Guide to demergers

Last Updated: August 14th, 2022

What is a demerger?

A demerger involves moving assets and or companies into different companies or new groups. On the face of it moving assets or companies into different structures and changing the grouping of shareholders is a change of ownership upon which tax arises on the disposal.

There are legitimate tax exemptions which mean that if a demerger is implemented following the right sequence of events the demerger can be structured tax neutrally or with a much lower rate of tax payable than would apply if the demerger was not implemented with tax efficiency in mind.

In the UK there are three different ways to demerge tax efficiently.

  • Statutory demerger route – the statutory demerger route can be the most tax efficient as often there is no stamp duty payable and the structure is exempt from income tax in the hands of the shareholder, capital gains tax is deferred until the shares are sold and there is cash to pay the tax and the company is exempt from the de-grouping charge. However, there are a number of conditions to be satisfied for tax exemption including but not limited to the demerger must not be in anticipation of a sale of the business and all subsidiaries in the group have to be trading. We find many businesses fail to satisfy the statutory conditions in which case the capital reduction demerger route is the answer.
  • Capital reduction demerger – this route is popular where there is one shareholder with subsidiaries and the shareholder want to separate the subsidiaries so that each is held independently to the other. If the demerger is in anticipation of a sale of the subsidiaries the statutory demerger route would not work but the capital reduction demerger route can be made to work tax efficiently. It is possible to avoid tax charges where the shareholdings are mirrored. Stamp duty charges can arise if the shareholdings change.
  • Demerging by liquidation – this is not as popular as many shareholders and directors do not want to be linked to a company in liquidation even if it is a solvent liquidation.

Why do companies demerge?

The reasons for a company demerging are varied. Typical commercial reasons include:

  • Reduced overheads and streamlining  – achieve costs savings through reduced overheads and combined resources;
  • To facilitate a sale – Business sales where the buyer does not want to acquire all of the assets or subsidiaries – the sellers move out the bits the buyer does not want;
  • Shareholder protection –  Directors feel putting the assets in a different company will add protection for shareholders – there are often timing issues to consider in such cases;
  • Business restructure and consolidation – The group has subsidiaries in different jurisdictions and wants to put them under one umbrella.
  • To release capital –  A demerger can be a neat way of releasing capital to shareholders. If the company has share premium it can use the demerger route to put the share premium to better use.
  • New investment – The reasons for capital reductions include investment into new areas. Another popular reason is because a part of the company is to be sold and the share premium will in effect from part of the proceeds received by shareholders on selling the demerged business.
  • Lender issues – A lender and or investor may be prepared to lend to one part of the business but not to other parts. A demerger can be used to provide the vehicle into which the lender and or investor is prepared to support.

But we see many other reasons behind the demergers we put in place.

What are the risks or pitfalls with a business demerger?

A demerger involves potential tax issues. For example, merging one subsidiary into another company involves the transfer of shares. HMRC will be looking out to see if there are gains arising on the transfer of shares which they can tax. Similarly HMRC will scrutinise the tax consequences of moving assets around a group.

Demergers are made up of steps requiring specific shareholder approval and filing of relevant forms at Companies House. If the components are not in place in the right order the demerger is prone to attack by creditors and or shareholder and can be unpicked.

The demerger will often require the approval of third parties such as banks and landlords. It is not wise to complete the demerger without the safety of advanced approval. Most third parties will want to approve the paperwork implementing the demerger.

With a capital reduction demerger the directors of the holding company will need to sign a declaration of solvency – basically confirming that post demerger the companies will be able to pay their debts.

How to plan a demerger?

Key issues arising under a demerger are best addressed by setting out a detailed step list before work on implementation of the demerger starts.

We always recommend a step list as this draws together the process of co-ordination between the various parties who will make the demerger successful such as the accountants, banks, landlords, directors and shareholders.

The step list is also good for focusing on timing for the demerger. Many demerger steps involve advance approval from HMRC that tax does not arise – timing for HMRC approval needs to be factored in and we recommend you allow at least one month. In exceptional cases we see if HMRC will expedite.

Depending upon the facts you may need heads of terms – for example if a new holding company is being set up you may need a new articles and a shareholders’ agreement.

If you are planning a capital reduction demerger there will need to be a review of the issued share capital because the group company must have issued share capital of more than the subsidiary being demerged. There are some structures we can put in place to get around lack of issued share capital.

What legal and other work is involved to create a demerger?

There really is no standard demerger as each company is different and there will be different hurdles to overcome.

Demergers can typically follow the following stages:

  • Working out the step list – this is the most important and complicated stage as it involves planning the way around pitfalls and tax traps which can so easily derail a demerger. It is not particularly document heavy but is intellectually demanding and the tax laws are intricate.
  • HMRC clearance application for the demerger – it is best to deal with clearance as early as possible to avoid delays whilst we wait for HMRC turnaround. HMRC do not rubber stamp and there can be queries and re-thinking to deal with. This stage is different from to dealing with HMRC stamp office which is the last stage. The clearance application is to seek confirmation from HMRC that the demerger is not going to crystallise tax charges for the shareholders.
  •  Creating a new holding company and subsidiaries
  • Entering into share for share exchange agreement –  to reorganise the shareholdings within the group if that is part of the demerger – this stage can be paper work heavy as you will need shareholder resolutions, board minutes, filings at Companies House, new articles and share certificates. The order of events is important if you are consolidating subsidiaries and or transferring assets.
  • Stamp duty clearance application – this is a different section of HMRC. Even if you believe stamp duty does not arise as you fall within an exemption we still recommend clearance if obtained. If stamp duty does arise a calculation on the value of the shares falling with the demerger is needed.
  • Transfer of assets to new subsidiary – the paperwork will depend upon what asset is being transferred. At this stage we find third party consents may be needed and banks should be informed.

Solicitors for demerger advice

As is clear from the above, demergers are complex with lots of options and significant implications for a business. Getting it right means choosing the right way to demerge based on commercial drivers. Our lawyers are specialists in clearly working through the options and in thje legal and tax work to implement, all in a practical and cost effective way.

Catherine Gannon

Catherine is an extremely experienced solicitor and deals with all types of corporate and commercial matters and advice and also tax law. She is well known for turning complex problems into solutions, priding herself on always finding a way. In her spare time she runs Gannons!

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