There are many reasons why shareholder-directors of private family companies may decide to split a single business into two or more separate entities and have tax issues later. Often, these companies have grown to a point where different members are responsible for distinct divisions or activities and, as the business expands, individuals may wish to take control of their own area independently. Disagreements about strategy or management can also lead to separation, each shareholder director taking over part of the business they have been running. A demerger may also be used to separate higher-risk activities from more stable operations or as a precursor to selling part of the business.
Whatever the motivation, the objective is usually to carry out the demerger as tax efficiently as possible for both the company and its shareholders, while ensuring that each resulting entity continues to trade. Although it is not always possible to avoid tax charges entirely, with careful tax planning it may be possible to reduce any income tax and/or defer capital gains tax (CGT). However, stamp duty may still be payable unless specific reliefs can be claimed.
Capital gains tax issues
CGT payable by shareholders is one of the main concerns in any demerger. When assets are transferred from the original company to a new company, the transaction is typically treated as a disposal at market value, even if no money changes hands. However, ‘roll over relief’ allows such transfers to take place without triggering an immediate CGT liability, provided certain conditions are met.
There are two principal methods of carrying out a demerger without incurring income tax or CGT: the statutory ‘exempt’ demerger and the ‘non-statutory liquidation’ method.
Statutory exempt demerger
A statutory exempt demerger allows a company to separate its business through what is termed ‘a distribution in specie’. Under these rules, the original company must remain a trading company and there must be a genuine intention to continue operating the separated businesses rather than selling. Provided the transaction is carried out for bona fide commercial reasons and no consideration is given (other than the assumption of liabilities by the receiving company), the transfer can take place on a ‘no gain, no loss’ basis, allowing the individual shareholders to receive new shares, and defer any gain until the new shares are finally sold.
To comply, the original company must have sufficient distributable reserves to cover the value of the assets being transferred.
Stamp duty tax issues
Stamp duty may be reduced or eliminated if the transaction qualifies as a reconstruction or demerger. The conditions being that:
- The transaction is being carried out for genuine business purposes.
- The shareholders in the new company (or companies) broadly reflect the ownership of the original company.
- The transfer is being made wholly or mainly in exchange for shares in the new company.
- Typically, the companies involved must be trading companies or part of a trading group.
Advance clearance from HMRC should be sought to confirm that that the transaction will be tax neutral and stamp duty reconstruction relief applies. Note that even where advance clearance is obtained, the distributing company is required to submit a return to HMRC within 30 days of making the distribution, setting out details of the transaction.
Non-statutory demerger
Where the statutory conditions cannot be satisfied, companies may need to rely on the ‘non-statutory route’. This is where the original company is placed into voluntary liquidation and the business assets are distributed to new companies owned by the shareholders. However, this method requires the original company to cease, with its operations effectively split between two or more new companies.
Other taxes
VAT also needs to be considered in a demerger. The transfer of a business should not have any VAT implications but again, only if conditions are met, including the continuation of the same type of business activity by the receiving company as a going concern.
Practical point
Other reconstruction techniques could be considered should a demerger not be possible such as a reduction in capital (wherea new holding company is incorporated to own the shares of the split companies) or a ‘share for share exchange’ (where the shareholders of the main company exchange their interests to a new company and receive shares in that new company as consideration).
Partner note:
HMRC Capital Gains Manual, CG45620 – Demergers
