Grasim can own its own shares with the approval of the court or hold it through a trust (in terms of Sec 100 of the Companies Act read with Sec 394) and it is also possible to cancel the shares with the court approval, points out M&A specialist Jayant Thakur. Yet another way of solving the difficulty would be for Grasim to sell its stake in Indian Rayon to another group company. One reason for favouring this course of action is that it will mean that cross-holdings will remain intact.

Shareholders: What is in the deal for the shareholders? Indian Rayon shareholders are the losers. First, because of the location ofits plants (portland cement in Karnataka which accounted for 38.5 percent of sales in 1997-98), the realisations are better and in white cement (located in Rajasthan) realisations are 2.5-3 times higher than portland cement. The profitability of the cement division will improve further due to expected commissioning of the bulk terminal by December 1998. The direct benefit of ready mix concrete plant (capacity:50,000 tpa at cost of Rs 5 crore) expected to be commissioned by December 1998, will not be available to Rayon shareholders. The expanded capacity (2.1 lac tonne) of white cement resulted in more than doubling of white cement capacity to 3.6 lac tonne and 1997-98 was the first full year on expanded capacity, accounting for 7 percent of sales. By the management's own admission, capacity utilisation was less than satisfactory due to the prevailing slowdown. Despite shareholders of Rayon getting Grasim shares, the benefit will be marginal because in 1997-98, capital employed in Grasim was 72 percent higherthan Indian Rayon. This means that the cash flows from the cement division would have meant a higher return on total capital employed in Indian Rayon. In other words, the cash flows of the cement division were worth proportionately more to the shareholders of Indian Rayon than they will be to shareholders in Grasim.

Another problem for Rayon shareholders would be the sea water magnesia plant which was commissioned after a delay of 9 months and cost overrun of Rs 108 crore. The management does not expect returns in the current and next year. The investment in the project is Rs 383 crore i.e. it accounts for 15 per cent of capital employed. Naturally, post hive-off, at least 20 percent of the balance-sheet won't contribute anything for two years. Further, the additional 35,000 tpa of carbon black capacity (project cost:Rs 130 crore) has gone on stream. Even prior to the expansion, this division was forced to cut production and reduce prices. The situation has only marginally improved due to imposition ofsafeguard duty of 25 percent. The situation will not improve for at least one more financial year due to the poor prospects of tyre industry-a major client.

One can safely conclude that cement would have been the highest cash flow contributor for Indian Rayon and with it being hived off, the least shareholders can expect is that this will be reflected in share swap ratio.

Capital Gains Tax: Whether Indian Rayon will be required to pay capital gains tax? One of the view taken is that since shares are alloted to shareholders, there is no capital gains and hence no tax. However, no recent supreme court judgements on the issue are available, points out Thakur. The supreme court judgement (under Indian Income Tax Act, 1922), in CIT v R. M. Amin 106 (ITR) is clear that capital gains tax need not be paid. But no judgement under 1961 Act is available and hence the final word on the issue is yet to be heard.

Carry Forward Loss: Another issue is of carry forward and set off of losses. Could a viewbe taken that since the unit to which loss pertained has been spun off, the benefit of the losses of the unit spun off would be available to the old unit (Indian Rayon minus cement division)? In the light of a Supreme court judgement in Veecumsees case (220 ITR 185), it is possible to conclude that the loss of the spin off would be available. This is beneficial for Indian Rayon.

Capital Gains for shareholders: What will not be beneficial to Indian Rayon shareholders is that if Rayon were to take reduction of capital route. In Kartikey Sarabhai v CIT 228 ITR 163 (SC), it was held that reduction in capital would lead to "transfer" as defined in Sec 2(47) of Income Tax Act. In the case of reduction of capital because of spin off, shareholders would be liable to pay capital gains tax and worse, according to Sec 55(2)(aa), the cost of acquisition would be taken as "nil". Another reason, why the swap ratio has to be favourable to Indian Rayon shareholders, if the capital reduction route istaken.

Conclusion: The bottomline is that logically, the swap ratio should be favourable to Rayon shareholders, to compensate them for the disadvantages of the loss of cash flow and the fact that they are left with significantly lower-earning assets. However, in that case equity dilution of Grasim will be higher. The cash flow of cement which would have served Rayon, will have to serve 73 percent higher capital employed (without equity dilution) of Grasim. If ratio is favourable to Rayon, Grasim shareholders will lose. Indian Rayon shareholders are in any case losers. This is because Grasim is the flagship of the AV Birla group and it may not make much sense to favour Indian Rayon, given the clouded future of most of its remaining businesses.

(with contributions from Urmik Chhaya)