How HDFC-HDFC Bank merger impacts shareholders and mutual fund investors

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Now that the new shares of HDFC Bank have been listed following its  issue to shareholders of parent entity HDFC, India's largest private sector lender on Monday entered the global club of companies with a market capitalisation of $100 billion.

Trading at a market value of about $151 billion or Rs 12.38  trillion it is now the world's fourth largest lender, according to Bloomberg Data.  The lender will also become one of the most-profitable corporations in the country. On a pro-forma basis, the merged entity had net profit of Rs 60,348 crore in the 2022-23 financial year (FY23).

How does the merger impact shareholders?
 

On Friday, HDFC Bank  allocated over 311 crore new shares of the bank to shareholders of merged entity HDFC Ltd .As per the scheme, every HDFC shareholder has got 42 shares of HDFC Bank for every 25 shares they hold. 

On a per share level, the ratio is 1.68 shares of HDFC Bank for every 1 share of HDFC. Suppose, if you own 100 shares of HDFC Ltd you will get 168 shares of the merged entity.

This essentially means  shares held in HDFC Ltd. will get cancelled and HDFC will own 41% of HDFC Bank.

This would increase the paid-up share capital of HDFC Bank from Rs 559.2 crore to Rs 753.8 crore, following the cancellation of the promoter's holding of 116.4 crore shares.

Shareholding pattern

Public shareholders fully own the bank. Foreign portfolio investors under Category-I now hold 50.46% stake in the merged entity, compared to 29.54% a quarter ago.

The government of Singapore owns 2.67% stake in the merged entity, and Invesco Markets Fund 1.21%. Mutual Funds’ cumulative holdings in the bank have gone up to 19.13% from 18.47% as of March end.

Insurance companies own 8.71% stake in the merged entity, compared to 8.01% a quarter ago. 

Life Insurance Corporation of India’s stake has gone up marginally to 4.89% from 4.16% a quarter ago.

HDFC Bank will dislodge RIL as the biggest weight in the Nifty50 and the Sensex

As per Nuvama, the merged entity will have 14.43 per cent weighting in the Nifty50, nearly 363 basis points more than RIL. In the Bank Nifty index, HDFC Bank’s weighting will rise to 29.1 per cent.  This elevation has propelled HDFC Bank ahead of Reliance Industries in terms of weightage. 

The merged HDFC Bank will have 7.53 billion outstanding equity shares. Due to the merger, 1.85 billion shares of HDFC will be converted to 3.1 billion shares for HDFC Bank. HDFC’s shareholding in the lender gets extinguished.

According to Santosh Meena, Head of Research at Swastika Investmart Ltd, the HDFC merger is a positive for the markets. "The HDFC twins were underperforming for a long time due to regulatory hurdles. However, as the market got clarity about the merger, both stocks began to rally. This is because the merger will create a financial services behemoth with a combined asset base of around 18 lakh crore," he said. 

HDFC Bank will see an upward weight revision to 29 per cent from 27 per cent in the Nifty Bank index.

In the  Nifty Bank index, HDFC Bank's weightage will rise from 26.9 per cent to 29.1 per cent. ICICI Bank, the second-largest private bank and previously the second-largest weight in the index, will witness a slight decline in its weightage from 24.4 per cent to 23.3 per cent.

“The merged entity will also have a high weightage in Nifty, which is why we are seeing strong bullish momentum in the index. Moreover, the appreciation of this merger extends beyond the market sentiment, as it is also being recognized and appreciated by investors on a fundamental level,” said Meena.

Mutual fund investors

A mutual fund can't invest more than 10 per cent in a single company. Now that HDFC Bank and HDFC have merged, 35 equity funds across 20 fund houses will cross the 10 per cent limit. Of the 35, 18 are large-cap funds, shows data analysed by Value Research. 

"Post-merger, HDFC Bank will have 15 per cent weightage in Nifty 50. Suffice to say that passive funds like index funds and ETFs will have an edge over active funds every time HDFC Bank goes on a run. That's because they don't have to abide by the '10 per cent limit' rule," said Value Research's analyst Ashish Menon.

Busy day for passives
 

The merger allows LTIMindtree and JSW Steel to enter the Nifty 50 and the Sensex, respectively. "This means passive funds will have a busy day because a total of 79 index funds and ETFs hold shares of HDFC," said Menon.

How will these shares be taxed?

As shares are considered as capital assets, any profits generated from sale of such shares are subject to taxation as capital gains under the provisions of the Income Tax Act, 1961.However,if the merger  meets certain criteria, it can be considered as tax neutral and  accordingly can get exempted from capital gains tax for both the amalgamating company and its shareholders.

The said criteria as explained by Tabrez Malawat,  Partner  at the Guild Advocates & Counsels, is

1. All the assets and liabilities of the amalgamating company (HDFC Limited) must become the assets and liabilities of the amalgamated company (HDFC Bank) as a result of the merger.
 

2. Shareholders holding at least 3/4th in value of the shares in HDFC Limited must become shareholders of HDFC Bank through the merger.
 

In the case of HDFC Bank, the merger satisfies the necessary conditions for tax neutrality

In the case of HDFC Bank, shareholders who transfer their shares in HDFC Limited in exchange for the allotment of shares in HDFC Bank will not incur capital gains tax on the transaction as such transfer pursuant to qualifying amalgamation is not considered a taxable event for the purposes of capital gains.
 

Consider an investor who purchased 60 shares of HDFC Limited on 1sJanuary 2020 at Rs 2,500 per share, resulting in a total investment of Rs 1,50,000. With the merger, this investor is entitled to receive 101 shares of HDFC Bank. If these 101 shares are subsequently listed on the stock exchanges and sold on 31st July, 2023 for Rs 2,000 per share, fetching a total of Rs 2,02,000, a capital gains tax will be applicable.

"Capital gains tax will only be applicable when the shares are sold, and not merely upon their listing, as the allotment is tax-neutral in the instant case. It should also be noted that cost of purchasing the HDFC Limited shares will be considered as the cost of acquisition for the HDFC Bank shares received in the merger," said  Malawat,

In the  example above, the adjusted cost of purchase for 100 shares of HDFC Bank will be Rs 89,109 (Rs 1,50,000/101*60). Consequently, a long-term capital gain on amount of Rs 1,12,891 (Rs 2,02,000 - Rs 89,109) will be realized and taxed accordingly.

When are shares considered long-term assets?

In the case of listed companies, equity shares held for more than 12 months are classified as long-term capital assets, while those held for a shorter period are classified as short-term capital assets.

Sandeep Bajaj, Managing Partner, PSL Advocates & Solicitors, explains this further: 

For Example On April 1, 2019, A paid  Rs 2,000 per share for 30 shares of HDFC Ltd., spending a total of Rs 60,000. A is entitled to receive 50.4 (42/25*30) shares of HDFC Bank based on the share exchange ratio at the time of the merger.

A will nevertheless receive only 50 shares of HDFC Bank because there is no such thing as a fractional share in India.
On July 17, 2023, these 50 HDFC Bank shares were listed on exchanges at a price of Rs1,700 per share. On August 1, A sells these 50 shares for Rs.1,800 per share, for a total sale consideration of Rs.90,000. 

In the above example, the holding period is from 1 April 2019 to 1 August, making the gains long-term capital gains.
 

"It will be assumed that the price paid to purchase shares of HDFC Ltd. equals the price paid to purchase shares of HDFC Bank (the merged entity)," said Bajaj.

For the sake of this example, the price to purchase 50 HDFC Bank shares received through a merger will be Rs. 59,524 (Rs. 60,000/50.4*50). This cost adjustment is made in comparison to the 50.4 share initial cost of the HDFC Ltd share entitlement. Therefore, a long-term capital gain of Rs.30,476 will result (Rs. 90,000 – Rs.59,524). 

Grandfathering

One important thing to note here is that the benefit of grandfathering will also be available in cases where shares of the amalgamating company were purchased on or before 31 January 2018.

"As for the 0.4 fractional entitlement, since it will not be given as a share, the shareholder will be paid consideration in cash or kind. This will be taxed as capital gains as the shareholder has not received shares in lieu of shares and so, unlike the swap of shares on a merger, no tax benefit is given here," said Bajaj.

Let’s assume that on the day A was paid for the fractional entitlement when the value of 1 share of HDFC Bank was Rs.1,820. The capital gain on the fractional entitlement will be the value of 0.4 shares, i.e. Rs.728 ( Rs.1,820*0.4) as reduced by the cost of purchase, i.e. Rs. 476 ( Rs.60,000/50.4*0.4) which comes out to be Rs.252.