The Hindu Business Line : Spin off

Very often we hear about company restructuring through transfer of business or assets to a subsidiary company. The latest in the list is the speculation about the transfer of 80 per cent participatory interest in D6 block in KG Basin by RIL to its subsidiaries.

There are various reasons for companies to opt for this exercise and there are many ways of implementing the transfer. This exercise is also referred to by different names such as ‘spin-off’, ‘drop down’, ‘subsidiarisation’, etc. History shows, though the rationale for spin off could be widely different, companies have enhanced shareholder value through spin-offs.

Why spin-off?

There are many instances where spin-off was chosen for strong financial reasons. This could be either for raising funds or for tax savings when the ultimate objective is to divest the business. When a multi-product company wants to raise funds though equity for developing a particular business, this is a useful model. Spinning off the particular business to a 100 per cent subsidiary and thereafter issue of shares of the subsidiary company to the strategic equity partner ensures equity funding for development of that particular business without diluting the ownership of the rest of the businesses.

Also, spin-off as a process of divestment is tax efficient especially when such spin-off is carried out well in advance of divestment. In these instances, spin-off to a subsidiary is implemented at cost so that no tax is triggered by this step. The subsequent divestment will be by way of sale of shares. The tax savings accrue on a few counts:

First, you can have indexation benefit on the cost of shares. Whereas for sale of business the taxable profit will be higher as it will not have the indexation benefit, the cost price of the business will be lower to the extent of tax depreciation. Table 1 illustrates the reduction in taxable capital gains for sale taking place one year after spin-off.

Further, if the divestment is done combined with listing of the subsidiary company through public issue, tax incidence will be much less. In this case, the divestment to strategic investor can be carried out through the stock exchange and the tax incidence is limited to STT (securities transaction tax) which is only 0. 25 per cent of the sale price (that is, 0.125 per cent each on the buyer and the seller) whereas the applicable tax rate for sale of business (falling within the definition of long-term asset) is 22.66 per cent.

In the above example, if we assume the sale price is Rs 2,000 lakh, the total saving in tax will be as shown in Table 2. Even in the case the shares are not listed in certain situations, the tax rate applicable for sale of shares will be lower. This will be true when the sale happens within three years of start-up but after one year of spin-off. Here the tax rate for sale of shares will be 22.66 per cent whereas for sale business it will be 33.99 per cent.

Another big advantage in divestment through spin-off is that divestment in phases will be possible. Such an option helps in maximising the realisation from sale.

There are also a few instances where spin-offs were chosen for strong business reasons. In certain cases the technology may be available only with equity ownership. In such situations, spinning off the particular business to a 100 per cent subsidiary and thereafter issue of shares of the subsidiary company to the strategic partner will secure the required technology for the business.

In the recent past we have also seen spin-off of tea gardens by Tata Tea and subsequent issue of shares to the employees. This spin-off has secured the employees’ commitment to the tea gardens and, at the same time, is helping Tata Tea concentrate on the development of the market.

The process

Spin-off can be carried out either through court process or through shareholders’ approval. Court process is useful to secure some of the approvals for transfer but will be time consuming compared to spin-off through shareholders’ approval. The choice is to be made in each case depending on the circumstances.

Spin-off is different from demergers and transfer of business to its parent or its parent’s subsidiary. In case of demerger, the ownership pattern of the demerged company remains the same as that of the main company. In the case of transfer of business to the parent company, the main company sells off the business to the parent company. When such transfers are made for strong business reasons, the shareholder value is enhanced. Years back when P&G wanted to invest heavily on brand to build-up market share, the brands were transferred from their partly-owned subsidiary company in India (a quoted company) to a 100 per cent subsidiary to have freedom to invest in the brand without worrying about quarterly results. As a result over a period they could increase the market share.

Similarly, Merck Ltd transferred its life science and analytics business to its parent company to concentrate on the main pharmaceutical business. In such cases, it is important that the transfers are made at the fair value to protect the interest of the minority shareholders.

(The author is Director, ICI India Ltd.)

Related Stories:
RIL to transfer KG D6 block interest to four subsidiaries
GHCL to spin off home textile biz

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