Thursday, October 18, 2007

Demerger of Reliance Industries Limited

S.Dinesh, Saumya Shekhar, Tathagata Ghosh, Vikas Agarwal, K.V.S.S. Narayana Rao




RELIANCE Industries Ltd has informed stock exchanges on 21st December 2005 that its demerger scheme has become effective from that day.

This has been possible as a certified copy of the Bombay High Court order dated December 9 sanctioning the scheme of arrangement between RIL and the `resulting companies' - Reliance Energy Ventures Ltd, Global Fuel Management Services Ltd, Reliance Capital Ventures Ltd and Reliance Communication Ventures Ltd - and their respective shareholders and creditors has been filed with the Registrar of Companies on December 21.

The scheme of arrangement is for the demerger of the coal-based energy undertaking, the gas-based energy undertaking, the financial services undertaking and the telecommunications undertaking of RIL into each of the resulting companies, respectively.

Proposed Formula

As per the scheme of proposed demerge cleared by the board of RIL and approved by Hon. Bombay High Court, following undertakings of RIL will be transferred to four Special Purpose Vehicles (SPVs) as under:
1. Business of RIL's Telecommunications Undertaking is to be transferred to Reliance Communication Ventures Ltd. (RCMVL);
2. Business of RIL's Coal Based Energy Undertaking is to be transferred to Reliance Energy Ventures Ltd. (REVL);
3. Business of RIL's Financial Services Undertaking is to be transferred to Reliance Capital Ventures Ltd. (RCLVL); and
4. Business of RIL's Gas Based Energy Undertaking is to be transferred to Global Fuel Management Services Ltd. (GFMSL)
RCMVL includes RIL's investment in Reliance Communications Infrastructure Ltd., Reliance Infocomm Ltd. and Reliance Telecom Ltd. The value of the investments of RIL in the demerged company is approximately Rs. 154 bn. REVL includes RIL's investment in Reliance Energy Ltd. The value of investment of RIL in the demerged company is Rs. 30 bn. RCLVL includes RIL's investment in Financial Services and Insurance. The value of investment of RIL in the demerged company is Rs. 6 bn. RIL's investment in GFM is not significant.
As per the scheme of amalgamation approved by Hon. Bombay High Court, all the existing shareholders of RIL (except the Specified Shareholders i.e. Trustees of Petroleum Trust, which holds 7.5% of shares of RIL, and four other companies i.e. Reliance Aromatics and Petrochemicals Pvt. Ltd., Reliance Energy and Project Development Pvt. Ltd., Reliance Chemicals Pvt. Ltd., and Reliance Polyolefins Pvt. Ltd., who collectively holds 4.7% of shares of RIL) will get one share of each demerged company against one share of RIL. As a result thereof, the total number of shares to be issued by the resulting demerged companies would be 122 crore as against existing 139 crore equity shares of RIL. So an existing RIL shareholder (except the Specified Shareholders) holding one share will get:
1. One share of RCMVL of face value Rs. 5;
2. One share of REVL of Face value Rs. 10;
3. One share of RCLVL of face value Rs. 10;
4. One share of GFM of face value of Rs. 5.
Since its valuation will decide the post demerger price of shares of RIL, RCMVL will get itself listed on all the Stock Exchanges, where RIL is listed currently. REVL will hold 45% equity stake in Reliance Energy and the Board of Reliance Energy will meet on 3rd January 2006 to discuss the amalgamation of REVL with Reliance Energy. RCLVL will hold 29% equity stake in Reliance Capital and the Board of Reliance Capital will meet on 2nd January 2006 to discuss the amalgamation of RCLVL with Reliance Capital. GFMSL will get itself listed on all the Stock Exchanges, where RIL is listed currently. Hence, shares of all the demerged companies will have full liquidity.
How do the Four Proposed SPVS stack up
Reliance Capital Ventures Ltd.
Reliance Capital Ventures Ltd. will have an equity share capital of 122.3 crore shares of the face value of Rs. 10 each, aggregating Rs 1,223 crore (US$ 281 million). The derived interest of over 23 lakh Reliance shareholders, in the RCL shares to be held by the SPV, will be approximately 5 shares of RCL for every 100 shares held in the SPV.
Reliance Energy Ventures Ltd.
Reliance Energy Ventures Ltd. will have an equity share capital of 122.3 crore shares of the face value of Rs. 10 each, aggregating Rs 1,223 crore (US$ 281 million). The derived interest of over 23 lakh Reliance shareholders, in the REL shares to be held by the SPV, will be approximately 7 shares of REL for every 100 shares held in the SPV.
Global Fuel Management Services Ltd (GFMS)
Over 23 lakh Reliance shareholders will receive 100 shares of GFMS for every 100 shares held in RIL. GFMS will be the holding company, with contracts for supply of natural gas from RIL, which are proposed to be utilized for Reliance Energy Group's power generation projects mainly in Uttar Pradesh and Maharashtra, and also other power projects in India.
GFMS will have an equity share capital of 122.3 crore shares of the face value of Rs. 5 each, aggregating Rs 611 crore (US$ 140 million). This company will be listed in due course, providing liquidity to over 23 lakh shareholders.
Reliance Communications Ventures Ltd.
Over 23 lakh Reliance shareholders will receive 100 shares of Reliance Communications Ventures Ltd (RCVL) for every 100 shares held in RIL. RCVL will be the holding company for the Infocomm Group of companies, including amongst others, Reliance Infocomm Ltd (RIC), Reliance Communication Infrastructure Ltd (RCIL), Reliance Telecom Ltd (RTL) and Flag Telecom.
RCVL will have an equity share capital of 122.3 crore shares of the face value of Rs. 5 each, aggregating Rs. 611 crore (US$ 140 million). RCVL will be listed in due course, providing liquidity to over 23 lakh shareholders. RCVL will hold a 65.9% stake directly and indirectly in RIC, and 35.2% in RTL. ADA Enterprises will have 4 listed companies - each with a shareholder base of over 23 lakhs.
Based on the above, the derived interest of RIL shareholders in each of the entities will be:
• approx. 5 shares of RCL for every 100 shares held in RIL
• approx. 7 shares of REL for every 100 shares held in RIL
• 100 shares of GFMS for every 100 shares held in RIL
• 100 shares of RCVL for every 100 shares held in RIL


Tax Issues of Reliance demerger


With Bombay High Court granting its approval under the Companies Act, 1956 to the proposal for the demerger of four Companies from Reliance Industries Ltd. (RIL), the tax implications on the shareholders of RIL of the entire exercise of demerger and merger of companies needed to be clarified.


First question that arose:

Whether the receipt of shares of four resultant companies totally free without any apparent financial consideration by RIL shareholders entails any tax liability in their hands either as normal income or as capital gains under the provisions of the Income tax Act. Can these be treated as Bonus shares for tax purposes?


Section 47 of Companies Act, categorically states that when a shareholder is issued any share in a scheme of demerger, there is no transfer and hence there is no capital gain. Section 47 is a section that lists situations, which do not constitute “transfer” for the purposes of charge to capital gains under section 45.

For ready reference, reproduced below is the relevant part of the said section”
“Section 47(vid): any transfer or issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company if the transfer or issue is made in consideration of demerger of the undertaking;”

Therefore when the shareholders of RIL received for free the shares of four resulting companies, there was no question of any tax liability arising on them. Similarly, these free shares did not constitute Bonus shares since under Bonus shares one gets the shares of the same company.

Second set of questions that arose:

What if the shareholders were to sell the shares of these four resulting companies and receive sale proceeds for the sale. Will there by any tax then? Will it belong term or short term? Will there be any cost? How to compute such gain?


To ascertain whether the gain is short term or long term, section 2(42A) provides that the period of holding of the demerged company (RIL) is to be included in the period of holding of the shares of the resultant company.


For ready reference reproduced below is the relevant part of Explanation 1, clause (g) to section 2(42A):
“Clause (g):
in the case of a capital asset, being a share or shares in an Indian company, which becomes the property of the assessee in consideration of a demerger, there shall be included the period for which the share or shares held in the demerged company were held by the assessee;”

Thus if the aggregate period of holding of RIL shares plus the period of holding of shares of resulting companies (Reliance Capital Ventures Limited and others) exceeds 12 months then the capital gain will be treated as long term and if the aggregate holding is less than 12 months then the capital gain would be short term. It is well known that long term capital gains on listed equity shares sold on a recognized stock exchange and in respect of which Securities Transaction Tax (STT) has been duly paid is exempt under section 10(38) and similar short term capital gain attracts concessional tax of only 10% under section 111A.

Since all the four resulting companies, Reliance Capital Ventures Ltd., Reliance Energy Ventures Ltd. and two others are all going to be listed companies, the shareholders receiving the sale proceeds would be squarely eligible to the benefits of the two sections 10(38) and 111A.

For long-term capital gain, since it is fully exempt, the question of computation of quantum of such gain is academic and hence not relevant. However, for short-term capital gain, it is relevant. Such gain is to be computed in accordance with the provisions of section 49(2C) which is reproduced here below:

“Section 49(2C):
The cost of acquisition of the shares in the resulting company shall be the amount which bears to the cost of acquisition of shares held by the assessee in the demerged company the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged company immediately before such demerger”.

It is in this background that the guidance issued on 16th January 2006 by RIL is relevant. The guidance indicates the exact proportionate assets deemed to have been allotted to Resultant Companies based on expert opinion and on that basis the gain of the individual shareholders will be computed with reference to their cost of RIL shares.

Thus, if the shareholder holding shares of Reliance Capital Ventures Ltd. were to sell the same on the BSE on say, 27th January 2006 for Rs.400 per share, then his capital gain will be computed on the basis that 1.3% of his cost of RIL shares will be deemed to be his cost of shares of Reliance Capital Ventures Ltd. and since the cost of RIL shares would be known to that shareholder, it will present no difficulty in ascertaining his gain. If such a gain were to be long term by including the period of holding RIL share, then the entire gain would be exempt. If such period of holding is less than 12 months and therefore short term, then such gain will be chargeable to tax at 10%.

Another set of questions could confront the shareholders when Reliance Capital Ventures Ltd. and Reliance Energy Ventures Ltd. are respectively merged with Reliance Capital Ltd. and Reliance Energy Ltd. As indicated in the earlier part, the shareholders of the two Ventures Ltd. are to be given shares in the amalgamated companies, that is, Reliance Capital Ltd. and Reliance Energy Ltd. in lieu of their holding in Ventures Ltd. companies.

The question on receiving of Reliance Capital and Reliance Energy shares attracting any capital gains is resolved by section 47(vii). For ready reference, the said section is reproduced below:-

Section 47(vii)
any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the amalgamating company, if—
(a) the transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company, and
(b) the amalgamated company is an Indian company;”
To conclude, as a result of the demerger of RIL into four companies and listing of them and issuing of shares into the resulting companies to the shareholders and thereafter amalgamation of the resulting companies into the respective companies, ultimately the shareholders will come to acquire shares of Reliance Capital Ltd., Reliance Ventures Ltd. and other two companies.


The entire exercise is extremely investor-friendly keeping in view the tax exemptions available to the investors in a situation of demerger and thereafter merger granted by the Income Tax Act, 1961. It appears that the process is intended to be completed in all respects by 31st March 2006 so that the provisions of the law as it stands today should apply and that the amendment, if any, by Finance Bill 2006, would not apply, since the amendments will be applicable only prospectively from assessment year 2007-08, that is, accounting year beginning with 1st April 2006 and ending with 31st March 2007.


Valuation Discovery Exercise (18th January 2006)

Post demerger price of RIL was decided based on special trading session held by BSE & NSE, which took place on 18th January 2006 between 8 a.m. to 9 a.m. RIL has set 25th January 2006 as the record date to give effect to the scheme of demerger.

References

http://www.thehindubusinessline.com/2005/12/22/stories/2005122202790900.htm

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