It’s often said that breaking up is hard to do. But when it comes to dividing a successful business into separate standalone entities, the separation process itself isn’t necessarily the hardest part. Depending on how the corporate restructure gets handled, unpicking shared assets and activities can trigger major tax bills for the companies and shareholders involved.

This blog will provide an overview of the primary strategies for carrying out a tax-efficient company demerger in the UK. These strategies can involve divesting business units to concentrate on core operations, facilitating management buyouts, or enabling different shareholder factions to part ways while preserving value. Understanding these tax-friendly mechanisms is crucial for significant long-term savings.

Why Demerge?

Let’s first outline some of the common reasons company directors contemplate carving up a single incorporated entity:

• One division or product line has grown so dominant that separating it allows greater focus and investment on the optimum strategy for that brand or customer niche.
• Shareholders responsible for running particular business units wish to take full control and ownership of those operations going forward.
• An external investor wishes to acquire and fund just one specific part of the company’s activities. Carving this out tidily facilitates the investment.
• Overall, company growth means still reporting as one consolidated corporation starts to become inefficient and cumbersome from an accounting and operational perspective.

Tax Treatment of Corporate Distributions

In most countries, any assets or value distributed from a company to its shareholders would automatically constitute taxable income for the recipients. This deemed ‘income distribution’ usually attracts dividend tax charges. Clearly, that could become extremely costly if significant tangible and intangible company assets get passed to investors as part of a demerger initiative.

Fortunately, the UK tax system incorporates specific reliefs and exemptions to facilitate ‘tax neutral’ company splits in qualifying scenarios. These enable shareholders to receive shares and assets from a corporate restructure without immediately incurring a chargeable tax liability.

Let’s examine the two main mechanisms…

Statutory Demergers

Also referred to as ‘tax exempt’ demergers, these adhere to certain conditions set out in legislation that effectively defer any tax obligations relating to the restructure distribution. Reliefs apply both for direct shareholders receiving holdings in the newly formed corporate entities and at the distributing company level on transferred assets or subsidiaries.

Two alternative structuring methods exist for statutory demergers:

Direct Method: Shares issued by the newly formed recipient company pass directly to existing shareholders in proportion to their current stake. Their combined holdings in both the existing company (retaining some assets/trades) and the new entity (housing divested parts) effectively preserve the value of the original single company investment.

Indirect Method: The assets, trade lines, or subsidiaries to be divested are transferred to a new corporate entity in exchange for the new company issuing shares directly to existing shareholders. Once again, this mirrors previous proportional stakes, just split across two corporations rather than one.

Under either mechanism, splits can enable cost-basis reallocation between old and new entities to reflect where divested assets have ended up.

While distributing assets is usually tax-exempt, statutory demerger criteria require both original and newly formed post-restructure companies to continue actively trading rather than immediately winding down or selling divested elements. Where shareholders want full autonomy to realise sale value from a spun-out entity, other mechanisms may be more appropriate.

Liquidation Demergers

For situations where immediately selling or listing divested divisions is likely, undertaking separation via a members’ liquidation offers more freedom. Also known as ‘non-statutory demergers’, these follow a slightly different sequence:

• The assets or subsidiaries to be hived off get transferred into a newly formed corporate entity.
• The original operating company then enters members’ voluntary liquidation.
• As part of the orderly winding-up process, the shares in the new entity are distributed to shareholders instead of directly transferring trade assets under a statutory demerger.

As long as the transfer between the companies takes place at market value, the distribution mechanism should be exempt from capital gains reliefs. This avoids triggering income tax charges at the shareholder level.

Once again, though, transferring assets across at nominal ‘no gain/no loss’ values remains key to facilitating the most tax-efficient separation process.

Other Potential Mechanisms

Depending on specific circumstances, two other corporate restructuring mechanisms can achieve similar outcomes to formal demergers:

Capital Reduction: Conceptually, this involves reducing the value of existing share capital and either returning excess amounts to shareholders or allocating amounts to newly issued shares. As with the demerger methods, this preserves underlying value distribution, simply transitioning parts across to new entities.

Share-for-share Exchange: Where two sets of shareholders want to swap respective stakes to take full control of specific company assets, a share exchange avoids triggering tax charges. As long as proportionate interests remain aligned and no additional payments or value gets introduced, swapping shares does not constitute a taxable gain.

Fundamentally, undertaking a demerger involves transitioning interests in assets from an existing corporate entity or entities into one or more newly formed companies, followed by distribution to existing shareholders. The critical focus areas to enable completing this tax-efficiently are:

• Ensuring asset transfers occur at appropriate market values rather than artificially inflated or nominal levels.
• Shareholder interests and stakes passing across are proportionate to existing holdings.
• Avoiding cash consideration coming into play and triggering potential income tax liabilities.

With careful planning and structuring, company directors have options to segregate and divest business units, subsidiaries or assets tax-efficiently and simplify unwieldy corporate structures. Seeking expert guidance from financial, tax and legal advisors is key, though – splitting up may remain hard to do, but the right advice ensures your tax burden doesn’t have to be!