(The Article was republished by Taxsutra on: https://www.taxsutra.com/dt/experts-corner/liquidity-esop-holders-through-demerger)
Background
Consider a case where a listed company is an operating – cum – holding company, and there are certain unlisted subsidiaries held by the listed company. Further, consider that such an unlisted subsidiary has an ESOP pool allocated for the employees of the unlisted company, and such ESOP pool has been vested to its employees.
Therefore, as an example, the listed company would own 90% of the unlisted subsidiary, while the employees would own 10% in the said unlisted subsidiary. From a commercial perspective, while the employees, technically, own a “currency” in the form of shares of a company, valued, on paper, at a particular valuation, such currency is not tradeable owing to the illiquidity of the unlisted company. Consequently, the employees have effectively been vested with “illiquid” currency in the form of a bonus ESOP pool, and with no avenue to liquidate the same.
One obvious answer to this is for the unlisted company to be merged with the listed company, where the shares held by the listed company in the unlisted company would be canceled, and the employees would be issued shares of the listed company, which would serve as a “liquid currency” for their exit. However, this would mean a loss of identity of a separate business carried on the unlisted company, because of the reason that the said unlisted company is amalgamated with the listed entity.
Problem Statement: Given the above background, it is imperative to explore avenues that would result in the retention of the identity of the business of the unlisted company from the perspective of the listed company, while giving liquidity to the employees of the unlisted company.
Demerger Scheme – Contours
In the context of the above Problem Statement, a possibility of a Demerger through a Scheme of Arrangement u/s 230-232 of the Companies Act, 2013 could be explored. In the present case, the Listed Company could consider the following structure:
- Incorporation of a wholly owned subsidiary (“WOS”) by the Listed Company
- Demerger of substantial business of the unlisted subsidiary to the WOS
- Issuance of shares by the Listed Company, and not the Unlisted Company as a result of the demerger
- Shares to be issued by the Listed Company only to the employees of the Unlisted Company as consideration for the demerger
The Resultant Structure could be diagrammatically represented as follows –
Resultant Structure: In the above structure, the employees will hold an equivalent stake in the listed company directly, thereby giving the employees a liquid “currency” in a tax-neutral manner at the time of issuance of shares by the listed company, and retaining the identity of the business of the Unlisted Company separate.
Key Considerations
Tax Neutral Demerger: Section 2(41A) of the Income-tax Act, 1961 defines “Resulting Company” (i.e., New Unlisted Company) to include the New Unlisted Company itself and its 100% holding company (i.e., the Listed Company). In order for a demerger to be tax neutral, the “Resulting Company” has to issue shares to the shareholders of the Demerged Company (i.e., the Unlisted Company”) – given that the definition of the “Resulting Company” includes 100% holding company, a listed company could directly issue shares to the employees and thereby, giving an exit by way of a liquid currency to the employees of the unlisted company, and the resultant demerger should be considered as tax neutral demerger.
SEBI & Companies Act Considerations: The said demerger would be effected through a Scheme of Arrangement u/s 230-232 of the Companies Act, 2013, which would require prior approval of the stock exchanges/ SEBI and thereafter the jurisdictional National Company Law Tribunal and other regulatory authorities. Given the elaborate timelines in executing the said transaction (say, 10-12 months), this would warrant advance planning to effectuate the same by the management of the listed company.
IndAS Implications: Shares issued by the Listed Company would be recorded as fresh capital issued with a corresponding debit recorded as an investment in the New Unlisted Subsidiary. Similarly, the New Unlisted Subsidiary would record the assets/ liabilities vested upon it at carrying amounts (being common control business combination), with a corresponding credit to Other Equity.
Stamp Duty Implications: Depending on the state in which the registered office of the Listed Company is situated, a certain percentage of the fair market value of shares issued (say, 0.7% in Maharashtra) would be considered for the purposes of stamp duty adjudication.
Key Takeaways
In the light of the above, through a demerger scheme, employees of an unlisted company could be given an exit (by way of issuance of shares by the listed company), without dissolving the identity of the separate business of the unlisted company, while giving a liquid currency to the value creators i.e., the employees of the unlisted company.