The Practical Guide to Limited Company Tax
If you have chosen to operate your business as a limited com...
By Jonathan London on 20th April 2016
Breaking up is hard. Just like all kinds of relationships, businesses can split up too and there are many reasons why this could happen: maybe departments have grown so large that they need to separate, or there’s a disagreement about how the business should be run.
Unfortunately, walking away is sometimes the best option, so grab the Ben & Jerry’s and a bottle of wine, we’re here to walk you through your options.
A “demerger” is a series of transactions undertaken to divide trading activities carried out by a company (or group of companies) between two or more companies (or groups of companies).
Whatever the reasons for a company splitting up, the aim should be to make the process as tax-efficient as possible for all shareholders, as well as making sure all parties involved remain trading.
It’s not always be possible to implement a reconstruction without having to pay some form of tax. You probably won’t need to pay income tax and CGT – it’s more likely that stamp duty will be charged. Although with careful planning, this charge can also be avoided.
It’s worth seeking advice from your online accountant to discuss the best method of splitting, but we’ll go through your options here.
Just as there are different reasons for demergers, there are different end combinations of companies.
If the demerged company is owned by all or some of the shareholders of the original company and the holdings in the original company are still retained, significant tax liabilities may be triggered for both the company and its shareholders if there are no special relieving provisions.
Whichever method is used, HMRC will want to know what procedure has been taken so they can confirm whether the disposal is really a distribution in disguise and therefore is taxable as income.
There are two main methods companies use to undertake a demerger without attracting an income tax or capital gains tax charge (CGT) (although stamp duty or stamp duty land tax may be relevant).
These are the ‘exempt’ demerger – the ‘statutory’ form of demerger; and the liquidation demerger – the ‘non-statutory’form.
A demerger can only be considered “exempt” under a number of conditions: the original company must remain a trading company and the intention is to retain the demerged or successor company and not to sell. There’s also a need for sufficient distributable reserves to effect the demerger.
If the statutory conditions are met, there shouldn’t be any income tax implications for the shareholders as the ‘exempt’ demerger will be deemed to have been made at asset market value.
There could be a chargeable gain, as there will be a receipt of shares, but the transaction should be covered by the ‘tax exempt distribution’ provisions (in TCGA 1992, s 192), where ’stand in shoes’ treatment is possible in respect of the shares.
The company will have relinquished part of its business to the new company and to ensure no chargeable gain the demerger has to fall within the ’scheme of reconstruction’ provisions (in TCGA 1992, s 139). This means that when there’s a scheme of reconstruction involving the transfer of the whole or part of a company’s business to another company, that transfer is at a ‘no gain no loss’ value.
The transfer must be made with genuine commercial reasons with no consideration made other than the assumption of its liabilities by the transferee company.
Stamp duty implications could occur as there’s a transfer of shares involved in the transaction, but in some cases (and with careful planning) this tax can also be avoided.
Some demerger projects are unable to meet the strict conditions that make a statutory demerger method possible. As such, these may have to take the ‘non-statutory’ procedure (Insolvency Act 1986 s 110). This involves the voluntary liquidation of the original company and distribution of the relevant assets by the liquidator to the new companies owned by the shareholders.
As there’s no ‘exempt’ statutory demerger (where shareholders of an existing company receive shares in another) this would normally be considered an income distribution to the shareholders.
Put simply, the disposing company must be liquidated before reconstruction is undertaken, as amounts received during liquidation are generally not considered income distributions.
A non-statutory liquidation demerger requires at least two transfers of the business unit. The original company will no longer exist: it’s been replaced by another company into which assets of the original company are transferred.
Reductions in share capital
This method is sometimes used instead of the liquidation route because this can have negative impacts (e.g. on credit ratings), as well as being costly. The usual procedure is generally for a new holding company to be incorporated to own the shares of the split companies.
The advantage of reductions in share capital as a method of reconstruction is that there’s no requirement to meet the conditions of the ‘exempt’ statutory distribution provision. At least not for companies that do not have sufficient distributable reserves but do not want to go down the ‘liquidation’ route.
While generally there are no income tax implications, the only concern will be for a CGT charge for the shareholders, but this can be deferred under the ‘stand in shoes’ rules for reconstructions (in TCGA 1992, s 136). Assets transferred from one company to the other are potentially covered under the transfer of business provisions (in TCGA 1992, s 139).
‘Share for share’ exchanges
This may be possible when the owners of one business intend to exchange their interests and receive shares in the new company as consideration. As long as no actual consideration is received and values are the same (no additional value transferred) the transaction is effectively a simple swapping of shares and shouldn’t warrant an income tax charge. CGT implications shouldn’t arise if the “stand in shoes” provisions in TCGA 1992, s 135 apply.
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