Breaking up is hard to do: tax restructuring in a demerger
When your company’s at a crossroads, the last thing you want is to be hit with unexpected taxes. We advise on the reliefs and support to make the parting of ways less painful.
Over time, many privately-owned companies will evolve to carry out a different set of activities from those that they initially set out to do. A manufacturing business may expand into retail to sell its products, or a highly profitable business may invest profits in residential properties, for example. Or a family business may set up a subsidiary for a junior family member to give them a head start in business.
Groups with diverse activities can often operate successfully for a certain period, but often there then needs to be a parting of the ways. A company with two or more activities may not be attractive to a purchaser who only wants to acquire one of them. Mixing trading activities in a group with significant investment interest is likely to be a disadvantage for the shareholders’ personal tax planning. And sadly, just as often, we see the management or owners of the differing business activities failing to agree on the best future for the group. That’s when it’s wise for each to go their separate ways.
The tax costs of asset removal
Unfortunately, where companies and tax are concerned, putting things into companies is easy but getting them out is more difficult. Without effective tax planning, the removal of assets from a company to a shareholder can give rise to Corporation Tax in the company, Income Tax or Capital Gains Tax for the recipient and, potentially, Stamp Duty too. Without reliefs it would be almost impossible for many companies or groups to reorganise, even where the structure causes significant commercial issues.
On the one hand, specific demerger reliefs can apply to transactions to break up companies or groups if certain conditions are met. Specifically, these prevent the crystallisation of tax charges for both the company and its shareholders. But the bad news is that these are highly restrictive in their application. For example, a claim for demerger relief will fail where the transaction is undertaken so that a third party can take control of one or more elements of the original business. And, generally, the relief can only apply to trading groups, so it can’t be used to separate trade and investment activities.
More reliefs to the rescue
But all is not lost. Other reliefs can be applied to a restructure. An example is where a liquidator is appointed to liquidate the holding company and distributes shares in two or more new holding companies to shareholders who hold the original assets of the company or group, in the new desired proportions. This mechanism can also be applied for shareholders who want to go in separate directions. In this case, each shareholder group will own the new holding company which carries on the activity in which they want to stay involved.
To make the process run smoothly, there will likely need to be some internal reorganisation of the group before appointing the liquidator. That way, transactions can proceed effectively without crystallising tax charges, and the company being liquidated will be as clean as possible to simplify the liquidation process.
For all these steps, it’s worth noting that HMRC offers a clearance procedure to ensure that no unforeseen tax charges arise for the company. This is essential for the liquidator, who will potentially carry the can for any corporate exposures that crystallise. But also for the shareholders, who should be treated as being party to a restructure and bear no immediate tax charges from the exercise.
Not for everyone
Note this route may not be suitable for all entities. For example, a listed company that wishes to retain its listed status is likely to opt for another route to prevent the costs of re-admission. What’s more, in some regulated sectors, the regulator may need convincing that a liquidation does not give rise to additional risks.
This may all sound complicated. But any reputable tax advisor and liquidator will have been down this path many times, and will be able to explain the steps in plain English to clarify what is going on and the costs and timescale of the process.
At PKF our tax team has worked with our advisory partners on many liquidation demerger projects to allow our clients to reorganise their groups in a tax and cost efficient manner. If you would like further advice on any issues raised in this article, please contact Chris Riley.