Peter Rayney concludes his three-part article with a worked case study of a capital reduction demerger.
Case study
David and Stuart are director-shareholders of Rush Green Ltd (RGL), holding 60% and 40% of its issued share capital respectively.
Over the years, they have reinvested the profits from RGL’s steel fabrication (‘Steel’) trade in buying various properties in the North of England, which are let to third parties. The steel business is worth £4 million, and the investment properties are worth £2 million. There is no debt.
David has decided that he would prefer to ‘retire’ from the steel business and he will take over the property investment business. Stuart will own and manage the steel trade. After taking professional advice, they have agreed that a corporate demerger using the ‘capital reduction’ procedure would be the most tax-effective way of achieving these objectives.
Step 1 – Insertion of a new holding company – Holdco
A new holding company (‘Holdco’) acquires 100% of RGL (worth £6 million) from David and Stuart. In consideration for the sale of their RGL shares, David and Stuart are issued with new Holdco shares on a 60%:40% basis (worth £6 million).
Provided HMRC accepts the share exchange is driven by commercial reasons (confirmed by an TCGA 1992, s 138 tax clearance), David and Stuart would not trigger any CGT charge on the sale of their shares in RGL (TCGA 1992, s 135). David and Stuart effectively subscribe £6 million for their shares in Holdco (reflecting the value of their RGL shares).
Holdco does not pay any stamp duty on its acquisition of RGL, as it is a ‘mirror-image’ share exchange (FA 1986, s 77).
Step 2 – RGL distributes investment property business and properties in specie to Holdco
Due to the considerable commercial difficulties in transferring the steel trade from RGL, it is necessary to move the investment property business. This is achieved by making a distribution in specie of the properties to Holdco (RGL has sufficient distributable profits/’revaluation surplus’ to ‘frank’ the carrying value of the investment properties).
The investment properties are transferred on a ‘no gain/no loss’ basis under TCGA 1992, s 171. The in-specie distribution is exempt from stamp duty land tax (since there is no consideration given) (FA 2003, Sch 3, para 1). The property investment business is a transfer of a going concern for VAT purposes.
Step 3 – Holdco’s share capital is reorganised. Holdco then transfers its 100% holding in RGL
David’s and Stuart’s existing ordinary shares are reclassified as A and B shares respectively. The A shares carry all rights over the steel trade (carried on through RGL) and the B shares carry all rights over the property investment business.
Holdco reduces its ‘share capital’ by £4 million by making a distribution in specie of its 100% holding in RGL (which holds the steel trade) to Stuart’s new ‘acquiring’ company (‘Newco’) in consideration for a new issue of ‘Newco’ shares to Stuart. TCGA 1992, s 139 corporate gains ‘reconstruction’ relief deems the holding in RGL (which is treated as a ‘business’) to be transferred a ‘no gain/no loss’ basis to Newco.
The transfer of the RGL shares to Newco is not a taxable distribution for Stuart, as it represents a return of capital. TCGA 1992, s 136 treats Stuart’s Newco shares as ‘stepping into the shoes’ of his former Holdco A shares for CGT purposes.
Whilst Holdco leaves the capital gains group (holding the investment properties) after it disposes of RGL, HMRC do not seek a degrouping charge (since the ‘the two-company group practice’ should apply – see HMRC’s Capital Gains manual at CG45410).
There is a stamp duty liability of around £20,000 on Newco’s acquisition of RGL.
Final corporate structure
Practical experience shows that HMRC are satisfied with capital reduction demergers, provided they are driven by genuine commercial reasons and are properly implemented. Various tax clearances are required.
Planning Tip:
The necessary ‘share capital’, which is subsequently reduced, is often created by a preparatory share exchange transaction.
