Demerger is a disjoining or a separation of one or more units of a company to form a new company independent from the original one. The following definition of demerger is excerpted from section 2 (19AA) of Income Tax Act, 1961-

“Demerger”, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company”

Demerger is a form of corporate restructuring which in undertaken by companies in order to promote specialization. Companies have started practicing demerger because of the many benefits it offers. Demerger allows a company to expand its operations in a very systematic manner. It allows a specific division or unit to grow as a separate and a focused entity, thereby increasing its efficiency and effectiveness. It benefits the shareholders by providing them better opportunities to participate in the management, operations, decision making process and profits of the applicant company as well as the resulting company. 

Demerger can be affected by any of the following three ways:

1. Demerger by agreement between promoters; or
2. Demerger under the a scheme of arrangement with approval by the Court under section 391;
3. Demerger under voluntary winding up and power of liquidator

Demerger by agreement between promoters

Demerger may take place by agreement between promoters of the demerging company. In such a scenario, the principle company may spin off its specific undertakings to the resulting company. All the property, liabilities and issues of the principle company, transferred to the resulting company immediately before the demerger, becomes the property, liabilities and issues of the resulting company.

Demerger under the a scheme of arrangement with approval by the Court under Section 391 of the Companies Act

In order to affect a demerger, there must be a provision in the Memorandum of understanding of the principle company. The scheme of such arrangement has to be submitted in the respective High Courts of the states where the head office of the principle as well as resulting company is registered.