Tax traps in reorganisations
Tax is commonly a central factor in how reorganisations are structured. Careful consideration needs to be given to tax planning to reduce the risk of significant tax liabilities to the business and its shareholders. The main goal is to reorganise the business and move assets around on a tax neutral basis whilst at the same time not triggering any tax liabilities for shareholders. Preserving entrepreneurs’ relief for shareholders is usually top of the agenda.
We look at:
- Potential for errors
- Income distribution and dividend in specie
- Tax on Shareholders’ capital gains
- Chargeable and intangible fixed asset gains corporation tax
- De-grouping tax charge
- Stamp duty
Potential for errors under a reorganisation or demerger
Reorganisations commonly involve transfer of assets from one company to another. The assets are usually shares in a subsidiary, goodwill, property or business contracts. The transfer is treated as a disposal by the transferor company for corporation tax purposes. In addition, capital distributions to shareholders (most typically, shares in another company) are potentially subject to dividend tax. However, not all is doom and gloom as various reliefs are available for certain qualifying schemes of reconstruction and statutory demergers.
Often a reorganisation or demerger includes the transfer of employees. One common error is to forget about this and run into breaches of the TUPE rules which attach to any transfer of staff for any reason. For cases where the shareholders are looking to preserve entrepreneurs’ relief the operation of TUPE must leave the shareholders employed by the company in they hold shares or a subsidiary at the point of any transfer.
Tax reliefs potentially available
The main reliefs are:
- Relief from corporation tax on capital and intangible fixed asset gains by the distributing company. The distribution is treated as taking place as no gain/no loss basis.
- Relief for the shareholders from capital gains tax receiving a capital distribution as part of a demerger (rolling over gains).
The relevant tax reliefs apply provided that certain conditions are satisfied. Certain types of reorganisations may have the advantage of more reliefs available than others. The rules are fairly complex and in our experience every case is different. For this reason we recommend you start with a feasibility study to check whether the conditions for relief are likely to be satisfied. A good feasibility study will provide a road map and step list for achieving the recommended structure. Part of the planning includes time scales for implementation. If the matter involves clearance applications to HMRC the average wait time is around 3 weeks. There can also be delays in obtaining shareholder approval but this does depend upon the shareholder population and the articles of association for the company.
Income distribution and dividend in specie
The simplest de-merger structure is a direct de-merger. It involves the payment of a direct dividend, dividend in specie, to the shareholders receiving shares in the demerged subsidiary. The indirect, or three cornered de-merger is slightly different. In an indirect de-merger the dividend is paid by the transfer of business or assets to be demerged to a company and shares in the transferee company issued directly to the shareholders. In both cases the distribution by a company to its shareholders will be treated as an income distribution and can be costly to individual shareholders who will pay income tax.
Provided that certain conditions are met both direct dividend and three cornered demergers may be treated as exempt distribution under the statutory demerger rules. This means there is no income tax liability for the shareholders.
Tax on shareholders’ capital gains – direct or indirect demergers?
Different rules for reliefs from taxation of chargeable gains apply in case of a direct or three cornered demergers. Direct dividend may qualify as an exempt distribution under the relevant provisions of CTA 2010 whereas in an indirect de-merger the relief from capital gains tax may be available under the schemes of reconstruction rules.
Chargeable and intangible fixed asset gains corporation tax
Under the scheme of reconstruction rules no corporation tax liability on chargeable gains will crystallise on the transfer of the de-merged trade by the distributing company of assets. Similarly, transfer of intangible fixed assets may be treated as tax neutral. Goodwill is an intangible fixed asset which forms part of any trading business. The treatment of goodwill depends upon when the business was first started and whether there has been one trade or new trades added. This is something to look into under any feasibility study.
De-grouping tax charge
Potential de-grouping charges may arise if a demerged subsidiary has intra-group chargeable gains assets acquired in the previous six years. The demerged subsidiary will be deemed to dispose of the assets at their market value at the time they were acquired.
The regime in respect of loan relationships, and intangible assets is similar, though not identical.
Different rates of stamp duty can become payable. The charges vary depending upon what is transferred.
Stamp duty on shares
Generally, stamp duty is payable at the rate of 0.5% of the consideration given for the transfer of shares. So this can catch share swaps where a new holding company is formed and the subsidiary trades hived up.
However, an exemption may be available in certain demergers if a transferee company pays for the transfer of shares or business by issuing shares in the exact proportions to the shareholders of the transferor company. This is known as ‘share for share exchange’.
Again, the qualifying conditions are fairly complex and a stamp duty relief may not be available if the structure is not carefully considered.
Stamp duty land tax where property is involved in the reorganisation
Broadly stamp duty land tax is payable at the relevant rates (which are much larger than the rate of stamp duty on shares) on the transfer of land (land transaction tax in Wales). There are reliefs available on intra-group transfers and demergers. But there are conditions on the reliefs – these being that stamp duty will become payable if the buyer leaves the group within three years of the property being transferred. Also the clawback will apply if the seller leaves the group and there is a change in control in the buyer within three years of the transfer.
De-mergers and reorganisations are used for a variety of reasons. Although there are tax reliefs available, designing the transactions as tax neutral will require an extensive knowledge of the relevant legal and tax position. Unless the structure fits within the tax rules there could be unexpected prohibited tax liabilities.