Finance Act 2026: The New Main Purpose Test for Demergers and Share Exchanges

Most capital reduction and liquidation demergers rely on the capital gains reliefs for share exchanges and schemes of reconstruction in sections 135, 136 and 139 TCGA 1992. Each relief has an anti-avoidance rule. Finance Act 2026 rewrote those rules with effect from 26 November 2025.

The short version

• The bona fide commercial reasons test has gone. A main purpose test aimed at the arrangements has taken its place.
• If the rule applies, the tax advantage is counteracted by just and reasonable adjustments, rather than the relief being lost for every shareholder.
• It applies to share issues and business transfers on or after 26 November 2025, with a transitional rule for clearances applied for before then.
• Clearance is still available under sections 138 and 139(5).
• HMRC accepts that deferral alone is not a tax advantage for this purpose.

The legislation

The change is made by sections 37 and 38 of the Finance Act 2026, which received Royal Assent on 18 March 2026. It was announced at the Autumn Budget on 26 November 2025, when HMRC published a policy paper and draft legislation.

"Arrangements" is defined widely. It takes in any agreement, understanding, scheme, transaction or series of transactions, whether or not legally enforceable.

When it applies

For section 137, which concerns shareholders, the new rule applies to arrangements involving an issue of shares or debentures on or after 26 November 2025. For section 139, which concerns the company transferring its business, it applies to arrangements involving a transfer of business assets on or after that date.

The old rules continue only where all three of these are true:

1. a company applied for clearance before 26 November 2025
2. HMRC, or the tribunal, notified it that it was satisfied
3. the shares were issued, or the assets transferred, before 26 January 2026, or if later within 60 days of that notification

That window will almost always have closed, so a demerger being planned now should assume the new rules apply.

What HMRC says the rule targets

HMRC's guidance is in its Capital Gains Manual, appendix CG-APP20. The main points are:

• Deferral is not avoidance. The rule does not apply where the only advantage is deferring a liability. Deferral is what the reliefs exist to provide.
• The focus is the arrangements. The question is whether specific features were added to reduce or avoid tax, not whether the exchange as a whole has a tax motive.
• Counteraction can be targeted. In HMRC's examples, only the shareholder who benefits from the avoidance feature is affected, and the relief carries on for the others.

Examples HMRC gives of arrangements that could be caught include loan notes issued to a shareholder about to leave the UK, steps designed to multiply Business Asset Disposal Relief, and changes to share rights designed to satisfy the Substantial Shareholding Exemption conditions.

How the question has shifted

Under the old rules the starting point was the transaction as a whole. Was the exchange or reconstruction carried out for bona fide commercial reasons? If tax was a significant motive, relief could fail for every shareholder above the 5% threshold.

Under the new rules the starting point is the arrangements. Has anything been included with a main purpose of reducing or avoiding tax? If so, what adjustment is just and reasonable, and for whom?

Two consequences follow. A commercial transaction with an incidental tax benefit, such as deferral, is less likely to be caught. But a commercial transaction with an added feature, such as loan notes for a departing shareholder or a new share class created to meet a relief condition, can be caught even though the transaction overall is sound. The counteraction is then aimed at that feature and the person who gains from it. The rule is narrower in scope but sharper in its targeting.

What it means for a demerger

For a typical demerger with genuine commercial aims, the change is broadly helpful, because HMRC accepts that deferral by itself is not a tax advantage. Two of HMRC's examples stand out:

• A demerger before a sale to an Employee Ownership Trust. A family group uses a capital reduction demerger to separate a business, which is then sold to an EOT. HMRC says the rule does not apply, because the purpose is to separate the business being sold and there are no additional arrangements reducing the shareholders' CGT.
• Separating trading and investment activities. HMRC says the rule would not apply where a business is restructured so that a later share sale qualifies for a relief such as the Substantial Shareholding Exemption, once the relief's conditions are met throughout the relevant period afterwards.

Some things have not changed:

• The statutory demerger rules in the Corporation Tax Act 2010 keep their own conditions, including the scheme tests in section 1081, which were not rewritten.
• The transactions in securities rules still apply to income tax advantages for shareholders.
• Stamp duty and SDLT reliefs still contain a bona fide commercial reasons test.
• Clearance still covers only what is disclosed. HMRC's guidance says a section 138 clearance confirms only that it considers there is no main purpose of avoiding tax on chargeable gains.

Practical points

• Commercial reasons still matter. They are the best evidence that tax is not a main purpose, and other reliefs test them directly.
• Look closely at extras. Loan notes, new share classes, cash elements and changes of residence are where the new rule concentrates, and each should have a clear explanation.
• Disclose plans for after the demerger. A sale or investment is not automatically a problem, but it needs explaining.
• Seek clearance first under sections 138 and 139(5) to gain certainty before anything is implemented.

Sources are Finance Act 2026, sections 37 and 38, TCGA 1992 sections 137 to 139 as amended (both on legislation.gov.uk), and HMRC's policy paper on anti-avoidance for share exchanges and reorganisations and its Capital Gains Manual, CG-APP20 (on gov.uk).

The right route depends on your facts and the order of the steps matters. Our specialist team prepares the advice, which is reviewed by a Chartered Tax Adviser. To plan a demerger under the new rules, book a call with our team, or see our page on the capital reduction demerger.

This article is general information, not advice. Tax rules change and their effect depends on your circumstances. Please speak to us before acting.

For more on how demergers work in practice, see our specialist demerger practice, Demerger Tax.