What is a demerger?
Demergers or spin outs involve a company being separated from the rest of the group/business so that it can receive investment, list on a stock market or be sold.
This is a very wide and complex topic so we’ll mainly focus on the scenarios which we normally come across and this is a short summary only, there are many other factors and rules to consider.
There are 3 main ways to effect a demerger: dividend in specie (a dividend not involving cash), reduction of capital or liquidation.
Its possible to plan a demerger to take advantage of various tax reliefs and exemptions:
Demerger relief exemptions apply: use dividend in specie so that the shareholders don’t pay any tax on the shares they receive in the demerged company
Demerger reliefs not available or insufficient distributable reserves to pay a dividend: use reduction of capital so that the shareholders don’t pay any tax on the shares they receive in the demerged company
Parent company can’t claim substantial shareholder exemption: use a group reconstruction first and then a reduction of capital
A statutory demerger is one which meets the criteria under the Corporation Tax Act 2010 sections 1073 to 1099 and so is classed as an “exempt distribution”.
The key benefits of qualifying are that the shareholders don’t have to pay tax on the shares they receive in the demerged company. They will receive the shares as a dividend in specie, so this doesn’t require a reduction of share capital, but it requires sufficient distributable reserves/profits being available.
In order for a demerger to qualify, the main criteria are:
- The demerged company must be at least a 75 per cent subsidiary.
- Condition A: The companies must all be EU Member State resident.
- Condition B: The companies must trading companies or members of a trading group (the company being demerged has to be trading or be a parent of a trading group).
- Condition C: The distribution must be for the benefit of the trade.
- Condition D: The distribution must not be made for the purposes of:
- the avoidance of tax or stamp duty
- the acquisition by persons who are not members of control of the company;
- the cessation of a trade or its sale;
- Condition E: the shares must not be redeemable and must be the whole of the share capital and voting rights of the demerged company
Refer to Reduction of capital for an explanation of what is involved in a capital reduction.
There will be no tax for the shareholders receiving the shares in the demerged company if TCGA92/S136 reconstruction relief is available.
What value should be used for the shares in the demerged company?
Book value can potentially be used for an exempt demerger by dividend in specie. However, there could be income tax payable by the shareholders if book value is used in a capital reduction as the shareholders would be receiving shares worth more than the reduction in capital.
Its essential to obtain clearance from HMRC prior to commencing the transaction or demerger to ensure that they agree with the exempt treatment. It can take quite a while to obtain the clearance, you should normally allow for at least 1 to 2 months.
Other areas to consider
There are many other factors and rules that should be considered before a demerger is executed. Here are some examples:
SDLT: there could be stamp duty payable on the transfer of shares, although it may be possible to claim tax exemptions
VAT: if the demerged business is transferred as a going concern this will generally be outside the scope of VAT
EIS: if there are any EIS shareholders in the demerged business it may be possible to use share for share exchanges/re-organisations to avoid EIS reliefs being withdrawn or clawed back.
Intragroup: its worth checking if there will be any tax issues arising from splitting a company from the rest of the group. For example if there are intercompany loans these could be subject to a tax if written off after the demerger or there could be assets subject to degrouping charge under capital gains tax.