What Happens to Employees, Contracts and VAT in a Demerger?

Quick answer: If a demerger only moves shares or an investment asset, nothing changes for staff, customers or suppliers. If a trading business moves to a new company, employees can transfer under the TUPE rules, contracts need to be assigned or novated, licences and registrations may need to be reapplied for, and VAT depends on whether the transfer is a going concern. Plan these items before the legal steps start, not after.

Start with what actually moves

Most worry about employees, contracts and VAT disappears once you ask one question: what is moving?

• A property or investments. These usually have no employees and few contracts beyond tenancies and loans. The people issues are small. The VAT and lender issues are not.
• A whole trade. Everything that belongs to the trade moves: staff, customer and supplier contracts, equipment, stock, licences and the VAT position.
• Only shares. If the demerger inserts or removes a company in a chain, but the trading company stays put, there is no change to its staff or contracts at all.

We design many demergers so that the trading company stays where it is and the property or investments leave. That is not always possible, but it removes most of the employment and contract issues. For the full set of routes, see our service page on capital reduction demergers.

Employees

When TUPE applies

The Transfer of Undertakings (Protection of Employment) rules, known as TUPE, protect employees when a business, or part of one, transfers to a new employer. In a demerger, if a trade moves from one company to another, staff who work in that trade will normally move with it on their existing terms.

In practice that means:

• the same pay, hours and holiday;
• continuous service carried across, which matters for redundancy and notice rights;
• the new company taking on the liabilities linked to those employees;
• a duty to inform and, in some cases, consult employees or their representatives.

If employees only work in the trade being moved, the position is straightforward. If some staff split their time between the two businesses, the group needs to decide who goes where, and to document it.

Practical steps

1. List every employee and the business they serve.
2. Agree who transfers and who stays.
3. Prepare the information and consultation, if required.
4. Make sure PAYE, payroll, pensions auto-enrolment and benefit schemes are ready in the new company.
5. Update employment contracts, statements and policies.
6. Check the employer liability insurance cover.

Employment advice on TUPE is a legal matter. It is for your solicitor or employment adviser to confirm. We coordinate it with the tax steps.

Contracts

A contract belongs to the company that signed it. If the trade moves, the contracts do not move on their own. The usual choices are:

• Assignment. The benefit of the contract passes to the new company. The other party may still need to agree, and the burden usually cannot be assigned without consent.
• Novation. All three parties agree that the new company replaces the old one. This is the cleanest option and usually the one lenders and customers prefer.
• Leave it where it is. The old company keeps the contract and subcontracts the work, which is rarely tidy.

Look in particular for:

• change-of-control or anti-assignment clauses;
• key customer and supplier contracts, and framework or tender arrangements;
• leases, where the landlord's consent is usually needed;
• bank facilities and guarantees (see our article on demerging mortgaged property);
• licences, permits and regulatory registrations;
• insurance policies and warranties;
• intellectual property, domain names and software licences.

Some licences are personal to the company. A new company may need to apply for its own, which can take time. Build that into the timetable.

VAT

Is the transfer a going concern?

If a business moves from one company to another as a going concern, it can be outside the scope of VAT, provided the conditions are met. These include that the new owner continues the same kind of business, and, where a VAT registration applies, that the buyer is or becomes registered. Without the relief, the transfer of assets may be a taxable supply, and VAT could be due on the value of the assets.

Property needs special care. The option to tax, and whether the new owner has made or will make their own option, affects the position for commercial buildings.

VAT registrations

• The new company. It will need its own VAT registration if it makes taxable supplies above the threshold, or may register voluntarily. In a transfer of a going concern, there are rules on whether the old registration can be passed on.
• The old company. It may need to deregister, or its taxable turnover may fall.
• Group registration. If the companies stay in a VAT group, supplies between them are generally disregarded for VAT. But every member of the group is jointly and severally liable for the group's VAT, and a demerged company that leaves the group will need its own registration.

Intragroup VAT can be a trap. A company that holds only shares may find that its costs do not carry VAT recovery. This is worth checking before the structure is final.

Example: Hypothetical Group Ltd runs a signage business and owns a freehold unit used by the business. The owners demerge the unit into Premises Ltd, which leases it to Group Ltd. If Group Ltd and Premises Ltd are not in a VAT group, rent from Premises Ltd to Group Ltd may carry VAT if the property is opted to tax. If the option to tax is not made, rent is exempt and Premises Ltd cannot recover VAT on its costs. The decision affects cash flow and should be taken before the transfer, not after. The figures and facts are hypothetical.

Other practical points

• Customers and suppliers. Tell them. New company details on invoices, new bank details and new terms cause errors.
• Banking. New accounts, mandates and, where needed, new lending.
• Accounting systems. Split the ledgers on a clean date.
• Data protection. Customer and staff data may need to be shared between companies on a lawful basis, which should be documented.
• Name and brand. Who owns the trading name and the website?
• HMRC registrations. PAYE, corporation tax and VAT each need updating.

Why the order matters

Tax clearances, lender consent, employee consultation and customer contracts all need time. The demerger itself may take a day, but the preparation takes weeks. A realistic plan starts with the practical items, because those are the ones that can delay everything else. Our article on how HMRC views a demerger application shows what to have ready for the tax side.

Talk to us about Capital Reduction Demerger

• Splits a business or takes property out of a trading company
• Needs no liquidator and no court application for a private company
• Reliefs and HMRC clearance usually make it tax-neutral

See how we help or book a free 20-minute call.

FAQs

Do employees have to agree to a demerger?

They do not vote, but if a trade transfers, TUPE applies automatically and the employer must inform and sometimes consult them. Changing their terms because of the transfer is restricted.

Do customer contracts transfer automatically?

No. Contracts stay with the company that signed them unless they are assigned or novated. Many need the other party's consent.

Is a demerger subject to VAT?

Not necessarily. Distributing shares is usually outside the VAT charge, but moving assets or a business between companies may be a supply. A transfer of a going concern can be outside the scope of VAT if the conditions are met. Check before you transfer.

Does the new company need a new VAT number?

Often yes, if it makes taxable supplies above the threshold or the going concern rules require it. If the companies are in a VAT group, they share a registration while they remain members.

Can I demerge without telling staff?

Not if the business that employs them is transferring. Even where the employer does not change, honest communication avoids rumours. It is good practice to speak to the team early.

Talk to us

If you are planning a demerger and want the tax, VAT and practical steps sequenced properly, book a call for a free 20-minute conversation with our team. Our service page on corporate restructuring also explains the wider options.

Sources

• Transfer of a going concern and VAT (Notice 700/9): https://www.gov.uk/guidance/transfer-a-business-as-a-going-concern-and-vat-notice-7009
• VAT groups (Notice 700/2): https://www.gov.uk/guidance/group-and-divisional-registration-vat-notice-7002
• Applying for statutory clearance: https://www.gov.uk/guidance/apply-for-statutory-clearance-for-a-transaction
• Reconstructions (ss136 and 139 TCGA 1992): https://www.legislation.gov.uk/ukpga/1992/12/section/136 ; https://www.legislation.gov.uk/ukpga/1992/12/section/139
• Anti-avoidance for share exchanges and reorganisations (from 26 November 2025): https://www.gov.uk/government/publications/capital-gains-tax-share-exchanges-and-reorganisations/capital-gains-tax-anti-avoidance-for-share-exchanges-and-reorganisations