Types of demergers

In a previous article we looked at some of the reasons for, and potential tax benefits of, forming a group.  We have also commented on there being times when it may be necessary to revisit a group structure, especially within the context of a restructure.

What is a demerger?

One option within a group restructuring will be to reorganise a group by demerging certain assets. Before progressing on such an approach careful consideration will need to be given to the practical issues of restructuring your business. 

How the group is split, whereby certain activities or assets are “demerged” from the existing group, will largely be dictated by tax considerations. It is important to ensure the steps required to implement the demerger fall within relevant conditions to ensure the demerger qualifies for tax reliefs and exemptions.

The steps to be taken will, in turn, be dictated by the reason for the demerger as certain tax reliefs are not available, or may be withdrawn, if the demerger is in anticipation of a sale of one or more of the demerged entities.

Types of demergers

There are various forms of demerger that may be considered. The different types of demerger can be broadly split into four types.

Direct dividend demerger

A direct dividend demerger effectively involves the parent company declaring a dividend of the relevant business / subsidiary that is to be demerged to the parent’s shareholders.

Three-cornered demerger

A three-cornered demerger is a variation on the direct dividend demerger whereby the parent company declares a dividend of the business (or shares in a newly formed subsidiary to which the business to be demerged is first transferred) to a newly formed separate company, “Newco”, in return for Newco issuing shares to the shareholders;

S110 demerger

A s110 demerger involves:

• liquidating the existing parent company (or a new holding company formed for this purpose);
• the liquidator transferring the relevant business / subsidiary or investment assets to be demerged to Newco 1 in exchange for Newco 1 issuing shares to the shareholders; and
• the rest of the business and assets / subsidiaries being transferred to Newco 2 in exchange for Newco 2 issuing shares to the shareholders;

Capital reduction demerger

A capital reduction demerger generally entails:

• inserting a new holding company with two classes of share (one class being entitled to the business / subsidiary or investment assets to be demerged and the other being entitled to the rest of the business and assets / subsidiaries);
• separating out the relevant assets / businesses to be demerged; and
• the new holding company then reducing its capital / cancelling the shares representing the business / assets to be demerged and transferring the business / assets to be demerged to a Newco, in return for Newco issuing shares to the shareholders.

Demerger tax implications

Essentially any demerger will involve a distribution of assets or shares to the shareholders or to a Newco which will issue shares to the shareholders in return for the transfer.

The key from a tax perspective is to ensure, as far as possible, that applicable tax exemptions or reliefs are available so as to avoid:

• any tax charge on the distribution for the shareholders; and
• any tax charge on the distributing company (on the transfer of the assets or shares)

As well as considering any tax charges arising on the demerger itself, the ongoing tax implications of the post-demerger structure should also be considered. If, for example, properties or investments are demerged into a separate company then going forward the shares in that company will not qualify for Business Asset Disposal Relief for capital gains tax purposes or Business Relief for inheritance tax purposes.  

Statutory Demerger

The first two types of demerger (direct dividend and three-cornered) are referred to as statutory demergers as they qualify for certain specific statutory tax reliefs.

One of the main disadvantages of the statutory demergers however is that the tax reliefs do not apply where separating out investment assets (as opposed to businesses) and there are anti-avoidance rules that apply whereby certain of the tax reliefs can be clawed back and income tax charges can arise on the shareholders if any of the companies involved in the demerger are sold or wound up within 5 years of the demerger.

They also require the distributing company to have sufficient distributable reserves to distribute out the shares of the relevant trading subsidiary or trade and assets of the relevant business that is to be demerged.

Non-Statutory Demergers

Whilst more complex than statutory demergers, non-statutory demergers (a s110 demerger or capital reduction demerger) are used where the conditions relating to the tax reliefs for statutory demergers may not be met such as if looking to separate out investment assets from the trading business, or if there are insufficient distributable reserves to be able to undertake a statutory demerger.

As a s110 demerger involves a liquidation, reserves are not an issue whereas under a capital reduction demerger the reserves can be created (as required) on the insertion of a new holding company.