The Hindu Business Line : Decoding a demerger

THAT the telecommunication business, the energy business as well as the financial services business were and are not being carried out by Reliance Industries Ltd (RIL) is an open secret. In fact, RIL itself concedes this when its financial accounts, including quarterly results, give segment-wise figures relating to only three businesses — petrochemicals, refining and others. And if you thought that the figures relating to telecom, energy, and so on, would be tucked inside the `others' category, perish the thought because the company itself concedes that this category includes primarily oil and gas and textiles.

That the telecom business of the Reliance group — of course it is no longer the Reliance group ever since the Ambani brothers, Mukesh and Anil, formed their own groups — is carried out under the banner of Reliance Infocomm Ltd is widely known to everyone. Yet the process of division of management responsibilities between the two Ambani brothers has been labelled as `demerger' of Reliance Industries.

To be sure, RIL had invested heavily in companies running these businesses. But that does not make the undertakings of these respective companies, the undertakings of RIL. RIL's assertion that it owned a telecom undertaking would have carried weight had the telecom business been done by it directly without forming a separate company for it. Ditto for its assertion as to energy and financial services businesses.

RIL has come out with a communication titled `For the attention of company's shareholders' in which it makes the extraordinary claim that telecom, coal-based energy, financial services and gas-based energy were indeed the undertakings of RIL which are being transferred to the resulting companies, Reliance Communication Ventures Ltd., Reliance Energy Ventures Ltd, Reliance Capital Ventures Ltd and Reliance Natural Resources Ltd respectively.

This obviously has been done to make the grade under the demanding definition of `demerger' given in Section 2(19AA) of the Income-tax Act, 1961 which among other things requires transfer of the undertaking(s) of the demerged company to resulting company or companies lock, stock and barrel. The net assets of the so-called telecom undertaking transferred lock, stock and barrel, for example, is touted to be Rs 15,389 crore. Apparently, this must be the cost or value of investment in Reliance Infocomm Ltd made by RIL for the simple reason RIL itself was not carrying any telecom business.

The sine qua non for making the grade as demerger is transfer of undertaking(s). RIL has failed this test miserably. The four holding companies, including Reliance Communication Ventures Ltd, obviously will not be vested with the undertakings that have been claimed to have been transferred to them. The telecom undertaking, for example, was and would be continued to be owned by Reliance Infocomm Ltd.

Why then did RIL choose to brazen it out? Perhaps it thought that bestowing the status of `demerger' for the complicated division of spoils between the squabbling brothers would save them as well as the public shareholders capital gains tax that otherwise might have become payable.

If the reorganisation exercise indeed did not culminate in demerger, other related claims of the company — that the holding period in RIL (demerged company) would be included while calculating the holding period of shares in the resulting companies and that cost of acquisition of RIL shares pre-demerger should be apportioned in the ratio of 52, 38.7, 7.3, 1.3 and 0.7 per cent among the demerged and the four resulting companies post-demerger — would go for a sixer. In fact, all the tax benefits posited by RIL on the basis of its belief that what it has achieved in the recent reorganisation exercise is demerger would fall like a house of cards if the tax authorities call its bluff and puncture its claims.

The Indian tax law, unlike that of the UK, does not recognise the group concept so much so that loss of one company in a group cannot be set off against the profit of another company in the same group. For tax purposes, individual companies of a group, no matter howsoever close they are to each other, are independent assessable entities. In the event, even a 100 per cent subsidiary's loss cannot be set off by the parent against its own taxable income.

RIL, Reliance Infocomm and Reliance Energy are thus separate entities. The undertakings owned by the latter two cannot by any stretch of imagination be deemed to be owned by RIL despite the sizeable shareholding by it in these two companies. It is for the Government to ponder whether it should treat companies incubating promising ventures — not under its own banner but through promotion of subsidiaries and associates — more fairly. But till specific amendments are made, RIL will have to live with our tax laws as they are. Its attempt to vest the just concluded reorganisation effort with the halo of demerger is likely to come unstuck should the taxman read the law as it is, as he must.

(The author is a Delhi-based chartered accountant.)