Demystifying the Bajaj Auto demerger

Readers may be aware that Bajaj Auto Ltd (BAL) has been demerged. Consequently, shareholders of the erstwhile BAL will receive shares of the demerged new companies as per the provisions of the demerger.

This article discusses the demerger and its tax treatment, shorn of all jargon, income tax sections, laws and rules. Shareholders of BAL would naturally be interested to know if they have any tax liability following the demerger, and if so how much. But, even non-shareholders may find the discussion useful, as the principles behind any demerger remain the same.

The demerger
The term ‘demerger’ simply means one company transferring one or more of its business operations into another company(s). The company that transfers such business operation is known as the “demerged” company, while the company to which the business is transferred is known as the “resulting” company.

Note these nomenclatures carefully since these will be used throughout the article. Once again, BAL is the demerged company and the new companies whose shares you will receive are the resulting companies.

In this case, BAL has been demerged into (a) BAL to focus on the auto business, (b) Bajaj Finserv Ltd (BFSL) to focus on wind energy generation, insurance, consumer finance etc, and (c) Bajaj Holdings & Investment Ltd (BHIL) to focus on investments and new business opportunities.

Simultaneously, the name of the erstwhile BAL has been changed to BHIL, and the name of the erstwhile BHIL, i.e the company to which the auto business has been transferred, has been changed to BAL.

The record date for the demerger is March 25, 2008.

Consequence of the demerger
The existing shareholders of BAL will get one share each in the resulting companies for every share that they held in BAL

Tax impact of the demerger
As per the Income Tax Act, a transaction of demerger per se has no tax implication on the shareholders.

Hence, when the shareholders of BAL are allotted the new shares in each of the three companies, there would be absolutely no tax implication whatsoever.

The tax implication will only arise when either the shares of BAL (now BHIL) or the shares of the new resulting companies are sold.

Tax implications when shares are sold
When the shares of any of the companies are sold, it would give rise to capital gains tax liability. The three issues that arise are:

1. Whether the new shares (in the resulting companies) are long-term assets or short-term: To find out whether or not shares in the Resulting Companies are long-term or not, the holding period of the original BAL shares will be included in the period of holding of the new shares

2. Indexation of the capital gains: The indexation will start from the date of allotment of the new shares and not from the date of acquisition of the original BAL. Relevance of indexation is only for working out the capital gain amount if the same has to be set off against capital loss. However, as explained further on, for most shareholders, there will be no need of this

3. Cost of acquisition of various shares after the demerger transaction: To calculate capital gains when the shares are sold, a vital piece of information is the cost of acquisition. Your original cost of acquisition of BAL shares will change now on account of the demerger. Plus, there will be a new cost accorded to the new shares of the resulting companies. The Income Tax Act specifies a formula that takes into account the proportion of the net worth of BAL vis-à-vis the book value of the businesses transferred to arrive at the new costs of acquisition.

Thankfully, Bajaj has done all the hard work for us. They have summarised the net results of the above calculations as per the following table.

 Name of % of cost of   company acquisition
  of BAL shares
 BHIL  56.5%
 BAL  22.1%
 BFSL 21.4%
 Total 100.0%

The above table indicates the proportion in which your original cost of acquisition of Bajaj Auto shares will be apportioned to the new shares.

Now let’s understand all of the above in terms of an example
Say, Anand had purchased 10 shares of Bajaj Auto for Rs 3,100 on January 10, 2007. Consequently, his total cost of acquisition would be Rs 31,000. Now, post the demerger, his new costs would be as below:

BHIL (56.5% of Rs. 31,000)  Rs. 17,515
BAL (22.1% of Rs. 31,000)  Rs. 6,851
BFSL (21.4% of Rs.31,000)  Rs. 6,634
Total  Rs 31,000

For the per share cost, just divide the above values by the number of shares. For example, Anand’s new cost of acquisition of Bajaj Auto (actually BHIL on account of the change in name) post demerger would be Rs 17,515 divided by 10, which works out to Rs 1,751.50. Ditto for other shares.

Now, let’s say he sells all the above shares on May 15, 2008. Since he has bought the shares on January 10 last year, over 12 months have elapsed and hence the shares will be long-term capital assets. Similarly, for the new shares, the period of holding of the original Bajaj Auto shares (now BHIL) will be taken into account, thereby making these long-term assets, too.

Therefore, since long-term capital gains are tax-free, if any or all of the above shares are sold on a recognised stock exchange, there would be absolutely no tax payable by Anand in the entire process. Were Anand to sell any of the share(s) within one year of the purchase of the original Bajaj Auto shares, he would be liable to pay 15% short-term capital gains tax. The cost of acquisition would continue to be in the proportions explained above.

sandeep.shanbhag@gmail.com