Understanding Demergers: Strategic Business Separation

In the dynamic world of business, restructuring is often necessary to streamline operations, prepare for a sale, or refocus company resources. One effective method of restructuring is a demerger.

This blog post about Understanding Demergers, the different types of demergers, their benefits and drawbacks, and essential considerations for successful implementation, with a particular focus on tax implications. Additionally, I will share two case studies demonstrating how demergers can be effectively utilized and how we work with our clients to help them achieve their ultimate goals and objectives.

Table of Contents

• What is a Demerger?

• Types of Demergers

• Why Do Companies Demerge?

• Tax Considerations in Demergers

  • Tax Efficiency in Statutory Demergers

  • Capital Reduction Demergers and Tax

  • Tax Implications of Demerging by Liquidation

• Potential Risks and Pitfalls

• Planning a Demerger

• Case Studies

  • Case Study 1: Facilitating a Sale

  • Case Study 2: Shareholder Protection and Restructuring

  • Case Study 3: Splitting a property investment company between two families

• Legal and Practical Considerations

• Solicitors for Demerger Advice

• Conclusion

What is a Demerger?

A demerger is a business restructuring strategy (or transaction) where a company divides its operations into separate entities. This can be particularly useful in preparation for the sale of part of a business or when a business has diversified into different areas. Moreover, a common scenario we see is with property investment companies, whereby property assets need to be split for whatever reason (see below).

Demergers can provide massive tax and commercial benefits, as long as structured carefully.

Types of Demergers

There are three primary types of demergers:

1. Statutory Demerger: This method is often the quickest and simplest, provided it meets strict conditions. Statutory demergers require HMRC advanced clearance to ensure compliance with tax regulations.
   

They are generally the most tax-efficient, as no stamp duty is payable, and the structure is exempt from income tax for shareholders, with capital gains tax deferred until shares are sold. Key conditions include that the demerger should not be in anticipation of a business sale, and all subsidiaries must be trading entities. The key word here is ‘trading’, and therefore, investment companies are automatically excluded.

2. Capital Reduction Demerger: One particular usage is among companies with a single shareholder and multiple subsidiaries, this method involves reducing the company’s share capital and transferring shares or assets to a new or existing company owned by the shareholder. This approach can be tax-efficient if shareholdings are mirrored, although stamp duty charges may apply if there are changes in shareholdings.
   

A more popular usage of a CRD is with property investment companies. As there is no requirement for entities to be trading (as above), it works beautifully whereby property investment assets need to be split between shareholders, perhaps due to a dispute or differing, amicable goals for the future.

3. Demerging by Liquidation: This less popular method involves liquidating a company to distribute its assets. Despite being a solvent liquidation, many shareholders and directors are reluctant to be associated with liquidation due to its negative connotations.
   

Why Do Companies Demerge?

Companies demerge for various reasons, including:

• Facilitating a Sale: Preparing parts of a business for sale by removing unwanted assets or subsidiaries. A regular scenario we see is where there are valuable properties (either commercial or residential) and the owner(s) would prefer to keep such assets/buyers are not interested in such assets.

• Shareholder Protection: Enhancing protection for shareholders by segregating assets into different companies.

• Reducing tax risk: Owning investment assets within trading companies/groups runs the risk of ‘diluting’ the whole entity to be of investment status. This is detrimental considering Business Asset Disposal Relief for Capital Gains Tax purposes, Substantial Shareholding Exemption for Corporation Tax purposes and Business Relief for Inheritance Tax purposes. A demerger helps by neutralising the risk.

• Business Restructure and Consolidation: Organising subsidiaries in different jurisdictions under one umbrella or separating different businesses all ran through the same trading entity.

• Releasing Capital: Providing a method to release capital to shareholders efficiently. Moreover, assets can be rabased to market value, eliminating any capital gains.

• New Investment: Facilitating investment into new areas or sectors by redistributing share premiums.

• Lender Issues: Creating a structure more attractive to lenders and investors who may prefer to finance only certain parts of the business.
  

Tax Considerations in Demergers

Tax planning is a critical component of any demerger transaction. Understanding the tax implications can make the difference between a successful restructuring and a costly one, which only comes to light AFTER the transaction whereby hundreds of thousands of pounds are now payable in tax. This is the scenario you would want to certainly avoid!

Tax Efficiency in Statutory Demergers

Statutory demergers, when structured correctly, can be highly tax-efficient. These demergers can eliminate stamp duty liabilities and defer capital gains tax until the shares are sold. Additionally, shareholders are exempt from income tax on the demerger. However, to achieve these tax benefits, the demerger must not be in anticipation of a sale, and all subsidiaries involved must be active trading companies. Obtaining HMRC clearance is essential to confirm these tax exemptions and ensure compliance.

Capital Reduction Demergers and Tax

In a capital reduction demerger, the company's share capital is reduced, and assets are transferred to new or existing entities. This method can also be tax-efficient, especially when the shareholdings remain unchanged. If shareholdings change, stamp duty may apply, which could impact the overall tax savings. Careful planning and execution are required to optimise tax outcomes in capital reduction demergers.

Tax Implications of Demerging by Liquidation

Although less common, demerging by liquidation can have significant tax consequences. Shareholders and directors often avoid this route due to the potential tax liabilities and the negative perception associated with liquidation, even when solvent. Understanding the tax implications and exploring alternative demerger methods is crucial. Usually, a capital reduction demerger is the alternative to a liquidation.

Potential Risks and Pitfalls

While demergers offer many benefits, they also come with risks and challenges. One major concern is the tax implications. Without proper planning, moving assets or companies can trigger significant tax liabilities. However, if implemented correctly, there are legitimate tax exemptions as per legislation that can make demergers tax efficient.

Demerger processes require specific shareholder approvals and the filing of relevant forms at Companies House. Incorrect sequencing can leave the demerger vulnerable to attacks by creditors or shareholders. In a recent case I have now been introduced to, the situation became chaotic due to poor management; no one really knew or knows what has happened. It was a clear example of the importance of meticulous planning and execution. I won’t go into it further!

Securing necessary approvals from banks, landlords, and other third parties is another critical aspect of a successful demerger. These approvals must be obtained before completing the demerger to avoid future complications. Failing to do so can result in significant operational and financial issues down the line.

Finally, directors must declare that the companies will be solvent post-demerging, especially in the case of a capital reduction demerger. This solvency declaration ensures that the companies will be able to pay their debts, maintaining financial stability and credibility with stakeholders.

Planning a Demerger

Effective planning is crucial for a successful demerger. Key steps include:

1. Creating a Detailed Step List: This outlines the coordination process among accountants, banks, landlords, directors, and shareholders, ensuring all parties are aligned. This is the most important step!

2. Securing HMRC Clearance: Advanced clearance from HMRC can prevent delays and provide certainty that the demerger will not incur unexpected tax charges.

3. Setting Up a New Holding Company: If necessary, establish a new holding company and any required subsidiaries.

4. Executing Share for Share Exchange Agreements: This involves paperwork-heavy processes such as shareholder resolutions, board minutes, and filings at Companies House.

5. Obtaining Stamp Duty Clearance: Even if exemptions are believed to apply, obtaining clearance from HMRC ensures compliance and avoids future issues.

6. Transferring Assets: Depending on the assets being transferred, this may require additional consents and notifications to third parties.
   

Case Studies

Case Study 1: Facilitating a Sale

ASWATAX assisted a marketing firm that wanted to sell one of its non-core business divisions. By implementing a statutory demerger, the firm successfully separated the division into a standalone entity. This not only streamlined the sale process but also ensured significant tax savings through deferred capital gains tax. Effectively, any gain is rolled over, rather than being crystallised at the point of transferring the trade. The demerger enabled the firm to focus on its core operations while efficiently divesting the non-core division.

Case Study 2: Shareholder Protection and Restructuring

A tech company with subsidiaries in various jurisdictions approached ASWATAX to restructure its business for better shareholder protection and operational efficiency. Using a capital reduction demerger, we helped the company redistribute its assets into separate entities under a new holding company. This move safeguarded shareholders' interests and simplified the management structure, facilitating smoother operations and strategic growth.

Case Study 3: Splitting a property investment company between two families

A property portfolio valued at £6 million had been held in a limited company since 1996. The two business partners, whose children are now in their 20s and 30s, felt it was the right time to split the portfolio they had built to ensure a clean succession and avoid potential disputes, given the understandable growth of both families. Initially, they sought advice from another firm but were not fully satisfied with the sub optimal solution presented. Following a recommendation, they approached us, and we took on their case.

The significant benefits for the clients included:

• Successfully demerging the portfolio with minimal tax impact (stamp duty was payable on shares at 0.5%, but we eliminated capital gains tax and stamp duty land tax).

• Achieving an uplift in the base cost of the entire portfolio, effectively resetting the capital gains and wiping out the accumulated gains over the years ie since 1996!

• Planning for inheritance tax for each new entity, transitioning them into family investment companies. This involved introducing freezer shares to mitigate inheritance tax exposure for the original partners.
  

Legal and Practical Considerations

Demergers are complex and require significant legal and practical work. Each demerger is unique, and there are no standard procedures due to varying business structures and objectives. Essential stages include:

• Developing the Step List: This crucial planning stage addresses potential pitfalls and tax traps and care must be taken. This is where the value lies.

• Applying for HMRC Clearance: Early application helps avoid delays and confirms that the demerger will not trigger unintended tax charges.

• Creating New Corporate Entities: Setting up new holding companies and subsidiaries as required.

• Executing Share Exchanges and Transfers: Involves extensive documentation and regulatory filings.

• Securing Stamp Duty Exemptions: Obtaining HMRC clearance to confirm exemption applicability.

• Transferring Assets: Ensuring all legal and third-party consents are in place.
  

Solicitors for Demerger Advice

Given the complexity, intricacies and nuances involved in demergers, choosing the right advisors is critical. At ASWATAX, our seasoned specialists provide clear guidance on the best demerger strategy based on your commercial drivers and ultimate objectives. We handle the legal and tax work with a practical and cost-effective approach, ensuring your demerger is successful and tax efficient.

Conclusion

Demergers are an extremely powerful tool for business restructuring, offering numerous benefits as outlined above. However, they also present significant challenges that require careful planning and execution. By understanding the different types of demergers and their implications, businesses can make informed decisions that align with their strategic goals.

At ASWATAX, we have the expertise to guide you through the demerger process, ensuring compliance with the tax and legal requirements while maximising the benefits for your business. Wiping out capital gains on a property portfolio continues to sit very well with me! Contact us today to learn more about how we can assist with your demerger and other tax planning needs.

Meet Omar Omar is a Chartered Tax Advisor (a.k.a an expert on tax issues) and founder of ASWATAX. He regularly shares his knowledge and best advice here on his blog and on other channels such as LinkedIn. Book a call today to learn more about what Omar and ASWATAX can do for you.

*Disclaimer: ASWATAX is a firm of Chartered Tax Advisors, and we strive to provide accurate, up-to-date tax insights. Tax laws may change, so this content is for general guidance only and not a substitute for professional advice. Seek independent tax and legal counsel before making decisions. ASWATAX is not liable for any loss from reliance on this information. Use at your own risk.