What is Demerger
A demerger is a form of corporate restructuring in which a company separates its business into two or more independent entities. The primary objective of this process is to enable the resulting entity to concentrate on its core activities, thereby improving operational efficiency, competitiveness, and above all shareholder value. Unlike a merger, which combines entities, a demerger focuses on division and specialization, allowing a business to streamline its structure and promote growth in a systematic manner.
In the Indian context, demergers are governed by a well-defined legal framework to ensure fairness, transparency, and protection of stakeholder interests. Through this mechanism, a specific division, undertaking, or unit of a company is transferred into a new or existing entity. This separation not only strengthens managerial focus but also enhances accountability and efficiency.
This blog is a part of our The Complete Guide to NCLT in India: Powers, Structure, and Jurisdiction Blogpost.
Types of Demergers
Demerger as a restructuring tool may be implemented in several ways, depending on the strategic objectives of the company. The most common forms include:
Divestiture
In a divestiture, a company disposes of certain assets, units, or divisions which is considered non-core or underperforming by selling them to another entity, typically for cash.
Spin-off
A spin-off occurs when a company creates a new independent entity by transferring part of its business into it. The shares of this new entity are distributed to the existing shareholders of the parent company, ensuring that they continue to hold proportionate ownership in both entities. This allows the new company to function independently with a distinct management and business strategy.
Split-off
In a split-off, the parent company divides itself into two or more entities to isolate specific businesses. Shareholders of the parent company are given an option to exchange their shares in the parent for shares in the newly formed company.
Equity Carve-out
An equity carve-out involves the parent company offering a portion of its subsidiary’s shares to the public through an Initial Public Offering (IPO). In this structure, the parent retains a controlling stake in the subsidiary while raising capital from the public markets.
Legal Framework
In India, the legal framework concerning demergers is governed by the Companies Act, 2013 and the Income Tax Act, 1961. The demerger process requires approval from the National Company Law Tribunal (NCLT) and compliance with regulatory and financial guidelines and disclosures, additionally in the case of listed entities it further involves compliance with the requirements prescribed by the Securities Exchange Board of India (“SEBI”). If the de-merger could potentially affect competition in the market, an application must be submitted to the competition commission of India (CCI). The CCI examines whether the transaction would create a monopoly or restrict fair competition. If the transaction poses risks to market dynamics, the CCI may impose conditions or reject the proposal.
Process for Demergers
The implementation of a demerger requires strict adherence to statutory provisions and regulatory oversight to safeguard stakeholder interests. The key stages in the process are as follows:
Board Approval
The process begins with an in-principle approval from the company’s Board of Directors. At this stage, the company prepares a comprehensive plan detailing the terms and conditions of the proposed demerger, setting the foundation for the restructuring exercise.
Formulation of Scheme of Arrangement
Following board approval, a scheme of arrangement is prepared in accordance with Sections 230–232 of the Companies Act, 2013. This scheme defines the scope of the demerger, covering aspects such as the transfer of assets, liabilities, contracts, employees, and licenses. It also lays down the rationale for the demerger, the share exchange ratio, conditions precedent, and the consequences of non-approval. Only after the scheme is finalized and approved by the Board is it submitted for further scrutiny by the National Company Law Tribunal (NCLT).
Application to NCLT
The scheme of arrangement is then filed with the NCLT, which serves as the primary regulatory authority for such restructurings. The Tribunal may direct modifications, seek additional regulatory clearances, or impose conditions to safeguard the interests of stakeholders before granting its approval.
Approval of Members and Creditors
As directed by the NCLT, the scheme must be approved by the shareholders and creditors of the company. Depending on the circumstances, the Tribunal may dispense with these meetings if it considers that stakeholder interests are adequately protected.
Post-Demerger Formalities
Once approvals are secured from the NCLT, as well as other regulators such as the CCI and SEBI (where applicable), the demerger takes effect. The final steps include updating statutory records, effecting the transfer of assets and liabilities, issuing shares in the resulting entity, and notifying stakeholders—including employees, creditors, and shareholders—of the structural changes.
Demerger and the Tax Landscape
Transfer of any capital asset is subject to capital gains tax in India; However, demerger enjoys tax-neutrality with respect to tax on transfer.
Section 2(19AA) of the Income Tax Act, 1961
As per Section 2(19AA) of the Income Tax Act, 1961 “demerger”, in relation to companies, means the transfer by a demerged company of its one or more undertakings to any resulting company.
It is to be noted that conditions u/s 2(19AA) are only to ascertain tax neutrality and the non-compliance of the same does not in any manner result in the arrangement not being regarded as a demerger.
Section 47of the Income Tax Act, 1961
Not every transfer of capital asset attracts Capital gains taxation and section 47 delineates those that don’t qualify as transfers under the Income Tax Act, 1961.
Tax neutrality u/s 47 for Demerged Company and Resulting Company:
- (vib) if the Resulting Company. is an Indian Company
- (vic) shares in an Indian Company by a foreign Demerged Company to a foreign Resulting Company such that (a) At least 25% of Foreign Demerged Company become shareholders of foreign Resulting Company (b) such transfer does not attract tax on capital gains in the country, in which the Resulting Company is incorporated.
- (vicc) transfer by demerger of a foreign DC (which derives its value substantially from shares of an Indian Co.) to a foreign RC such that that (a) At least 25% of Foreign DC become shareholders of foreign RC (b) such transfer does not attract tax on capital gains in the country, in which the RC is incorporated.
Thus section 47 of the Income Tax Act is a necessary provision that exempts certain transactions from being classified as transfers. This is important as under the Act, any profit or gain arising from transferring a capital asset shall be chargeable to capital gains tax. Section 47 helps avoid capital gains tax in many instances by excluding certain transactions from this definition, mitigating the burden of tax for certain transactions.
Conclusion
Demergers in India have emerged as an important tool for corporate restructuring, enabling companies to enhance efficiency, promote specialization, and unlock shareholder value. Backed by a robust legal and tax framework, demergers strike a balance between business flexibility and regulatory oversight. As Indian businesses continue to diversify and expand, demergers are likely to remain a key strategy for ensuring growth, competitiveness, and sustainability.
