Seven Demerger Mistakes That Lead to a Tax Bill

Demergers rarely go wrong because of an obscure rule. They go wrong because of a short list of predictable errors: the wrong route, steps in the wrong order, or a later event that takes a relief away. The common thread is that demerger reliefs come with conditions and anti-avoidance rules, and most of them look at the whole plan, including what happens afterwards. Fixing the plan before anything is signed costs far less than repairing it afterwards.

1. Choosing the route before understanding the facts

The three main routes are a statutory demerger, a capital reduction demerger and a liquidation demerger, and each has its own conditions. The costliest version of this error is using a statutory demerger to separate property. The statutory rules in the Corporation Tax Act 2010 cover trading activities only, and holding property for rent is usually an investment activity. If the conditions fail, the distribution is not exempt. The shareholders can face an income tax charge and the company can have a capital gain.

Avoid it by starting from what each business does and what the shareholders want afterwards, and only then choosing the route.

2. Acting first and asking HMRC later

Clearance is not compulsory for most demergers, but it is usually the right first step. It tells you, before anything irreversible happens, whether HMRC accepts the transaction is not caught by the relevant anti-avoidance rules. Acting first removes the chance to change the plan if HMRC has concerns, and some clearances must in any case be obtained before a particular step, such as the issue of shares.

Avoid it by building clearance into the timetable. HMRC has 30 days to answer a complete application, and further questions restart the clock.

3. Leaving facts out of the application

A clearance is only as good as the disclosure behind it. If the application omits an expected sale, a planned cash payment or a shareholder about to emigrate, the clearance may not protect what actually happens.

Avoid it by disclosing plans that are known or reasonably expected, even if not yet certain. If plans change after clearance, take advice before going ahead.

4. Forgetting property that has already moved within the group

Moving property between group companies is usually tax-free at the time, using the intra-group capital gains rules and SDLT group relief. The difficulty comes when the receiving company later leaves the group. A demerger is often exactly the event that causes that.

Some exits are exempt, for instance an exempt distribution under the statutory demerger rules, but those exemptions have conditions of their own.

Avoid it by listing every intra-group transfer of property or other chargeable assets from the last six years before choosing the steps.

5. Assuming stamp duty and SDLT reliefs will follow the gains analysis

Stamp duty on shares and SDLT on land each have their own reliefs and tests. They do not follow the capital gains treatment automatically. The usual traps are:

• Mirror-image tests. Share-for-share stamp duty relief and SDLT reconstruction relief broadly need the shareholders to hold the same proportions before and after. Partitions, where shareholders take different businesses, usually fail.
• Control arrangements. Stamp duty relief on a new holding company can be refused where there are arrangements for someone to obtain control of it.
• Three-year clawbacks. SDLT reconstruction and acquisition relief can be withdrawn if control of the acquiring company changes within three years.

6. Letting cash into the deal without a plan

Shareholders sometimes want cash to even out a split, or the company wants to repay a loan or buy out someone who is leaving. Each can cause trouble:

• The reconstruction reliefs expect shares, not cash, to go to shareholders. Cash usually means a part disposal.
• The transferring company must receive nothing for the business other than the assumption of liabilities.
• After a statutory demerger, a chargeable payment to shareholders within five years can be taxed as income.
• The transactions in securities rules can turn what would be capital into income.

Avoid it by deciding early whether any cash will move, and planning and disclosing it as part of the scheme.

7. Ignoring the position after the demerger

A demerger changes which companies the shareholders own, and that affects reliefs that look forward:

• Business Asset Disposal Relief. The company whose shares are sold must meet the trading and personal company tests for the two years before the sale.
• Inheritance tax Business Relief. Shares in a company that mainly holds investments, such as let property, do not qualify.
• The Substantial Shareholding Exemption on a later sale of a subsidiary.
• Filings after completion, including the 30-day return following an exempt distribution, stamp duty adjudication and SDLT returns.

Avoid it by modelling where each shareholder will stand in two or three years, not only on the day of the demerger.

Why these errors keep happening

Demergers are occasional events for most companies and most advisers. The rules sit across corporation tax, capital gains, income tax, stamp duty, SDLT, company law and insolvency law. Each relief tends to be checked on its own, while the real danger lies in how they interact. A step that is fully relieved by itself can trigger the clawback of another relief two steps later. People also tend to start from the result they want and work back to the paperwork. For a demerger, the conditions of each relief need to shape the steps from the beginning.

A quick self-check

• Do we know whether each business is trading or investment?
• Do we have a list of intra-group asset transfers from the last six years?
• Do we know who will own what, and whether any cash will move?
• Do we know if a sale, investment or succession step is expected within three to five years?
• Is clearance planned before any step is taken?
• Have stamp duty and SDLT been checked separately from capital gains?

If any answer is no, it is worth talking before you go further. Our specialist team prepares the advice, which is reviewed by a Chartered Tax Adviser. Book a call with our team, or read our guide to 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.