Splitting a company - Tax efficiently
Most private companies begin as sole owner-managed entities; after a few years, some grow to involve family members working for the business, handling different departments or types of operations, or expanding to encompass more than one business under the company name. Family members might wish to take a specific department forward independently from the others. For various reasons, a demerger might be considered, with the goal of executing it as tax efficiently as possible for the shareholders.
The two primary methods by which a company can carry out a demerger without triggering an income tax charge for the shareholders are through an 'exempt' demerger (the 'statutory' form) or a liquidation demerger under the Insolvency Act 1986 (the 'non-statutory' form). If neither of these methods is feasible or appealing, a reduction in share capital or a share-for-share exchange may achieve the same outcome.
Statutory Demerger
There are several conditions that must be met for a demerger to be considered 'exempt' under the statutory rules. One key condition is that the original company must remain a trading company and the intention must be to keep the demerged or successor company, not sell it. However, most demergers aim to separate one business for sale, with shareholders parting ways.
Whether the demerger is structured using the 'direct' or 'indirect' methods, both constitute a distribution that would typically be taxable as income to the shareholders, taxed at dividend rates. Instead, the distribution is treated as a part-disposal of the shares in the distributing company, subject to a capital gains tax (CGT) charge as there would be a receipt of shares. However, the transaction should be covered by the 'tax-exempt distribution' provisions where the assets are transferred at 'no gain, no loss'. Eventually, the CGT base cost of the surrendering company will need to be apportioned between that company and the new one (usually upon the first disposal of shares from either holding).
The 'direct' method is where the shares in the distributing company and the shares in the company being distributed together 'stand in the shoes' of the original shares. The 'indirect' method involves transferring trading activities to a new company that issues shares to the shareholders of the transferring company as consideration. Note that there may be stamp duty considerations, although reliefs may be available, provided the shareholdings of both companies mirror each other.
Liquidation Demerger
If it is not possible to meet the conditions for a statutory demerger, another company or subsidiary will need to be incorporated and the trade transferred to the 'new company'. The 'original company' is then liquidated, with the distribution of the relevant assets to the 'new' company made by the liquidator.
Other Methods
The 'reduction in capital' route is sometimes preferred over liquidation. The typical procedure involves incorporating a new holding company to own the shares of the split companies. Similar to other methods, there will be no income tax implications for the shareholders, and any CGT charge can be deferred. Assets transferred from one company to another will be covered under the transfer of business provisions.
'Share for share' exchanges might be possible where the intention is for the owners of one business to exchange their interests with another and receive shares in the new company as consideration. As long as no cash consideration is received and the values are equal, so no additional value is transferred, the transaction is essentially a swap of shares with no tax implications.
Practical Point
The distributing company must file a return to HMRC within 30 days of making the distribution, including details of why it is believed to be exempt. Specific rules ensure that only legitimate 'business separation' occurs and that the distributions are not part of an arrangement to avoid paying VAT.
