How to prepare for expansion
Gannons was approached by two brothers (Peter and John) who ran a recruiting business (Recruitment Ltd) but were also diversifying into recruitment software.
Investors had suggested that they were keen to invest in the Software business but not the recruitment business. Therefore, Gannons was instructed to consider the ways to spin the software business out of the recruitment business.
We recommended that we follow the route of a “capital reduction demerger” as this allowed the directors and shareholders to split their businesses into separate recruitment and software businesses in a tax neutral way and be operated independently. Hence Software Ltd was set up. It is a good deal for the shareholders because they are effectively transferring shares and becoming shareholders in two businesses without:
- paying any stamp duty, which is normally paid when shares are transferred; nor
- paying capital gains tax on the creation of assets in the form of two businesses.
There were a number of steps to work through and we briefly highlight these steps below.
- The first job was to prepare a feasibility report looking into what was achievable and how to achieve it. The feasibility report is one of the most complicated stages as it requires mapping out the road map. In these types of scenarios there are many roads that could be pursued and you need to avoid dead ends.
HMRC advanced clearance
- Next step we first secured advanced HMRC clearance on the tax neutrlity point.
At the start of the process there was one group. The companies were structured as follows:
- Peter and John both owned 500 shares each in ABC Ltd.
- ABC Ltd is the sole shareholder in Software Corp.
At the end of the rpocess the companies were structured as follows – there were two groups:
- Recruitment Holdco
- Recruitment Ltd (wholly owned by Recruitment Holdco).
- Software Holdco
- Software Ltd (wholly owned by Software Holdco).
In order to fall within the various tax legislative provisions which have to be met to proceed tax neutrally it is necessary to avoid new holding companies as the above examples show.
Having set your holding companies up, a capital reduction demerger is a means of transferring a subsidiary (in this case Software Ltd) by undertaking a reduction in the share capital of the parent company (in this case the new company we put in place, Recruitment Holdco). The capital reduction (a cancellation of shares in Recruitment Ltd) reflected the market value of the assets transferred (the value of Software Ltd) and hence it represented a return of capital as opposed to income distribution such as a dividend. With a return of capital, shareholders do not incur income tax on the transaction.
The capital reduction demerger route required shareholder approval and a solvency statement. In our case the directors had no concerns about insolvency.
Recruitment Ltd did not have substantial share capital. Therefore, we implemented a share for share exchange to place a company with a high share capital at the top of the group. The result was that this new company, Recruitment Holdco Ltd, had share capital equal to the market value of the existing group.
HMRC clearance for the holdco
We obtained HMRC clearance that putting in place the new holding companies did not trigger any CGT charge for the shareholders, nor the companies on the exchange of Peter and John’s shares in Recruitment Ltd for Recruitment Holdco Ltd. There was no stamp duty on this transaction and we obtained clearance from HMRC to confirm the point. The subscription value of the Recruitment Holdco shares represented the market value of the Recruitment Ltd and there was no physical outlay of cash.
With the basic structure in place we re-designated the shares to reflect the different trades.
Reduction of share capital
To achieve the demerger Recruitment Holdco reduced its share capital. The capital reduction reflected the market value of the assets transferred to Software Ltd and hence it represented a return of capital as opposed to income distribution. The shareholders did not incur an income tax charge on the transaction.
The share capital once reduced equalled the value of Software Ltd (represented as Y Shares) transferring over to the new Software Holdco.
The consideration for the reduction in share capital in Recruitment Holdco was the transfer of shares in Software Ltd. The capital reduction required Peter and John as shareholders to agree to the Y Shares in Recruitment Holdco being cancelled; and as consideration for this, Recruitment Holdco undertook to transfer the shares in Software Ltd to Software Holdco. Software Holdco issued further shares to Peter and John equivalent to the shares cancelled in Recruitment Holdco.
The demerger was documented in a tripartite agreement (also called a demerger agreement).
Tax clearance was obtained from HMRC, which gave the taxpayers, our clients, peace of mind.
Numerous filings were prepared and sent to Companies House.
We also dealth with EMI option holders.
Software Ltd went onto raise funds under EIS and we helped them with that.
We have dealt with many companies wishing to carve up the business for a wide range of reasons. Re-organisations are often an effective way of resolving shareholder disputes often between families by dividing up the assets. Many investors and or purchasers are interested in part but not all of the business – re-organisations or demergers are often the perfect solution.
Manages to explain difficult concepts in easy to understand language. In tune with her clients.