Topical Tax Points on Demergers

Demergers are popular from a tax perspective as, broadly speaking, provided they are correctly structured they can allow for the separation of trades / businesses (including investment businesses) with no or minimal tax leakage. This can allow one trade to be sold, attract investment or be ring-fenced separately from another trade or business / asset.

In the current business and economic climate, and as noted in our previous Tax Bite sent on 16 April (“Protecting Assets”), trading companies with valuable property (or other) assets sat in them should consider reorganising their structure one way or another to try to ring-fence these valuable assets from trading risk.

A recent tax change that is a further driver for considering a demerger is the reduction from £10m to £1m in the lifetime limit for gains qualifying for entrepreneurs’ relief (ER - to be renamed business asset disposal relief). If a property asset was not wanted by the purchaser of a trading business and it was not standing at a significant gain, it was typically possible when the higher ER limit was in place, for the selling shareholders to extract the property from the company at an effective personal 10% capital gains tax rate. However with such a significant reduction in gains qualifying for ER, it is now much more likely that the limit will be used up in full on the sale of a trading company before taking into account the value of any property, which would in effect double the applicable rate of CGT (to 20%) if the property were extracted using the same structure – there may therefore now be more of an incentive to undertake a demerger to separate out the property from a trade prior to a sale and this would always have been needed if the property was standing at a significant gain.

It is also possible that a demerger of a property that is standing at a capital gain, by way of transfer of that property to a new property investment company within the group, followed by a demerger of that company, could give rise to a “step up” of the base cost of that property to its current market value in the property investment company.

The various methods available to demerge, and their basic tax implications, are generally well known and beyond the scope of this Tax Bite (but please note there are numerous traps for the unwary, so detailed advice, comprehensive clearance applications to HMRC and careful implementation are crucial). However there are a couple of recent stamp duty developments of note:

• The stamp duty relief (known as section 77 relief) that can apply on the first step of a typical demerger (placing a new holding company on top of the existing company / group), so long as there is a “mirror image” in the shareholdings in the existing company before the transfer and the new holding company after the transfer, is now subject to a “disqualifying arrangements” test (section 77A), meaning broadly that the relief won’t be available if there are arrangements for a sale or change of control of the new holding company at the time of the transfer, subject to certain relaxations. Typically in practice this should not act as a blocker to the relief but means that care has to be taken with how the demerger is structured, particularly if a sale of one part is in prospect or the demerger is being undertaken to split assets between two (or more) shareholders.

• If the demerger involves the transfer of shares in a subsidiary to a separate new company owned by the current shareholders, there is a further stamp duty relief (section 75 relief) potentially available. This relief again requires a mirror image in terms of the ultimate shareholders and shareholding proportions in the transferred and new holding company before and after the transfer. We have been made aware that HMRC has on some occasions recently denied claims for the relief where there is a plan to sell the new holding company shortly after the demerger, even though those plans remain subject to contract and it is clear on the face of the legislation that this should not be an issue. HMRC have been contacted to ask if this represents a change of policy, and it is hoped that this will be clarified shortly.

Posted on 26/10/2020 in Demergers


About us

Parisi Tax is a specialist tax law firm. Our clients benefit from having on-demand access to a wealth of tax knowledge and deal expertise.