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We are all too familiar with the situation where a business has grown organically or through acquisition and finds itself with a corporate structure that is no longer fit for purpose. Often, new trading or investment activities are started up in separate group companies to de-risk the established trading activities and this structure no longer works commercially. Alternatively, there may be a need to demerge non-core assets with a view to selling the business in the future.

Other examples of this planning we have experience of dealing with are:

  • The demerger of property assets from trading activities for two separate groups prior to a merger of the two separate trades;
  • To separate two distinct trades due to shareholder conflict. Two shareholders may have different focuses and decide to each concentrate on one trade each;
  • A simple separation of investment assets from trading activities for asset protection purposes.

There are many commercial reasons for a group or company to carry out a demerger, but if this type of restructuring is carried out incorrectly it could lead to significant tax liabilities for both the individual shareholders and the companies involved. The taxes needed to be considered include Income Tax, Capital Gains Tax, Corporation Tax, Stamp Duty and, depending on the circumstances, Stamp Duty Land Tax, VAT and Inheritance Tax also. Clearly, with so many different taxes at stake it is important to be guided through the pre-planning, planning and implementation stages by an experienced tax expert.

There are various ways to execute these demergers in a tax efficient manner such as a statutory demerger, a members’ voluntary liquidation method and in recent years the more popular choice being a capital reduction demerger.

What is involved in a capital reduction demerger?

A capital reduction demerger allows the restructuring of a company via a return of the shareholders’ capital.

The process usually involves (amongst other administrative and commercial matters) a reorganisation of the current share capital of the business, the insertion of a new holding company, potentially some transfers of shares in subsidiaries (if required) and a reduction of capital with a resulting transfer of the shares/assets you wish to demerger to a newly incorporated company or companies (depending on in how many ways you wish to split the assets) outside the existing group.

Each of the steps required in the process can be carried out relying on well-established reconstruction and reorganisation reliefs. HMRC clearance can be sought (which we would always recommend) to confirm that these reliefs should apply and the capital reduction demerger can be implemented without giving rise to any tax charges.

However, each step in the process does have potential pitfalls, which could lead to unnecessary and, more importantly, unexpected and unwanted tax liabilities. The individual shareholders’ and the companies’ position must be evaluated at each stage to ensure that, for example, an action taken which is commercially sound for the company does not lead to a tax liability for the individuals involved and vice versa.

What are the advantages of a capital reduction demerger?

A statutory demerger requires the existence of sufficient distributable reserves to perform the demerger and has to involve the demerger of two or more trading activities. A capital reduction demerger does not rely on the reserves being sufficient and can also be implemented to separate activities or assets which can be both trading and non-trading.

Whilst a members’ voluntary liquidation can also be used to separate trading and non-trading assets/activities, this would require the appointment of a liquidator. This brings with it not insignificant additional costs. There is also often a reluctance from business owners to go through any liquidation process due to fears of potential reputational damage despite it being a solvent liquidation.

How can we help?

As noted above, whilst capital reduction demergers can be carried out in many circumstances without any tax leakage at all, it is important to plan the steps with care to avoid potential issues and liabilities arising from inaccurate interpretation of the law or the oversight of a particular rule.

We have extensive experience in working with our clients to understand their end goals for any demerger process. As well as the tax expertise, we would also be able to discuss the commercial and administrative aspects of this planning to ensure there are no unexpected surprises along the way.

With all the complexities involved in these types of restructuring projects, it must be said that the tax and legal advice costs are not insignificant. However, when these costs are weighed up against the potential upsides of achieving the correct corporate structures for the future of the business/businesses and the potential downsides of attempting to carry this out without the advice of an experience professional, it is clearly well worth it.

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