Tax Bite: The end of Reduction of Capital demergers?
HMRC recently published a wide-ranging consultation, "Modernising the taxation of distributions and repayments of capital from companies", available here. The consultation includes proposals on a number of areas that are of interest to those advising private companies and their shareholders, including around share buy-backs, distributions from non-UK companies, extending the close company loans to participators rules to non-UK companies, and amending the transactions in securities rules.
In this Tax Bite we focus on one proposal in particular: the impact on demergers.
The "frozen capital" proposal
The consultation proposes that where a new holding company ("Newco") is inserted above an existing company via a share-for-share exchange, the share capital in Newco would, for tax purposes at least, be "frozen" at the amount originally subscribed on the shares in the original company - rather than reflecting the market value of those shares as contributed to the exchange.
This is a fundamental change to the mechanics that underpin reduction of capital ("ROC") demergers. ROC demergers have become the most commonly used method of implementing a demerger. They are flexible and can be used in advance of a sale of one part of the business. However, in order to give the intended (tax neutral) outcome, it is very important that the first step (putting a Newco above the existing company / group) results in Newco having sufficient share capital for tax purposes to cover at least the market value of what is to be reduced (demerged) and returned to the shareholders on the later steps. The frozen capital proposal, if implemented, would effectively bring ROC demergers to an end.
What about statutory demergers?
The government recognises that removing the ROC demerger route will push some businesses towards the statutory demerger regime. The current conditions for implementing a statutory demerger are many and restrictive, resulting in these forms of demerger being relatively uncommon.
The consultation proposes liberalising several of the conditions. At present, a statutory demerger simply cannot be implemented if there is a proposal to sell either part of the business. It is proposed that this condition will be softened, but a statutory demerger will still not be able to be used to facilitate an onward sale or change of control within 5 years. For businesses looking at separating in anticipation of a sale (which is the most common form of demerger we see), therefore, this would be a crucial limitation.
Will section 110 demergers come back into fashion?
If ROC demergers are no longer available and statutory demergers cannot be used ahead of a sale, section 110 liquidation demergers (which involve placing the original company into members' voluntary liquidation and distributing its assets to new successor companies) may see a resurgence. They can be used to facilitate a sale of one part of the business. They do, however, require the original entity to be wound up, a licensed insolvency practitioner to be appointed, and are more procedurally complex and therefore costly, so we have not seen many of these being implemented for a long time, but that may change again.
Alternatives to a demerger
Where no demerger route is available or appropriate, careful tax advice will be needed on the best (or least worst) way to structure a sale of part of a business. Hive-downs into a subsidiary ahead of a share sale, or selling the entire business and buying back the part the client wishes to retain, would be among the possibilities to be analysed.
For now, these proposals are at consultation stage, with no draft legislation and no fixed timetable for implementation, but advisers and clients need to be aware of what may very well be coming. Businesses contemplating a demerger or pre-sale restructuring in the next 12 to 24 months should take advice now on whether to accelerate plans under the current rules or consider what the alternatives could be. This is of particular importance to companies that have separate businesses in them, or groups where it is anticipated that subsidiary companies or even trades are likely to be sold separately.
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