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As a firm with many SME trading company clients we often advise on scenarios where a company has two successful trading divisions and the Directors wish to transfer - or demerge - one of those divisions to a separate company owned by the same shareholders.  There can be varying commercial drivers for this.  The company may be changing direction and wish to focus on one high growth trading division whilst keeping the original division “ticking over”.  Or the company may wish to create greater brand awareness or differentiation for each division in the external market place.  Alternatively, the company may wish to create greater management focus and performance measurement and reward by operating the divisions through separate companies.

A demerger under which a trading division (and its associated assets, liabilities and employees) is distributed/ transferred to a new company which in return issues shares on a pro rata basis to the shareholders of the original company clearly has significant commercial, legal and tax ramifications.   

Basic tax analysis

In the absence of relieving provisions, where a company simply distributes assets to another company it would ordinarily be liable for corporation tax on any gains arising, and the shareholders would be treated as receiving distributions (dividend income) for income tax purposes.

The demerger code in the tax legislation

Fortunately, however, the tax legislation recognises that there is an economic benefit to demergers.  Consequently, where the detailed conditions in the legislation are met (including bona fide commercial reasons and no tax avoidance tests) a demerger can proceed on a tax neutral basis for the distributing company and its shareholders.

Where the numerous conditions are met the beneficial tax consequences of a demerger can be summarised as follow: 

  • The transfer of chargeable assets such as land and buildings or goodwill from the original company to the new company takes place on a no gain, no loss basis for corporation tax purposes;
  • The distribution of the assets is an “exempt distribution” and is not subject to income tax in the hands of the shareholders;
  • The demerger should qualify as a “scheme of reconstruction” meaning that the shareholders will not be treated as making disposals of their original shares for CGT purposes.    

As ever, the devil is in the detail and it is vital to take co-ordinated legal and tax advice when contemplating a demerger.  However, unlike some break ups, a demerger does not have to be painful from a tax perspective! 

 

If you would like any any advice on this please do not hestitate to contact me