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The capital reduction demerger provides a powerful tool for facilitating the splitting of activities of companies and corporate groups. It is often possible to undertake a capital reduction demerger without giving rise to adverse tax implications, even if the company wants to split out its trades before a sale.
Unlike a statutory demerger, a capital reduction demerger does not rely on the existence of sufficient distributable reserves and, can be employed to separate activities which include both trading and non-trading activities.
It is likely to be particularly attractive in cases where a trade and property are held in the same company and the shareholders of that company would like to reorganise them into separate entities without incurring the costs and potential reputational issues of appointing a liquidator (even if it is a solvent liquidation).
A capital reduction demerger allows the restructuring of a company via a return of the shareholders’ capital.
Many companies will have been incorporated with little nominal share capital and, in many instances, the first step in a capital reduction demerger will be to insert a holding company above the existing company or group. The holding company acquires the existing company by way of a share-for-share exchange with the result that it has issued share capital of the holding company is equal to the market value of the existing company.
This should then provide scope, subject to a declaration of solvency by the directors, for the new holding company to undertake a reduction in its share capital.
The holding company’s share capital can then be reorganised into two or more different classes, with each class of share carrying the right to the assets and liabilities of a different trade or subsidiary company. The holding company’s capital is then reduced by transferring the assets as a dividend in specie to a further new company and the shares relating to those assets are then cancelled.
As a result, the trades or subsidiaries held by the original company are demerged into two separate companies.
The process can be adopted to suit different circumstances including the separation of trading and investment activities, separating out different trading activities into separate companies and splitting activities between different groups of shareholders who wish to go their separate ways.
Each of the requisite steps can be undertaken relying on well-established reconstruction reliefs and HMRC clearance can be sought. In particular, no income tax charge should arise for the shareholders of the original company or holding company, provided the value of what is being demerged is no more than the capital reduced. The distribution is a capital distribution and therefore the reconstruction reliefs should apply and there is, moreover, no disposal by the original shareholders.
Relief from stamp duty may be available; however, charges may arise if the new companies are not owned by the same shareholders as the original company.
In short, a capital reduction demerger enables a company or group to be reorganised, in a broadly tax neutral way. However, while such a demerger can be achieved with tax neutrality, it must be implemented with great care.
We can review your specific circumstances and goals and consider which route is most appropriate to your situation. Throughout it is essential to ensure that HMRC clearances are sought and received to ensure that the various tax reliefs are available.
For more information on capital reduction demergers please feel free to contact a member of our helpful tax advice team. You can also read more articles below.