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Effect of demerger on shareholder liability

QUESTION: I am a shareholder in Larsen and Toubro Co. Ltd., which has recently demerged, so that the convertible debentures, which I held are now satisfied by the issue of shares in Ultra Tech Cemco Ltd. I would like to know what would be the treatment that would be given in ascertaining capital gains on sale of shares acquired by me. I believe that there will be no liability on the shares received on demerger.

ANSWER: It is difficult to provide an answer for any particular instance of demerger, as the terms of such demerger may require to be considered. But the general law relating to demerger and its tax consequence can be indicated.

Where the demerger is one under a scheme of arrangement under Sec. 391 to 394 of the Companies Act, there is no tax incidence either for the demerged company under Sec. 47(vic) or for the shareholders under Sec. 47(vid).

Similarly Sec. 47(x) exempts any transfer by way of conversion of bonds or debentures into shares or debentures of that company. Since there is conversion of debentures into shares of another company, Sec. 47(x) may have no application. Since what is converted is not shares, Sec. 47(vid) would have no application. But Sec. 55(2)(aa) would, however, provide that where holder of capital asset being share or any other security is allotted any additional financial asset without any payment, the amount actually paid for the original asset would be deemed to be the cost clearly indicating that there is no liability on mere allotment of any financial asset for "any share or any other security" within the meaning of Sec. 2(h) of Securities Contracts Regulation Act, 1956 which reads as under:

"(h) "Securities" include: (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate; (ii) Government securities; (iia) such other instruments as may be declared by the Central Government to be Securities; and

(iii) rights or interests in securities".

Once the cost of the original share is taken, the period of its holding should also be reckoned for judgement, whether it will be short term or long term asset within the meaning of Sec. 2(47A) of the Act, so that in the case of any listed security on conversion, the prior period of holding should also be reckoned. It further follows that the indexation benefit should also be available with reference to such period of holding, because the law would deem the asset after conversion to be the same as the original asset.

However, indexation benefit is not available for money bonds, so that for period it was held as convertible debenture, it could possibly raise a controversy as to eligibility for indexation benefit.

While this will be the general position of law, if there is any inference from the terms of a particular demerger, I should imagine that the demerged company would advise its shareholders as to the tax implications to enable tax compliance.

S. Rajaratnam

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