Instead of merging HDFC
(formerly L&T General Insurance) with the larger entity HDFC
Ergo, the promoters have gone the reverse way.
As the first merger
companies in the non-life space in India, the transaction was bound to create interest, which it did. The ‘reverse merger’ has not been noticed, though.
There is no doubt the deal is value positive for the existing shareholders. And, as and when the new entity is listed on the stock markets, it would hope that potential investors
would believe the same.
Regulatory and Development Authority of India (Irdai) confirmed that it had given the approval for the ‘reverse merger’. The deal, as it is structured, makes sense for the companies as it will be tax-efficient, a person close to the developments said. But, in the post-General Anti-Avoidance Rules (GAAR) era, some questions from the revenue authorities could emerge.
Last week, HDFC
Ergo announced it had secured the approval of the National Company Law Tribunal (NCLT) and Irdai
to complete the merger
with itself. The merger
became effective from August 16.
Interestingly, the word ‘reverse merger’ was not used, and for good reason. The deal will consolidate HDFC
Ergo’s position as the third-largest private insurer in India with a market share of over 5.25 per cent, according to Irdai’s June 2017 data. In 2016, HDFC
Ergo had bought out L&T General Insurance
and rechristened it HDFC
The entity has till now operated as a wholly owned subsidiary of HDFC
issue is simple. Tax
authorities can justifiably ask if a merger
is meant only to create tax
shelter, to which the parties will have to demonstrate there is, instead, a larger public interest involved. GAAR
kicked in from April 1 this year.
“It wasn't so before GAAR
as the courts did not have the right to question this angle,” said a partner from one of the big four audit firms. An email sent to HDFC
Ergo a few weeks ago remained unanswered.
Corporate governance expert Kaushik Dutta, however, said both from the shareholders’ point of view as well as larger potential investors, creating a tax-efficient structure was quite fine.
“As long as the shareholders (in this case parent company HDFC
and German insurance
company Ergo) have more on the table, the deal works from the corporate governance perspective,” said Dutta, head of Delhi-based think tank Thought Arbitrage Research Institute that tracks corporate governance.
A media report has noted that the net worth of standalone entity HDFC
Ergo was Rs 1,812 crore as on March 31, 2017. This is expected to drop to Rs 1,485 crore after the merger
due to the accumulated losses
This is where the tax
advantage stemming from the reverse merger
comes in useful.
Ergo has also been careful to ensure that amid all these developments the connect with the insured public is maintained. This could be the reason why the company has not made it up front that it is merging with its subsidiary to create a third new entity. While it is true that nothing palpable would have changed for the public, insurance
does run on a very thin sliver of confidence among those insured. No company will want to disturb this confidence. Thus, while the reverse merger
makes sense financially, it is not a public accreting idea.