Corporate Demergers In Listed Entities: Key Legal Consideration And Practical Insights For Value Creation

Corporate demergers with subsequent listings offer Indian companies significant strategic and tax advantages but require meticulous advance planning. Companies must prepare long-lead items before receiving NCLT approval to meet Securities and Exchange Board of India's 60-day listing timeline.

Recent demergers by Reliance Industries Limited and Tata Motors demonstrate this route's growing popularity for value unlocking. Tax-neutral status under Section 2(19AA) of the Income Tax Act, 1961, ("Income Tax Act") eliminates capital gains for all parties while enabling independent market valuation of separated business units.

INTRODUCTION

Corporate demergers have emerged as a significant strategic tool for businesses seeking to unlock shareholder value, enhance operational focus, and pursue distinct growth trajectories across different business segments. A demerger, as defined under Section 2(19AA) of the Income Tax Act, refers to the transfer of one or more undertakings of a company (the "Demerged Company") to another company (the "Resulting Company"), pursuant to a scheme of arrangement under the Companies Act, 2013, approved by the National Company Law Tribunal ("NCLT"). In a corporate demerger, the shareholders of the Demerged Company receive shares in the Resulting Company in exchange for the business undertaking being transferred, without requiring any cash consideration.

In the event of a demerger involving a listed company, the Resulting Company generally pursues an independent listing on Stock Exchanges, i.e., National Stock Exchange of India ("NSE") and BSE Limited ("BSE") (collectively referred to as "Stock Exchanges"). This enables the demerged business to trade as a standalone listed company, allowing the market to assess its value independently based on its unique fundamentals, growth potential, and industry conditions. Unlike an initial public offering ("IPO"), where new capital is raised from public investors, listing pursuant to a demerger involves the admission of shares for trading on the Stock Exchanges in accordance with the scheme of arrangement approved by the NCLT.

This comprehensive article is structured to provide detailed insights into (1) the regulatory framework governing demergers under the Companies Act, 2013, various SEBI regulations, and related applicable laws; (2) the tax aspects involved, particularly the conditions for achieving tax-neutral status under the Income Tax Act; (3) the practical benefits that listing pursuant to demergers offer to companies, shareholders, and other stakeholders; (4) the comprehensive process for listing of the Resulting Company on Stock Exchanges following the demerger; (5) the critical distinctions between an information memorandum filed for listing post-demerger and a prospectus issued for public offerings; (6) practical challenges involved in the listing of an entity following a corporate demerger.

RECENT DEMERGER ACTIVITY: INDIA'S CORPORATE RESTRUCTURING TREND

Tata Motors' recent approval to demerge its commercial vehicle business into Tata Motors Commercial Vehicles Limited underscores the growing momentum behind corporate demergers in India, following Reliance Industries' 2023 demerger and listing of Jio Financial Services Limited and Sterlite Technologies' demerger and listing of STL Networks Limited.

These transactions reflect a broader pattern: Indian conglomerates are increasingly using demerger-led listings to drive focused growth, operational efficiency, and market-driven valuation discovery.

REGULATORY FRAMEWORK

• Companies Act, 2013: Sections 230-232 of the Companies Act, 2013 read with Companies (Compromises, Arrangements and Amalgamations) Rules, 2016

• SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015

• SEBI Master Circular on Schemes of Arrangement dated June 20, 2023 ("SEBI Master Circular")

• SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 ("ICDR Regulations"): Schedule VI

• Securities Contracts (Regulation) Act, 1956: Sections 23-26

• Securities Contracts (Regulation) Rules, 1957: Rule 19(2)(b)

BENEFITS OF LISTING POST DEMERGER

• Strategic and Operational Benefits

• Enables each business unit to focus on its core competencies and strategic priorities without cross-subsidization or resource allocation conflicts.

• Separate listing enables the market to value each business independently based on its own fundamentals, growth prospects, and industry multiples.

• Empowers dedicated management teams with decision-making authority and accountability for their respective businesses.

• Demerged entities can pursue independent strategies and partnerships aligned with their business objectives.

• Regulatory and Compliance Benefits

• Each entity focuses on regulations specific to its industry rather than managing diverse regulatory requirements.

• Separate boards can consist of industry-specific expertise and independent directors.

• Eliminates complexities arising from cross-industry regulatory overlaps.

• Tax Benefits Pursuant to Demerger

• Tax-Neutral Demerger under Section 2(19AA) of the Income Tax Act

Demerger can qualify as 'tax-neutral' if it satisfies all conditions prescribed under Section 2(19AA) of the Income Tax Act.

• Tax Benefits for Tax-Neutral Demergers

1. For the Demerged Company:
2. Transfer of capital assets by the Demerged Company to the Resulting Company is exempt from capital gains tax.
3. No tax on reduction in book value of investments as a result of demerger.

• For the Resulting Company:

1. Accumulated losses and unabsorbed depreciation of the Demerged Company attributable to the business undertaking transferred, can be carried forward by the Resulting Company.
2. Cost of acquisition of assets is determined based on the written down value in the books of the Demerged Company.
3. No deemed dividend distribution tax on issue of shares to shareholders of the Demerged Company.

• For Shareholders:

1. Receipt of shares in the Resulting Company is not treated as a transfer and is exempt from capital gains tax.
2. Cost of acquisition is determined by apportioning the original cost of acquisition between shares of the Demerged Company and the Resulting Company in proportion to their net-book values.
3. Period of holding for computing capital gains includes the period for which shares of the Demerged Company were held.

FROM DEMERGER TO LISTING: KEY STEPS FOR REGULATORY COMPLIANCE

• Phase 1: Demerger

• Board Approval: Obtain approval of the board of directors of both the Demerged Company and Resulting Company for the scheme of arrangement.

• Regulatory Approvals: Apply for and obtain no objection certificate from Stock Exchanges and the Securities and Exchange Board of India.

• First Motion Application: File Company Scheme Application (First Motion) with the NCLT. This initiates the formal legal process of the demerger.

• Shareholders and Creditors Approval: Conduct meetings to obtain necessary approvals from shareholders and creditors as directed by the NCLT.

• Second Motion Petition: File Company Scheme Petition (Second Motion) with NCLT after obtaining the required approvals from shareholders and creditors and publishing the newspaper advertisement.

• Statutory Authority Clearances: Obtain clearances from relevant statutory authorities including Regional Director ("RD"), Registrar of Companies ("ROC"), and Official Liquidator ("OL").

• NCLT Final Order: Receive final NCLT order approving the scheme of demerger. This marks a critical milestone in the demerger process.

• ROC Filing: File the certified true copy ("CTC") of the NCLT order with the ROC using Form INC-28. The filing of Form INC-28 formalizes the demerger and serves as the triggering event for the Scheme to become legally effective. The date of filing of the NCLT order with the ROC is generally regarded as the "Effective Date" of the Scheme, unless a different date is specified in the Scheme or directed by the NCLT. From this Effective Date, the position of all assets, liabilities, and undertakings of the Demerged Company as on the Appointed Date stand transferred to and vested in the Resulting Company in accordance with the approved Scheme.

• Phase 2: Listing of the Resulting Company

• Exemption Application ("EA") and Draft Information Memorandum: The EA under Rule 19(2)(b) of the Securities Contracts (Regulation) Rules, 1957 is prepared and submitted to the Stock Exchanges for in-principle approval, after which it is forwarded to SEBI to obtain approval for listing the Resulting Company without an IPO. The EA is submitted for the purpose of claiming exemption from complying with the requirement of ensuring that a minimum of 25% of the shares proposed to be listed are offered to the public. The application includes several documents, such as secretarial records, a copy of the scheme of arrangement, the shareholding pattern, details of complaints against the Company, agreements with market intermediaries, necessary undertakings, and the draft Information Memorandum.

• Final Application, Final Information Memorandum and Newspaper Advertisement: Final listing application is submitted to the Stock Exchanges along with the final Information Memorandum and the required newspaper advertisement is published. It is pertinent to note that the newspaper advertisement must be published on the same day as filing the final listing application.

• Listing of the Company: Approval is received from the Stock Exchanges, and the formal listing process for the Resulting Company's shares is completed.

IPO PROSPECTUS VS. INFORMATION MEMORANDUM: KEY DIFFERENCES

KEY PRACTICAL CHALLENGES

• Financial Statement Preparation: The listing of the Resulting Company's securities on the Stock Exchanges is required to be completed within 60 days of receipt of the NCLT's approval order for the scheme of arrangement. One of the major challenges in meeting this stringent timeline is preparing restated, audited, and consolidated financial statements for the three preceding financial years, along with stub-period financials covering the period from the beginning of the current financial year up to the date of filing the Exemption Application.

• Condonation Application: If a Resulting Company is unable to list its securities on the Stock Exchanges within 60 days of receiving the NCLT's approval order for the scheme of arrangement, it may submit a condonation application along with either the initial exemption application or the final application. The condonation application must include a detailed, date-wise account of the key events, actions, and steps taken by the Company to comply with the SEBI Master Circular, along with an explanation for the delay beyond the prescribed 60-day period. The Stock Exchanges and SEBI retain the discretion to accept or reject the reasons for the delay set out in the condonation application.

• Third-Party Name Usage: If the Resulting Company uses the name of any third party in documents submitted to the Stock Exchanges or SEBI, prior written consent from that party must be obtained. Managing the use of third-party names in the transaction thus presents a practical challenge, requiring close coordination with multiple stakeholders to ensure proper documentation and regulatory compliance.

• Addressing Exchange Queries: Addressing queries from the Stock Exchanges during the review process can be time-consuming and complex, as the Stock Exchanges have broad discretion to request documents and information to ensure compliance with SEBI regulations. These queries often require detailed, well-supported responses with appropriate documentation.

• Monitoring Trading Activity: The Resulting Company and Demerged Company must monitor trading activities of shares held by Directors, Promoters, Promoter Group, Key Managerial Personnel, Senior Management Personnel, agencies involved in the listing process, and their relatives. This monitoring is critical for compliance with Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 and other applicable laws.

• Disclosure Requirements: The Information Memorandum must include detailed sections covering, among other matters, business operations, risk factors, industry overview, capital structure, regulatory framework, company history, management, promoter and group company details, litigations, government approvals, and financial statements. Preparing such a comprehensive disclosure document is inherently challenging, as it requires extensive data collection and coordination across multiple teams and stakeholders, which can make it difficult to adhere to the strict 60-day timeline.

CONCLUSION

The SEBI-mandated 60-day listing timeline following NCLT approval presents a material execution challenge for listed companies undertaking demergers. While the information memorandum can be finalized only upon receipt of NCLT approval, the compressed post-approval timeline leaves little room to complete the extensive listing formalities if preparation begins only after the NCLT order is issued.

Successful demerger-led listings therefore demand a parallel and forward-looking approach to regulatory compliance. As NCLT proceedings progress, companies must simultaneously advance critical preparatory work, including drafting restated and audited financial statements, engaging statutory auditors, compiling disclosure documentation, and addressing prerequisite compliance requirements. This parallel-planning strategy transforms the post-approval window from a period of regulatory pressure into one of structured finalization and timely filing.

The regulatory framework governing demerger listings in India, anchored in the Companies Act, 2013, the SEBI Master Circular, and applicable tax legislation, offers both clarity and guidance. The commercial benefits of demergers, including tax-neutral treatment, sharper operational focus, and enhanced shareholder value, remain compelling. Ultimately, the distinction between transactions that proceed seamlessly and those that encounter regulatory delays lies in execution discipline, specifically in treating listing preparedness as a fundamental component of the demerger process from the outset.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.