Guide to demergers

What is a demerger?

A demerger describes the process of separating one company or business into two or more separate companies. Demergers can take place for a variety of reasons, such as preparing part of a business for sale or allowing shareholders to separate their interests and pursue different business strategies. A demerger can, where the relevant conditions are satisfied, be structured to be tax efficient so that shareholders do not face an immediate tax charge simply because they receive shares in two companies following the demerger.

There are practical and tax considerations, as well as advantages and disadvantages, associated with demerging.

Types of demerger

In the UK, there are three different ways to structure a tax-efficient demerger, depending on the circumstances. The main routes include:

• Statutory demerger route – Statutory demergers, where appropriate, can be a tax-efficient route with a relatively straightforward procedure. What can complicate statutory demergers is generally the tax position and the need to satisfy specific statutory conditions. HMRC advance clearance is commonly sought to provide greater certainty over the proposed tax treatment.
• Capital reduction demerger – This route is popular where shareholders want to break up the group structure and separate subsidiaries so that each is independent. The basic method is that the company reduces its share capital and simultaneously transfers shares or other assets to a different or new company also owned by the shareholders. This type of demerger is common in anticipation of a sale. Depending on the structure and the relevant conditions, it may be possible to avoid immediate tax charges. Stamp duty charges can arise if the conditions for available relief are not satisfied or the shareholdings change.
• Demerging by liquidation – This is another possible route, although it is less popular where shareholders and directors do not want to use a liquidation process, even where the liquidation is solvent. The treatment of assets, including goodwill, needs to be considered carefully as part of the proposed structure.

Why do companies demerge?

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

• Reduced overheads and streamlining  – Separating businesses can help simplify group structures and allow each business to focus on its own operations and resources.
• To facilitate a sale - Business sales where the buyer does not want to acquire all of the assets or subsidiaries – the sellers can move the unwanted parts of the business out before the sale.
• Shareholder protection -  Directors may feel that putting assets in a different company will provide greater protection for shareholders, although there can be important timing and structural issues to consider.
• 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 way of releasing capital to shareholders. If the company has share premium, it may be possible to use the demerger route to put that capital to better use.
• New investment - Capital reductions may be used to facilitate investment into new areas. Another popular reason is where part of the company is to be sold and the demerger separates the business being sold from the remaining group.
• 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 through which the lender and/or investor is prepared to provide funding.

What are the risks or pitfalls with a business demerger?

Demergers require planning. Areas to think about include:-

• Tax - demerger involves potential tax issues. On the face of it, moving assets or companies into different structures and changing shareholdings can create tax consequences. However, specific tax exemptions and reliefs can apply where the relevant conditions are satisfied and the demerger is implemented in the correct sequence. HMRC may scrutinise the tax consequences of moving assets around a group, and the transaction must have appropriate commercial reasons. Stamp duty can also be payable and is often overlooked.
• Shareholder approval - Demergers are made up of a series of steps that may require specific shareholder approvals, together with the filing of relevant forms at Companies House. If the components are not put in place in the right order, there can be significant legal and commercial consequences, including risks for the transaction if creditors or shareholders challenge the arrangements.
• Third party approvals - The demerger will often require the approval of third parties such as banks and landlords. It is important to identify these requirements in advance and obtain the necessary approvals before completing the relevant steps. Third parties may also want to approve the paperwork implementing the demerger.
• Solvency - With a capital reduction demerger, the directors of the holding company may need to provide a declaration of solvency. The directors will need to be satisfied that the relevant statutory requirements are met and that the companies can meet their liabilities following the restructuring.

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.

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.

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 legal requirements, commercial issues and potential tax traps that could derail a demerger. It is not necessarily document heavy, but requires careful analysis of the proposed structure and the applicable tax rules.
• HMRC clearance application for the demerger – It is best to deal with clearance as early as possible to avoid delays in the implementation process. HMRC does not simply rubber stamp applications and there can be queries and changes to the proposed structure may need to be considered. This stage is different to dealing with the HMRC Stamp Taxes office. The clearance application is intended to establish whether the proposed demerger can qualify for the relevant tax treatment.
•  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 paperwork heavy as you may need shareholder resolutions, board minutes, filings at Companies House, new articles and share certificates. The order and timing of these events is important, particularly where subsidiaries are being consolidated or assets transferred.
• Stamp duty clearance application –This is a separate HMRC process. Even if you believe stamp duty does not arise because you fall within an exemption, appropriate advice should be taken on whether clearance or relief is available. If stamp duty does arise, a calculation based on the relevant value of the shares or other consideration may be needed.
• Transfer of assets to new subsidiary – The paperwork will depend upon what asset is being transferred. At this stage, third-party consents may be needed and banks and other relevant stakeholders should be informed where appropriate.

Demerger Support

As is clear from the above, demergers are complex, with multiple structural options and significant legal, tax and commercial implications. Getting it right means choosing the right way to demerge based on your commercial objectives and the structure of the existing business. Our specialist corporate legal team can work through the available options and assist with the legal and tax-related implementation, providing practical advice and keeping costs under control.