The Hindu Business Line : Reliance Industries: The mechanics of the demerger

SHAREHOLDERS of Reliance Industries will meet later this week, on Friday, to discuss and vote on the Scheme of Arrangement for Demerger proposed as per the settlement arrived at between the Ambani brothers in June. The EGM notice together with the explanatory statement is an imposing legal document that most shareholders may find difficult to read.

The document contains interesting details on the strategy adopted to give the separation exercise the character of a "demerger" in order to avoid tax liability. The most interesting part of the whole story is the rationale given in support of the demerger. But first the operative part.

Modus operandi: Here is how the entire deal is being structured.

The business of Reliance Industries(RIL) has been segregated into five "undertakings"— coal-based energy undertaking, gas-based energy undertaking, financial services undertaking, telecommunication undertaking and, finally, the remaining undertaking, that is, businesses retained by RIL, namely, petrochemicals and oil and gas.

Each of these undertakings will comprise of the investments (equity shares) of RIL in the respective businesses apart from certain building premises (see graphic). For instance, the gas-based energy undertaking will count among its assets 95,000 sq ft of space at the Reliance Centre at Ballard Estate in Mumbai.

The liabilities of each of these undertakings will comprise the loans "relatable" to them; details of what these loans are and their quantum have not been disclosed.

The excess of assets transferred over liabilities for each of these four undertakings will be adjusted against RIL's revaluation reserve and securities premium account.

This is where the valuation of the respective assets and the quantum of liabilities become important as RIL is likely to sacrifice a part of the reserves it holds, which in turn affects its shareholders.

These "undertakings" will be hived off into four subsidiaries — Reliance Energy Ventures Ltd., Global Fuel Management Services Ltd., Reliance Capital Ventures Ltd. and Reliance Communication Ventures Ltd. Each of these companies will then issue shares to RIL shareholders in 1:1 ratio. Interestingly, the par value of the shares of Global Fuel Management and Reliance Communication Ventures will be Rs 5 a share compared to Rs 10 for RIL's shares.

Why the demerger?

The rationale given for the demerger is interesting. Apparently, each of the businesses being hived off now has "tremendous growth and profitability potential and are at a stage where they require focused leadership and management attention... . there are also differences in the manner in which each of these businesses are required to be managed".

The statement goes on to say that RIL has proposed the demerger "in order to enable distinct focus of investors to invest in some of the key businesses and to lend greater focus to the operation of each of its diverse businesses".

No quarrels with the logic. But what about the differences between the two Ambani brothers and the eventual settlement that we all thought was the reason for the restructuring of businesses in the first place? The explanatory statement says that "with a view to achieve greater management focus and keeping in mind the paramount and overall interests of the shareholders" of RIL..., the board of directors "believe that Shri Anil D. Ambani... will provide such focussed management attention and leadership to the financial services, power and telecom businesses... and Shri Mukesh D. Ambani... will continue to lead the other businesses including petrochemicals, oil and gas exploration and production, refining and textiles and other businesses comprising the Remaining undertaking... "(RIL)

Shell companies come in handy

None of the four companies that result from the demerger is a newly floated one. Each has been around for a while under different names though what it was created for and what it was doing till now is unknown. For instance, Reliance Energy Ventures was known as Reliance Terra Networks Pvt. Ltd. in its earlier avatar and was originally incorporated in July 2000. Global Fuel Management Services was called Reliance Platforms Communications.Com Pvt. Ltd. and was first incorporated in March 2000.

Similarly, Reliance Capital Ventures was earlier Reliance Energy Technical Services Pvt. Ltd. and was incorporated in September 2004 while Reliance Communication Ventures was incorporated in July 2004 as Reliance Infrastructure Developers Pvt. Ltd.

Will the scheme pass the test?

The entire exercise of settlement between the brothers has been given the character of a demerger so that stamp duties and capital gains taxes can be avoided in the hands of RIL and its shareholders. The exercise satisfies the letter of the law as the assets have been transferred along with the liabilities, and shareholders in RIL will also be shareholders in the resulting new companies.

The effect may be different if the taxman were to interpret it differently for what is being "demerged" are not physical assets used in production but investments, especially in the case of power and financial services. The Companies Act clearly distinguishes sale of investments(shares and bonds) and sale of assets. While shareholder approval is required for the latter, it is not necessary for the former.

In the present case, except for a few building premises, the majority of assets being transferred are shares in the group companies that are into power and financial services. It is only in the telecom business that there is a transfer of plant and machinery and equipment. So will this qualify for a demerger and the attendant benefits?

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