Craig Simpson and Richard Coombs, Tax Partners at Bates Weston give an overview of the three main types of company demerger – liquidation demerger, capital reduction demerger and statutory demerger.
WHAT IS A DEMERGER?
A demerger is a type of business restructuring and is often considered when a company has more than one type of product or service and the directors wish to separate this from the other business.
Company demergers can be complex, but in the UK there are typically three different ways to demerge trades and businesses tax efficiently.
- Liquidation demerger
- Capital reduction demerger
- Statutory demerger
Which route you take depends on what you are trying to achieve. Our tax team will help you to develop a clear view on the commercial, legal and practical aspects of a demerger and to understand the tax consequences.
WHY WOULD A COMPANY DEMERGE?
There are many possible reasons, but some of the most common reasons for a demerger include:
- Preparing a business for sale where a potential buyer does not want all the assets or subsidiaries of the current business
- Protecting the interests of shareholders by holding assets in more than one company
- Releasing capital to shareholders
- To attract new investment in the newly demerged business.
Craig Simpson, Tax Partner at Bates Weston considers the three types of demerger frequently used in the UK.
Liquidation demerger
A liquidation demerger involves the liquidation of a company and its assets (typically shares in subsidiaries and property) which are then transferred to new companies as part of a scheme of reconstruction. This allows the activities of a company or group to be subdivided into a number of new companies as appropriate.
It is less commonly used than a few years ago, due mainly to the relative simplicity and potentially lower cost of the capital reduction demerger discussed below, but still has its uses. The liquidation demerger relies on the use of reconstruction reliefs to avoid tax charges at shareholder and corporate level. Such demergers can be expensive as they require the involvement of a liquidator, two sets of lawyers, and tax advisors.
They are often used:
- To separate trades where the larger part of the group is being sold. This may enable the vendors to benefit from 10% CGT under Business Asset Disposal Relief
- To split trades and businesses into separate ownership for shareholders who are parting company
- To split investment activities from trading activities
Capital reduction demerger
Capital reduction simply means making payments to shareholders, out of the company’s share capital, equal to the amount of money deemed to have been paid by a shareholder to acquire the company’s shares. In effect the company reduces its share capital and, in return, transfers other assets of the same value to them.
During a typical capital reduction demerger a new holding company is inserted over the existing company (or group). The shares in the holding company are also sometimes redesignated into different classes of shares so that the rights of each class are attributable to different assets held by the group
The demerger is achieved by a reduction of one class of shares and the cancellation of those shares. The share capital represented by those shares is returned to the shareholders by transferring the demerged assets to a new company owned by those shareholders.
The capital reduction demerger is probably the most common demerger route, largely due to a change in the Companies Act 2006 which allows an unlisted company to reduce its capital without the need for court approval. Such a demerger relies on the same tax reliefs as a liquidation demerger but can be achieved without the need to liquidate. As a result, it is far easier to implement and should be less costly.
Again, a capital reduction demerger can be used for splitting trades and/or investment businesses.
Statutory demerger
HMRC recognise that businesses grouped together could be run more effectively if they were to pursue their own interests under independent management and ownership. The statutory demerger provisions under tax law make it simpler to divide and separate corporate ownership of trading activities, without incurring the hefty tax liabilities that would normally be incurred. For these provisions to apply, statutory demergers must comply with strict conditions, including that the demerger is not undertaken in anticipation of a sale and all subsidiaries must be trading.
A statutory demerger is only suitable for the splitting of trades – but not where one of the demerged trading entities is to be sold. It cannot be used for splitting investment businesses such as property letting. Accordingly it is less common in practice, but where the conditions are right it is the most simple of all of the demergers and therefore should always be considered as part of any feasibility study into what might be possible.
Conclusion
Demergers offer potentially tax free methods to split a company’s business activities or transfer assets out to a new company. Without following one of the methods outlined above the tax costs of simply transferring a business or asset to another company can be prohibitive.
It is imperative that the person designing the demerger has expertise in them, as there are numerous pitfalls for the unwary and is something that due diligence teams looking to acquire a business will crawl over. We have seen numerous examples of demergers that have been designed in such a way that the required tax reliefs will simply not apply and so the company will have a nasty shock if HMRC ever look into it. HMRC advance clearance should always be sought, but as has been mentioned in our other articles on the subject of demergers, this does not guarantee the demerger will “work”. The clearance merely confirms that HMRC accept that it is being done for bona fide commercial reasons rather than tax avoidance. You therefore still need to ensure that each step is designed carefully and that the lawyers used to draft the documentation to effect the steps are experienced in this area.
We have many years of experience at designing and implementing demergers. Please call us on 01332 365855 to discuss your options or, if you are an advisor and you have potential clients who may be looking at a demerger or contact Craig Simpson or Richard Coombs.
As always, you are reminded that this article is generic in nature and you should take no action based upon it without consulting your professional advisor.
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