidelines, and protections necessary to guarantee these transactions’ equity and openness.

A demerger is the transfer of one or more undertakings from a company to another existing company or the formation of a new company.

An amalgamation, on the other hand, is defined under the Income-Tax Act, 1961 as the merging of one or more companies with another company or the merging of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger).

As it is important for any business operations fast-track approach is available for both mergers and demergers, enabling accelerated approvals and a more efficient process, for example, merger of Tata Chemicals and Tata Global Beverages, merger between India’s top two cinema franchises, INOX and PVR, merger between Tata Air India and Vistara airlines.

Merger and its Advantages

A merger is a calculated move by two or more businesses to pool their resources, operations, and assets to form a new company. Gaining economies of scale, breaking into new markets, growing market share, and promoting innovation are the primary goals of mergers. There are various kinds of mergers, each with a distinct strategic function, such as conglomerate, vertical, and horizontal mergers.

The word ‘merger’ has not been defined under the any act but another such term that exist is amalgamation and its definition is prescribed under Section 2 (1B) IT Act[1] as “the merger of one or more companies into another company or the merger of two or more companies to form one company in such a manner that the assets and liabilities of the amalgamating companies vest in the amalgamated company.”

But there is also a thin difference between merger and amalgamation that amalgamation led to formation of an entirely new company, but merger is a consolidation process wherein the resultant company may be a new or existing company.

In Principal Commissioner of Income Tax case[2] the Supreme Court stated the idea of term amalgamation as blending of two or more existing undertakings into one undertaking where the shareholders of each blending company become substantially the share-holders in the company which is to carry on the blended undertakings.  Further court also highlighted that there may be amalgamation either by the transfer of two or more undertakings to a new company, or by the transfer of one or more undertakings to an existing company.[3]

Merger is differentiated into two types

Vertical demerger: This involves the separation of different business verticals or lines of business within a company, resulting in the creation of separate entities for each vertical.

Horizontal Demergers: In a horizontal demerger, a company’s business is divided into two or more separate entities, based on geographical location, product lines, or other relevant factors.

Demerger and its Advantages

Term “demerger” is clarified in Section 2 (19AA) of the IT Act. It refers to the transfer of a demerged undertaking from the demerged business to the resultant company in a form that allows it to continue as a going concern, in accordance with a Scheme of Arrangement approved by the Act’s Sections 230 to 232.

Through demerger companies can focus on their core competencies which can enhance decision-making and operational effectiveness. Since autonomous firms are able to be judged on their own performance, they may draw in more targeted investment interest and possibly increase shareholder value.  

Via demerger companies can lower their exposure to market swings and focus on areas where they have a competitive edge by selling off non-core assets.

For instance, Hewlett-Packard (HP) demerged into two separate companies – HP Inc., focusing on personal computers and printers, and Hewlett Packard Enterprise, concentrating on enterprise solutions and services. Here demerger enabled both companies to pursue their distinct business strategies more effectively.

Tax Benefits in Merger and Demerger

Mergers and demergers are typically regarded as tax-neutral transactions, because according to Section 47 of the IT Act, these transactions are not subject to capital gains tax because they fall outside the definition of “transfer.”

Tax benefit in Merger

As per section 47(vi) of the IT Act, states that if the merged firm is an Indian company, then capital gains resulting from the transfer of assets by the merging companies to the combined company will be tax-free.

According to section 47(vii) of the IT Act, capital gains arising from the transfer of shares by a shareholder of the amalgamating companies are exempt from tax as such transactions will not be regarded as a ‘transfer’, if the same is made in consideration of the allotment of shares in the amalgamated company; and the amalgamated company is an Indian company.

Tax benefit in Demerger

According to Section 47(vib) of the IT Act, if in a demerger, there is any transfer of a capital asset by the demerged company to the resulting company and if the resulting company is an Indian organization, then such a transaction will not attract levy of capital gains tax.

According Section 47(vid) of the IT Act, if there is an issue or transfer of shares by the resulting company in consideration of the demerger of the said undertaking(s), to the shareholders of the demerged company, the transaction will not be amenable to capital gains tax.

Conclusion

In India, mergers and demerger have shown as one of the most effective ways to overcome the various business challenges that exist today and foster company expansion. Local businesses appear to have benefited from restructuring mostly through mergers and demerger, operating on a larger scale, and other synergistic efforts in increasing their global competitiveness.

However, it appears that the introduction of foreign companies into the Indian market through mergers has increased competition, which has forced domestic businesses to enhance their customer satisfaction and business operations through mergers and acquisitions or other suitable means.

[1] Income Tax Act, 1961 

[2] (ARISING OUT OF SPECIAL LEAVE PETITION (C) NO. 4063 OF 2020)

[3] Halsbury’s Laws of England, 4th Edition Vol. 7 Para 1539.