This article is written by Harshita Agrawal, a student from MS Ramiah College of Law who is pursuing a Certificate Course in Advance Corporate Taxation from Lawsikho.

Introduction

Recently, NCLT vide its order dated 10 January 2020 approved the scheme of arrangement amongst TATA Chemicals Limited and TATA Global Beverages Limited and their respective shareholders and creditors. This scheme has brought a great impact in the Indian Market. This article sets out to give a detailed analysis of this scheme of acquisition and see what its unique features were.

Background

Tata Chemicals Limited (“Demerged Company”) is a public listed company, incorporated on 23 January 1939 under the Companies Act, 1913. It is engaged in multifaceted businesses dealing in basic chemical products and speciality products and also in the consumer products business. The Demerged Company is one of the magnate players in the food category, selling products under the brands such as Tata Sampann and Tata Salt among others.

Tata Global Beverages Limited (“Resulting Company”) is a public listed company, incorporated on 18 October 1962 under the Companies Act, 1956. It is engaged in the business of marketing, distribution, and sale of tea, coffee and water. The Resulting Company is a notable player in the beverage category, selling products worldwide under the brands such as ‘Tata tea’ and ‘Tetley’ among others. The Resulting Company was targeting on FMCG to increase its growth.

What was the deal?

The purpose of the deal between these two Companies was to integrate and synchronize the business structure so that the Consumer products business of the two enterprises can be integrated into one single entity. So, what’s the use of integrating the Consumer business of the two enterprises into one? (This we will discuss in the later half in detail)

Another purpose of this scheme was that the Demerged Company would be able to focus on its basic chemistry and speciality. So, again what was the need of this deal and did a sound outcome come with this attempt? What were the key considerations of the deal as per scheme of arrangement.

Key Considerations of the deal 

• The complete Consumer Products Business, as a going concern of the Demerged entity was transferred including its assets, investments, rights, approvals, licenses and  and powers, leasehold rights and all its debts, outstanding amounts, liabilities, duties, obligations and employees which belongs to the Consumer Products Business. However, the immovable properties were excluded from the deal.
• The appointed date of the deal was 1st April, 2019 and the effective date (as defined in the scheme of arrangement) was on the date all the approvals and sanctions were obtained by the Demerged Company and the Resulting Company.
• Date of Approval of the Scheme was 8th January 2020 and 10th January 2020 (Mumbai and Kolkata NCLT.)
• The consideration of the scheme was that the Resulting Company shall issue to the shareholders of the Demerged Company whose names appear in the Register of Member of the Demerged Company at the recorded date, 114 equity shares of the Resulting Company of INR 1/- each fully paid up for every 100 equity shares held in the Demerged Company of INR 10/- each fully paid. However, if any share is held by the Resulting Company or its subsidiaries in the Demerged Company then the Resulting Company shall not issue such shares to the above. If any shareholder is entitled to a partly paid share of the Resulting Company then the Resulting Company shall aggregate such share to one fully paid up share.
• All the taxes would be borne by the Demerged Company which accrue to the date before the Appointed Date. All the taxes would be borne by the Resulting Company of all the operations and activities of the Demerged Company which take place after the appointed date. Further, the Resulting Company is also eligible for all the refunds of the Demerged Company after the appointed date.
• All the contracts, deeds or instruments in which the Demerged Company is the beneficiary or party which are subsisting or have effect on the Appointed Date is now in full force and binding in favour or against of the Resultant Company.
• All the legal proceedings by or  against the Demerged Company of whatsoever nature pending or arising before the Effective Date is now enforced and continued by or against the Resulting Company.
• All the employees of the Demerged Company before the Effective Date have become the employees of the Resulting Company without any break or interruption of their service.
• The authorised share capital of the Resulting Company after this scheme becoming effective has been increased to INR 1,25,00,00,000 (Rupees One Hundred and Twenty-Five Crores).
• The name of the Resulting Company is changed to ‘Tata Consumer Products Limited.’
• The consideration was in Share Issue Ratio for every share of Demerged Company to the share of Resulting Company.

Was this Demerger Common Control Business or Non-Common Control Business?

If you are not from accounts background, you will be amazed to know what is common control and non common control business like I was. Indian Accounting Standard (“Ind-As”)-103 has brought in the concept of common control and non-common control business. It has defined common control business as a business combination in which the same person or  group controls the combined entities or business both pre and post combination. The company may be said to have common control if the same person or group has control over the financial statements and other operating policies. The control should not be temporary in nature. 

In the present case, the Demerged Company and the Resulting Company has non-common control business. This is because the shareholding pattern in both the companies were different. It is important to determine whether a common control business exists or vice versa because it will determine the accounting treatment of the arrangement.

Accounting treatment of this scheme

As I mentioned earlier, the accounting treatment differs in both common control business combination and non-common control business combination. Under common control business, combination pooling of interest methods are used to account for the books of the Demerged and Resultant Companies. This include:

1. Accounting of all the identified assets and liabilities will be at their carrying amount i.e., adjustments should not be made to reflect their fair values.
2. Retained earning’s balance shall be merged in the books of acquiree with that of acquirer and the preservation of these reserves shall be identified.
3. The differences between negative or positive shall be recorded and shown separately under the head Capital Reserves of Reserve & Surplus. In some cases, it is adjusted against Amalgamation Adjustment Deficit Account.   
4. Goodwill shall not be recorded under common control business combination.

The conditions are reversed in the case of non-common control business combination.

 Accounting in the books of Demerged Company

The Demerged Company recorded the transfer of assets and liabilities at book value in pursuant to Pooling of Interest Method (Section 2 (19AA) of the Income Tax Act, 1961). As the demerger was a non-common control transaction, the Demerged Company debited the fair value of the undertaking to the ‘Retained Earnings’ in pursuant to Appendix A and Ind-AS 10 “Distribution of non-cash assets to owners.”

Further the difference between the fair value of net assets and carrying value of net assets adjusted through P&L A/c. The figures then of earlier years were restated.

In the notes to accounts, the value of the Demerged undertaking is disclosed as ‘Discontinued Operations’ in pursuant to Ind-As 105.

Accounting in the books of the Resulting Company

The assets and liabilities were recorded at their respective book values (in compliance with Section 2 (19AA) of the Income Tax Act, 1961.) Consideration of the scheme was recorded and shown at the fair value and hence, the difference between the consideration and net assets recorded (at book value) was recorded as goodwill/capital reserve.

In order to comply with Ind-As 103 the assets and liabilities were recorded at their fair values and then the adjustment was made to the differences against the goodwill/capital reserve. The distribution of shares by the Resulting Company to the Demerged Company was recorded as Dividend.

Tax impact on this deal

Taxation in the hands of Companies

Section 2(19AA) of The Income Tax Act, 1961(hereinafter referred to as “Act”) has made demerger of company to the Resulting Company (if both the companies are Indian Company) as tax free subject to a condition that assets and liabilities shall be recorded at their book value. But according to Ind-As 103 all the non-common control transactions shall be recorded at fair value. This was a problem. Since it records at fair value, the transaction will not be tax free under Section 2 (19AA) of the Act. However, the Central Government vide Finance Act 2019-10 amended the definition of Section 2 (19AA) of the Act to avoid this conundrum. The amended section provides that the assets and liabilities can be recorded as provided in Ind-As 103 and still they would be tax-free.

Taxation in hands of shareholders of Demerged Company

As per the Act tax is not levied upon the shareholders at the time of demerger but is levied while exercising the allotted shares under the Resulting Company. For this capital gain needs to be computed on the basis of holding of shares. The Deemed Cost of Acquisition of Asset for Computing Capital Gain is provided under Section 49 of the Income Tax Act, 1961. It provides the cost of acquisition for assets which the assessee has acquired. According to the Section 49 (2C) of the Income Tax Act, cost of acquisition of the resulting company shall be the amount of shares which the assessee has held in the demerged company. The cost of acquisition of original shares shall be the amount after reducing the amount received under Section 49 (2C) of the Income Tax Act, 1961.

For the purpose of determining cost of acquisition of shares held in the resulting company as per Section 49 (2C) and Section 49 (2D) of the Income Tax Act, 1961, the cost of acquisition shall be 0.66%.

Name of the Company	% of total cost of acquisition
Tata Chemicals Limited	99.34%
Tata Consumer Products Limited	0.66%
TOTAL	100%

Deduction under the Income Tax Act

Deduction can be claimed by the Resulting Company under Section 10AA(5) of the Income Tax Act, 1961.The Deduction under this provision cannot be claimed by the Demerged Company.

Value Lock in after Demerger

There was a huge value unlocking for both the Companies after streamlining the Consumer and FMCG goods under the same brand as it added to the productivity of the Demerged Company by focussing only on the chemistry and speciality product company which can help it to build strong cash flows in near future. Overall value unlocking was around Rs 25000 crores.

Let us have a look at the share value of these companies before and after the demerger.

Tata Chemical	31.01.2018	31.03.2019	30.092020
P/E Ratio	16.95	7.79	1.1
M Cap (in Crs)		15000	7623.58
MPS	718.45	588	299.25

 

Tata Consumer	31.01.2018	31.03.2019	30.09.2020
P/E Ratio	42.92	29.52	85.58
M Cap (in Crs)		12,871	46,690.42
MPS	290.60	208	506.65

The market cap of the Resulting Company increased thrice from 2019 after receiving nod from NCLT. Thus, this demerger was fruitful to the Tata Group.

Conclusion

Thus, synergizing the right business at the right place can create a huge value unlocking which can be beneficial for both the Companies at large. Tata Demerger scheme is the perfect example of synergizing the right business at the right place. This proves that sometimes M&A can create huge difference in the market.

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