Parting company - tax treatment of demergers
It is sometimes considered commercially beneficial to divide the trading activities carried on by a company to be carried on by two or more companies. Such demergers are undertaken for various reasons, including:
- where family shareholders of a company wish to run parts of the business independently, perhaps because of a disagreement about the future of the business,
- moving one or more companies/businesses into separate companies for a future sale, or
- to realise shareholder value where parts of a group would achieve better marketability as separate companies.
Generally, the separation of shareholder interests or underlying assets between new companies can trigger income tax charges on distributions to the shareholders, corporation tax on the disposal of assets, or both. The tax rules treat certain distributions as 'exempt', meaning that they are not to be treated as 'distributions' for tax purposes. The distributions which are eligible for exemption include:
- a transfer by the distributing company, to its ordinary shareholders, of shares in one or more subsidiaries (as defined); and
- a transfer to another company or other companies of:
- a trade or trades; or
- shares in one or more of its subsidiaries,
in exchange for the issue of shares by the recipient company to the ordinary shareholders of the distributing company.
In either case, two conditions must be satisfied:
- the demerger must be wholly or mainly for the benefit of some of the trading activities which were previously carried on by the distributing company or its subsidiaries; and
- the distribution must not have as one of its purposes the avoidance of tax.
Where it is not possible to carry out a statutory demerger, a non-statutory demerger provides an alternative method. A non-statutory demerger could be used :
- where there is an intention to sell one or more of the businesses to be demerged,
- where there are insufficient reserves to make a distribution of the demerged assets, or
- where a non-trading business is being demerged (e.g. a property letting business).
In a non-statutory demerger a liquidator is appointed and the relevant company is wound up, with the businesses to be demerged distributed under insolvency law.
Tax for the companies
A non-statutory demerger could result in tax charges arising on the companies disposing of the assets being distributed. Relief is by the tax rules and, if the relevant conditions are met, a non-statutory demerger can be undertaken in a tax neutral manner.
Tax relief only apply for a 'scheme of reconstruction' (as defined), with the conditions:
- Only the ordinary shareholders of the original company can receive shares in the successor company (or companies).
- The proportionate shareholding in the successor company (or companies) must be the same as in the original company.
- All (or substantially all) of the business or businesses carried on by one or more of the original company is carried on by the successor company or companies.
- If the third condition cannot be met, there will still be a scheme of reconstruction if the scheme is carried out under a compromise or arrangement under company law. However, no part of the business or businesses can be transferred outside the UK.
Tax for the shareholders
The individual shareholders who receive shares in another company, on the reconstruction, could be treated as having received an income distribution.Â However, the company making the distribution is wound up before the reconstruction and amounts received during the course of the winding up are treated as a capital distribution.Â The shareholders can then take advantage of the tax relief if there is a 'scheme of reconstruction' (see above).
If the tax relief applies the shareholders will be treated as not disposing of their shares in the distributing company and the shares they acquire in the successor company (or companies) will "stand in the shoes" of the original shares in the distributing company.
For the tax relief to apply the shareholders' proportionate interest in the original company and successor company must be the same and the reconstruction must be undertaken for bona fide
Other tax issues
There may be stamp duty and stamp duty land tax (SDLT) liabilities. Where there are mirror shareholdings between the 'old' and 'new' companies, it should be possible to claim exemption from stamp duty and SDLT.
If the new company succeeds to the trade and assets it may be possible to transfer trade losses with the relevant trade.
For VAT purposes a transfer would normally fall within the transfer of going concern provisions and, therefore, would not be subject to VAT. However, the situation can be more complex where property is involved.
A non-statutory demerger does not protect against tax charges arising when the asset-holding company leaves the group. Therefore, if any assets (including goodwill) have been transferred intra group, within six years of the demerger, the tax position of assets leaving the group need to be considered.
As with all such tax situations, advice should also be sought before proceeding.Â For further details call Alan Boby on 01295 250401 or email firstname.lastname@example.orgAlan BobyEllacotts LLP
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