RACY CASES 50 China meets his match — Reliance demerger demystified.


 V Pattabhi Ram and Pavan N Rao

Wafers had a cup of Cappuccino in one hand and a piece of roasted papad in the other. “Terrible combination” thought the captain, but decided to keep his counsel.  As the clock chimed six, China walked in.  “Hey, Wafers, tell me what is price-discovery”? He said that without even so much as a “Good evening.”  Wafers bit the bait.  It was her one opportunity to carry coal to New Castle. “Look, price discovery is the process by which you find the fair price of a stock through the interaction of buyers and sellers dealing in the stock market.” Sipping cappuccino, Wafers remarked, “But China why do you ask”?

“I read that the NSE and the BSE held a special one-hour session on 18th January 2006 exclusively for the trading of the Reliance stock to enable ‘price discovery’. That got me curious” explained China. “Don’t the stock exchanges make a living out of continuously discovering prices? Why did they need a special session?”  It was Wafers’s second opportunity to carry coal to New Castle.

Mopping her hair up she said, “You see, Reliance Industries Ltd (RIL) is demerging leading to four new companies apart from Reliance.  Now, RIL has the highest weight on the Sensex and the second highest weight on the Nifty. Upon de-merger some of the assets of the company will be given to the four resulting companies which would mean that for the investor the value of the Reliance stock would come down.  And, while RIL will continue to be on the Index the resulting companies will not form part of the Index. That would mean that the Index too would fall. Hence the opening level of the indices for 18th Jan had to be determined”, demystified Wafers.

“Well, that explains it,” remarked China. And wondered, “But I can’t understand one thing.  The dispute was between bade miyan and chote miyan.  So, why is the de-merger yielding 5 companies?”  Ha, here was another opportunity for Wafers to play Ms. Know All.  She explained, “True.  Apart from RIL there are four other, what we technically call, ‘resulting companies’ namely Reliance Communication Ventures Ltd, Reliance Energy Ventures Ltd, Reliance Capital Ventures Ltd and Reliance Natural Resources Ltd.  Now, RIL was not only an integrated petrochemical business but was also well diversified. It had exposure to Power business, Finance and Investment, Natural Resources and Telecom. The de-merger was an opportunity to restructure the group into companies handling vertical businesses.”

“Oh! I see,” remarked China.

“Well, to make matters even more intriguing, two of the resulting companies will soon merge with the companies that they hold”, added Wafers. “Reliance Energy Ventures Limited and Reliance Capital Ventures Limited will be merged with Reliance Energy Limited and Reliance Capital Limited respectively which are actually the principal shareholders in the amalgamating company!”  China nodded.  Wafers was sure that if she told him about holding companies and special purpose vehicles he would see stars.

“Now what are the tax implications?” asked China.  He had over time invested in 1,000 shares of RIL at an average cost of Rs 550 and was wondering whether the de-merger would lead to taxes at his hands. Wafers ordered two more burgers.  She was beaming. For, It wasn’t every other day that she had the opportunity of educating China.  “For every share in RIL you get one share each in each of the four companies”.  China thought, “So four thousand new shares for me on the whole.”  And asked, “Do I pay capital gains tax now.”  Wafers explained, “Nope. At this point there is no capital gains because the issuing of shares under a de-merger is not a transfer” Someone hissed “Section 47?”  Wafers turned around stunned but could see no one.

“Of-course there would be capital gains when the shares of RIL or the resulting companies are sold?” asked China.  “Yup” said Wafers.  And added, “at that point the date of acquisition will become important in deciding whether the gains are long term or short term. That date will be the date on which you acquired RIL”.  Wafers heard someone hiss Sec 2 (42A).  She turned around but found no one.

“So if I had bought RIL six months ago and sold Reliance Capital Ventures seven months later, the total holding period of Reliance Capital Ventures will be construed as 13?” asked China. Wafers wasn’t surprised that her friend was quick on the uptake.  “Yes” she said.  And added, “In that case the gain will be long term capital gains and will be tax free.  If the total holding period is less than 12 months it would count as short term capital gains and will attract 10% tax.  “Section 111 A.”  “Was she hearing voices?” wondered Wafers.

“Okay!” exclaimed China. “In that case the cost of acquisition becomes important.  And how do I compute it?” he asked.  Wafers was ready with her answer.  She reeled out the Section that she had crammed into her head.  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 de-merged company the same proportion as the net book value of the assets transferred in a de-merger bears to the net worth of the de-merged company immediately before such de-merger” China almost spilled his cappuccino.  “But from where do I pick those numbers” from he asked. “RIL has issued a guidance on 16th Jan” guided Wafers.  “Lay your hands on one.”

China wasn’t through as yet. “You said two of the resulting companies would be merged with two other companies.  What is the tax position in that case?” asked China.  “Same as is the position with de-merger” remarked Wafers.  China pointed out, “The scheme of de-merger and the subsequent amalgamation plans are tax-efficient.” Wafers couldn’t help but caution, “Whether they turn out to be strategically sound for the legacy of Dhirubhai remains to be seen.”

“I am impressed,” said China. “With Reliance’s planning or my erudition?” asked Wafers. And on a sudden idea, she added, “How come you did not know any of this?” China smiled. “Of course I knew it all. I was just checking if you knew it!  See, you have to crack May 06.”  Wafers almost threw the cappuccino on China’s face.

 

 

 

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About Pattabhi Ram

A chartered accountant by profession, a writer by passion and a teacher by accidental choice.
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