Breaking Up Is Hard To Do! ‘Splitting’ A Company

 

There are many reasons why directors of private limited companies decide to split one company into two or more companies. Many will be owner-managed or family businesses that have grown such that different members are responsible for separate departments or types of business. As the business has grown, each may wish to take that department forward, separate from the other parts. 

 

Family members may have had disagreements as to how the business as a whole is run and wish to go their separate ways, taking with them the part of the business for which they have been responsible. A demerger may also be relevant as a precursor to selling one or more of the particular businesses, retaining the remainder. One area of the business may be a higher risk business and as such the whole would be better suited to separate legal entities. A demerger is also a way to split and separate the liabilities relevant to particular businesses owned by the company as a whole.

 

Whatever the reasons, the aim will be to undertake the procedure as tax efficiently as possible for both company and shareholders alike, whilst at the same time ensuring that each company remains trading. It may not always be possible to implement a reconstruction without some resulting tax payment, but income tax and CGT often need not be the ones payable and it is more likely that stamp duty will be charged. Although, again, with careful planning, this charge too can sometimes be avoided.

 

Just as there are differing reasons for demergers, so there are different end combinations of companies. The detail that follows refers to demergers where the resultant demerged company is owned by all or some of the shareholders of the original company and the holdings in the original company are still retained. Without special relieving provisions, such arrangements could trigger significant tax liabilities for both the company and its shareholders. Whichever method is used, HMRC’s interest will generally be to look at the procedure undertaken to ascertain whether the disposal is really a distribution in disguise and as such taxable as income. 

 

The two main methods by which a company may undertake a demerger without attracting an income tax or capital gains tax charge (CGT) (although stamp duty or stamp duty land tax may be relevant) is either via an ‘exempt’ demerger (under CTA 2010, Pt 23, Ch 5) (the ‘statutory’ form of demerger) or a liquidation demerger (under Insolvency Act 1986, s 110) (the ‘non-statutory’ form).

 

There are a number of conditions that must be satisfied before any demerger can be deemed ‘exempt’, not least that the original company must remain a trading company and that the intention is to retain the demerged or successor company and not sell. There is also a need for sufficient distributable reserves to effect the demerger. 

 

Should the statutory conditions be satisfied, no income tax implications should arise for the shareholders as the ‘exempt’ demerger will be deemed to have been made at asset market value. There may be a chargeable gain, as there will be a receipt of shares, but the transaction should be covered by the ‘tax exempt distribution’ provisions (in TCGA 1992, s 192), whereby ’stand in shoes’ treatment is possible in respect of the shares. The company will have disposed of part of its business to the new company and to ensure no chargeable gain, the demerger will need to fall within the ’scheme of reconstruction’ provisions (in TCGA 1992, s 139), which broadly states that under a scheme of reconstruction involving the transfer of the whole or part of a company’s business to another company, the transfer is at a ‘no gain no loss’ value. The transfer must be effected for bona fide commercial reasons with no consideration made other than the assumption of its liabilities by the transferee company.

 

There may be stamp duty implications as the transaction involves a transfer of shares, but in some cases, with careful planning, this tax can also be avoided. 

 

Many demerger projects may not be able to satisfy the strict conditions necessary to ensure the statutory demerger method is possible, and as such may have to go down the ‘non-statutory’ procedure (Insolvency Act 1986 s 110), which broadly involves the voluntary liquidation of the original company and distribution by the liquidator of the relevant assets to the new companies owned by the shareholders. 

 

As there is no ‘exempt’ statutory demerger, where shareholders of an existing company receive shares in another, this would normally be regarded as an income distribution for the shareholders. The disposing company therefore needs to be liquidated before the reconstruction exercise is undertaken, as amounts received during the course of liquidation are generally not income distributions. A non-statutory liquidation demerger requires at least two transfers of business unit. The original company will cease to exist, being replaced by other companies into which assets of the original company are transferred.

 

• Reductions in share capital

The ’reduction in capital’ route is sometimes undertaken in preference to the liquidation route because of the negative impact a liquidation can attract, as well as the cost. The usual procedure is broadly for a new holding company to be incorporated to own the shares of the split companies. 

 

The advantage of this method of reconstruction is that there is no requirement to meet the conditions of the ‘exempt’ statutory distribution provisions, not least for companies that do not have sufficient distributable reserves but do not want to go down the ‘liquidation’ route. 

 

With generally no income tax implications, the only concern will be a CGT charge for the shareholders, but this can be deferred under the ‘stand in shoes’ rules for reconstructions (in TCGA 1992, s 136). Assets transferred one company to the other are potentially covered under the transfer of business provisions (in TCGA 1992, s 139).

 

• ‘Share for share’ exchanges 

Such an exchange may be possible where the intention is for the owners of one business to exchange their interests and receive shares in the new company as consideration. As long as no actual consideration is received, and values are the same such that there is no additional value transferred, the transaction is effectively just a swap of shares, and as such will not generally attract an income tax charge; nor would CGT implications generally arise if the ‘stand in shoes’ provisions in TCGA 1992, s 135 apply.

 

A demerger needs to be structured in a way that avoids tax for both shareholder and the original company. Tax exemption is not possible for non-trading companies or when the demerger has been undertaken with a view to change of ownership or possible future sale.  

 

Transactions such as demergers and reconstructions are complex by nature. Specialist advice is essential, and it is usual for such transactions to be undertaken in legal agreements. Advance clearances can be sought whereby HMRC is asked to confirm that the tax provisions have been complied with.