Demystifying the detail around Demergers
There are a great many cases in which a demerger can be carried out without any tax charges arising
What is a demerger?
A demerger is a type of corporate reorganisation in which the business activities of one company (or group of companies) are split out into two or more companies (or groups) that are then held separately.
The ownership of the successor companies will often mirror that of the original company. However, it is also possible for each of the successor companies to be owned by a different subset of the original shareholder group.
There are a great many cases in which a demerger can be carried out without any tax charges arising, either for the shareholders or the underlying company. In other scenarios, some tax leakage is unavoidable, even where the transaction steps are designed to minimise this as far as possible. However, the upfront cost of the demerger is often more than justified by the commercial and longer-term tax benefits of the transaction.
Why do privately-owned companies carry out a demerger?
There are many reasons why privately-owned companies might want to undertake a demerger. Some of the more common reasons are as follows:
1. To help facilitate a future sale of part of the business
Where it’s possible that part (but not all) of a corporate group might be sold in the future, it’s worth considering a demerger of that business ahead of time. It can make the later sale process easier if there’s a discrete business packaged up and ready to go.
It also means the shareholders make the disposal rather than the group that’s left behind. They receive and pay tax on the sale proceeds personally, rather than having to extract proceeds from the residual group, which would typically result in a higher overall tax rate.
2. To segregate a company’s trading and investment businesses
The presence of substantial investment activities in a group that is otherwise largely trading can compromise the shareholders’ tax position. It can prevent them from obtaining Business Asset Disposal Relief (BADR, formerly known as Entrepreneur’s Relief) on a subsequent disposal of the group, and it can compromise the availability of Business Property Relief (BPR) – an Inheritance Tax relief – on their shares.
To improve the shareholders’ tax position, we can use a demerger to extract a group’s investment business into a separately held group. Post-demerger, and after a time has passed, BADR and BPR should become available in respect of the trading group. This can save a significant amount of tax on a later disposal of shares, or when a shareholder passes away.
3. To break up the company’s assets in the event of a shareholder dispute
It’s a sad but unavoidable fact that company shareholders – particular the shareholders of family-owned companies – often fall out with one other. It can become very difficult to run the underlying business in an effective way where irreconcilable disputes arise, and trust breaks down.
The best approach for all parties is often to split the existing company business and assets into multiple separate businesses, each held by a different shareholder or group of shareholders – that is, to carry out a demerger. This is usually best suited to investment businesses, where the underlying asset portfolio can be more easily partitioned into separate pools of value.
4. To facilitate succession planning
Without appropriate planning, the ownership of family investment companies may become more complex over time as shares are inherited by multiple children, grandchildren and so on. Periodically demerging an existing company into separate entities held by different branches of the family can help simplify the ownership and management of the company as time goes on.
5. To help rationalise the business’ activities
Demerging peripheral, incompatible or underperforming parts of the business can help the remaining business to focus on what it does best. The demerged operations can then be run as discrete businesses, often with significant benefits. A business previously operated as something of an afterthought can often thrive away from the shadow of the wider group – management may be more motivated (and separately incentivised) to grow the business, it may help to resolve conflicts of interest, facilitate the development of a very different brand, attract new external investment, and so on.
How does a demerger work in practice?
Every demerger needs to be designed by reference to the particular facts and circumstances, taking into account the tax profile of the shareholders, the companies’ assets and activities, and the objectives of the transaction, and many other factors.
That said, there are broadly three different ways in which a demerger can be undertaken. These are:
(a) A ‘statutory demerger’ – this involves the parent company declaring a distribution of the relevant business / subsidiary to the shareholders. Shares can be distributed directly to the shareholders (a ‘direct’ demerger) or to a new company set up to receive the demerged activities (an ‘indirect’ demerger).
There are various conditions that must be met in order to undertake a statutory demerger. For example, statutory demergers can only be used where the demerged and residual businesses are both trading businesses, so they can’t be used to separate an investment business from a trade.
(b) A ‘capital reduction demerger’ – this generally involves putting a new holding company above the existing company structure with two classes of shares (one class being entitled to the business that will be demerged; the other entitled to the remainder), after which the holding company:
• cancels the first class of shares, and
• transfers the demerged business to a new company in exchange for a new issue of shares by that company to the holders of the cancelled shares.
This transaction is generally more complex than a statutory demerger, but usually represents the best approach where the statutory demerger conditions are not met (e.g., where the demerger doesn’t involve trading entities).
(c) A ‘liquidation demerger’ – this generally involves liquidating the parent company (or a new holding company set up for this purpose) and then transferring the businesses of the parent company to new companies set up by the shareholders. This kind of demerger is only rarely used, as a ‘capital reduction’ demerger can typically be used to achieve the same outcome with lower implementation costs.
Would you like to know more?
If you would like to discuss any of the above in more detail, please get in touch with your usual Blick Rothenberg contact or with Robert Harness using the form below.