What Is a Stock Demerger? Meaning & Impact on Shareholders

In the dynamic world of investing, companies often restructure to streamline operations, focus on core businesses, or unlock shareholder value. One such corporate action that grabs investor attention is a demerger. If you’ve ever wondered what happens when a company splits into multiple entities and how it affects your investments, this guide will help you understand demergers simply and engagingly, including how to track them on platforms like Groww.

What is a Demerger?

A demerger is a corporate restructuring in which a company transfers one or more of its business units or divisions into a separate entity. After the demerger:

• The original company continues to exist with its remaining business operations.
• Shareholders of the original company typically receive shares in the newly formed entity.
• Both companies operate independently with separate management and finances.

The primary goal is to create more focused businesses that can operate efficiently and unlock hidden value for investors.

Reasons Why Companies Undertake Demergers

Companies choose demergers for a variety of strategic and financial reasons:

• Focus on Core Operations: Streamlining operations to concentrate on the main business.
• Unlocking Shareholder Value: Often, the separate entities may have higher valuations than a combined structure.
• Regulatory or Compliance Requirements: Certain businesses may need to operate separately for legal reasons.
• Risk Management: Isolating risky or unrelated business segments to protect the main company.
• Attracting Investors: Independent entities may appeal to niche investors or markets.

Types of Demergers

Demerger structures can vary depending on the purpose and method:

Spin-Off: 

The parent company creates a new independent company, and shares are distributed to existing shareholders. The parent entity distributes the newly issued shares of the subsidiary to the existing shareholders on a pro rata basis, i.e., proportionately to their present ownership. In this case, the original parent company’s shareholders will automatically become the new company’s shareholders. 

The basis of ownership will remain the same, although the shareholders will now hold shares in two separate companies. The goal here is to separate two business lines, with each focusing on its own growth strategy, and to unlock greater value for shareholders by enabling the market to value the businesses independently. 

Split-Off: 

This is when shareholders exchange all or some of their shares in the parent company to gain shares in the new company. The shareholders will choose whether to remain invested only in the parent organisation, shift entirely to the new subsidiary, or hold shares in both. The total outstanding shares in the parent entity will decrease, as those shares will be retired. 

The objective here is to enable shareholders to self-select preferred investments based on the varying reward and risk profiles of the subsidiary and parent companies. This allows more targeted divestment by particular groups of shareholders.

Asset Sale or Transfer: 

Specific assets or divisions are transferred to a new or existing company, in this case, to another independent entity for cash or other assets, like the acquiring company’s stocks or debt securities. Hence, the selling entity will receive compensation, such as cash or stock, and then decide on the distribution of the proceeds, which may include reinvesting in the core business, reducing debt, or paying dividends to shareholders. 

The original company’s ownership will remain the same, though its capital structure and asset composition will change. The shareholders will not automatically receive shares in the acquiring company or in the divested business division/unit. The goal is immediate liquidity along with disposing of underperforming assets, or even exiting a particular market completely. 

Legal and Regulatory Framework (India & Globally)

In India, demergers are regulated under the Companies Act, 2013, along with SEBI guidelines for listed companies. Approvals from the National Company Law Tribunal (NCLT) may be required, and schemes must be fair to protect shareholder interests.

Globally, countries have their own regulatory frameworks. For example:

• In the US, demergers may be subject to SEC regulations on securities issuance and disclosures.
• In Europe, corporate laws ensure that shareholder rights are preserved during demergers.

How Demerger Works (Process Overview)

The process of a demerger involves several steps:

1. Board Approval: The company’s board approves the demerger plan.
2. Shareholder Approval: Shareholders vote on the proposed scheme.
3. Regulatory Approval: Authorities such as the NCLT and SEBI provide the necessary approvals.
4. Asset and Liability Transfer: Assets, liabilities, and employees are transferred to the new company.
5. Share Allotment: Shareholders receive shares in the new entity in accordance with the prescribed ratio.
6. Listing and Trading: The new company gets listed, and shares start trading independently.

Demerger vs Merger vs Spin-off vs Divestiture

Here are some key aspects worth noting in this case. 

• Demerger: A company splits into multiple entities; shareholders receive shares in the new entity.
• Merger: Two or more companies combine to form a single entity.
• Spin-Off: A division becomes a new company, and shares are distributed to existing shareholders.
• Divestiture: A company sells a portion of its business to another company or investor.

Here is a table to help you better understand the core aspects. 

Impact of Demerger on Shareholders

Demerger can affect shareholders in the following ways:

• Receiving new shares - Existing shareholders will receive shares in the newly formed entity without any cash transactions. It is based on a prefixed share exchange ratio. 
• Value creation potential - Shareholder wealth may increase in the long run if the newly formed entity does well and is worth more individually than a diversified or single entity.
• Volatility in stock prices - The share prices of both the new company and the parent may fluctuate considerably around the time the demerger is announced and immediately after the demerger. This is mainly due to the market adjusting to the new company structures.
• Focus and diversification - Shareholders will receive a more diversified portfolio across business categories, and new entities will benefit from dedicated focus and management teams for specific operations.
• Tax liabilities and implications - Tax liabilities may arise (capital losses or gains) when the shares are eventually sold in either the new company or the parent entity. The adjusted cost basis has to be noted for calculating future capital gains taxes upon selling the shares.
• Changes in dividend policies - The new company’s dividend policies may differ from those of the original entity. Shareholders may receive separate dividends from each new entity, leading to higher or lower overall dividend income.

Tax Implications and Compliance

In India, demergers can be tax-neutral under certain conditions if they follow the prescribed SEBI and Income Tax rules. However, it’s important to:

• Check the tax treatment of capital gains on shares sold post-demerger.
• Ensure compliance with reporting requirements in your investment account.

Here are the key compliance and tax implications: 

• Demergers that meet Section 2(19AA) criteria will be exempt from capital gains tax under Section 47, which treats share allotment and asset transfer as non-transfers. 
• There has to be approval for the demerger scheme under the Companies Act of 2013 (NCLT), and, for GST purposes, fresh registration is mandatory for the new entities. 
• There are no capital gains on transferring liabilities/assets, and tax deductions for demerger expenses (1/5th over a period of 5 years) are available. 
• Shareholders do not have to pay immediate tax on the receipt of new shares, while accumulated profits may be transferred, potentially allowing shareholders to realise their value as capital gains later. 
• ITC (input tax credit) transfers are proportionate to the assets transferred and are reported on Form ITC-02. GST is exempt for asset transfers of going concerns; otherwise, it is applicable. 
• There are SEBI (Securities and Exchange Board of India) guidelines/regulations which apply to the demerger process and listed companies. 

How Demerger Affects Share Price

• Short-Term Volatility: The prices of both the original and the new companies may fluctuate after the demerger announcement.
• Market Perception: Investors react to growth prospects, management quality, and independent performance.
• Long-Term Value: Well-executed demergers often unlock shareholder value by allowing each company to focus on its core business.

How to Track Demerger Events on Groww

Groww makes it easy for investors to monitor demerger events:

• Check your portfolio for announcements related to corporate actions.
• Use the “Corporate Actions” section to see upcoming demergers and record dates.
• View the share allocation ratio and trading dates for the new entity.
• Get timely notifications to plan your investment decisions.

Key Investor Takeaways

• Demergers create independent entities to unlock value and focus on core operations.
• Shareholders often receive shares in the new company, maintaining ownership stakes.
• Prices may show short-term volatility, but long-term benefits are possible.
• Regulatory approvals and compliance ensure fairness and investor protection.
• Platforms like Groww simplify tracking demerger events and managing investments.

Conclusion

Demerger is a powerful corporate strategy that can unlock value for both companies and investors. By understanding how the process works, its impact on shareholding, tax implications, and market behaviour, investors can make informed decisions. Platforms like Groww make it easier to track demerger events and manage portfolios effectively. Keeping an eye on such corporate actions ensures that you stay ahead in your investment journey and make the most of opportunities arising from structural changes in companies.