Companies demerge themselves. When they do, your shares in the original company now gives you more shares of other companies. The Sintex demerger gave you 1 share of Sintex Plastics for each share of Sintex you owned. The PTL share gave you a share of Artemis. A Grasim shareholder got 7 shares of Aditya Birla Capital Limited for every 5 shares of Grasim owned.
How does it now look for tax purposes? If you bought a share at Rs. 100 and it demerged, what’s the purchase price (and date) of the new shares?
We’ll answer this here.
Example: The Sintex Demerger
The Sintex stock has been demerged into two: the Plastics Company (Sintex Plastics Technologies Limited or SPTL) and the Textiles arm (listed as Sintex).
The Sintex stock was at Rs. 105 before the demerger date. And then it crashed to Rs. 20. Because the listed company – Sintex – was the smaller part. The bigger part was in SPTL, which listed much later. (Read: Sintex’s prospects, in our Outlier in Focus piece)
SPTL has now listed and after a few days of a fall, it’s at Rs. 107 or so.
If you owned one share of Sintex earlier at Rs. 105, it’s now worth Rs. 31.8 (one share of Sintex) plus Rs. 107 (one share of SPTL) for a total value of Rs. 137.8.
(Okay, that’s awesome, but this is a bull market so please discount all big moves)
If you sold some of them today, how do you calculate your profits?
The Price of Each: Split by Book Value
When the stock demerged, a certain amount of book assets and debt etc went to each company. Based on the split of such book value, we can divide our purchases. The book value split is very different from the way the market splits the valuation – I might pay a higher price for a pure plastics play than for a double-play.
The company will know this. You won’t. So the company will (usually) issue a note saying look, we split the book value like this, so this is how you should split your acquisition price.
The split price is your purchase price for the purpose of tax calculations.
Sintex has such a note.
So if you bought a Sintex share at Rs. 100, then:
- You effectively have one share of Sintex at Rs. 36.38
- And one share of SPTL at Rs. 63.62
If you had bought at multiple times (bought at 100, 105, 110 etc) then each purchase is split appropriately.
The Date of Purchase: Remains the Same
The date of purchase of all the demerged shares is the same. When you split the share purchase in a ratio, you will be deemed to have bought the new “demerged” company also at the same earlier date. The date of demerger is not used for anything, tax wise.
If you own shares of Sintex for five years and you now have new SPTL shares, those SPTL shares are also recorded as being bought five years ago.
(Put another way, if you sold the SPTL shares today, you will have long term capital gains, not short term)
Is There Tax on the Demerger Itself?
Will the demerger itself be taxed? That is, will the shares be considered as your selling the original and getting two shares?
A demerger is not a “transfer of asset”. It’s just splitting the asset into different parts. So the tax department won’t even get into the equation.
We hope this makes things clearer for owners of shares that are now “demerged”.
Side note: Demergers create value?
You saw this in Sintex. The PTL demerger – where the price was around 140 before the demerger – saw Artemis list at 150 with the price of PTL at 43.
The Grasim demerger is still waiting for ABCL to be listed, and when it does, we’ll see if value was “unlocked”.
This happens because companies, when they are one entity, get valued on their primary business. You probably didn’t even know that Sintex – which makes plastic tanks and custom mouldings – also had one of India’s largest textile mills. (The “tex” is from there).
M&M is a company that deserves to demerge – it has holdings in auto and tractors(obviously), auto parts companies (sure), defence, agri products, tech (TECHM), leisure (Mahindra holidays), Real estate and much more. They need to divide this into different operational companies and one holding company. If they did, M&M would be valued at much more, in my opinion.
But there are lousy demergers. Sterlite Technologies demerged, but there’s one arm that isn’t listed (Sterlite’s power transmission division). Reliance, when it demerged, gave some massive list of tiny shares like “Reliance Communication Ventures”, which had to eventually merge with other companies to be really valued. Such demergers don’t do much.
Overall, though, demergers are good if the company is in disparate businesses. And in other cases – like Warren Buffett’s, more famously – mergers may create more value if there is a much better deal in a single umbrella.
Note and Disclosure: Author owns some of the stocks mentioned above, and has transacted in them recently. These stocks have also been part of Capitalmind Portfolios. This is not a recommendation to buy or sell any of the above, and is not to be treated as advice.