It is common for directors and shareholders to want to reorganise a corporate structure. This might involve a merger or demerger. An array of reliefs in the tax system may facilitate this – and produce some surprising benefits.
The circumstances where this planning may be of benefit are many and various. Shareholders may want to pursue different paths or, alternatively, owners may want to separate different business activities in a company into separately owned entities. Without the right approach, there can be very significant and unwelcome tax charges.
An example of planning we have implemented
Our clients owned all the shares in a trading company equally between four individuals. In addition to a successful and profitable trade, the company also owned land and buildings with development potential. The Directors intended to secure planning consent in respect of this land and, in fact, permissions were due imminently at the time of the proposed demerger. The aim was to demerge the company into two new companies -one owning the trade and the other owning the development land. Each separated company would still be owned by the four individuals equally.
The legal steps involved placing a holding company (HoldCo) above the trading company, creating a new subsidiary (SubCo) underneath HoldCo, transferring the land into SubCo and then demerging SubCo into a new external holding company (Property HoldCo) owned by the four shareholders. The demerger took place by way of a ‘capital reduction demerger agreement’. There would then be two separate groups; HoldCo owing the trading company and Property HoldCo owning SubCo (which owned the development land).
The tax planning opportunity
Where a demerger is being undertaken, the main objective is to ensure that any tax costs arising on the demerger itself are kept to an absolute minimum. Without any reliefs the transactions involved would give rise to personal Capital Gains Tax (CGT) charges, Corporation Tax (CT) on gains, Stamp Duty (SD) on share acquisitions, Stamp Duty land Tax (SDLT) and VAT on the property transfer and, most damaging, income tax (at 38.1%) on a deemed distribution.
Fortunately, specific provisions relating to ‘share for share’ transactions mean that the personal CGT charges can be avoided. The CT charge will not materialise in these specific circumstances if another relief is available. SD and SDLT will not be charged because of separate reliefs that interact helpfully in these circumstances. By using a ‘capital reduction’ approach, there is no taxable distribution and so there is also no 38.1% income tax charge.
Some of the reliefs can be denied by HMRC where the transactions do not have sufficient commercial justification. Clearance can be obtained from HMRC by which they will confirm that they will not seek to apply these powers based on the facts presented.
In this instance, it was possible to demerge the land interests with no immediate tax charge at all. That left the clients with two separate entities, each with a holding company. It would be possible to collapse each structure and remove the holding company, but the clients have chosen not to do so as the holding companies present some other potential opportunities.
The clients are now in a position to operate the businesses independently. If there is a future opportunity for sale of either the trade or the development land, a sale can take place in either case in a highly tax-efficient manner. For example, the shareholders could sell the trade by selling shares in HoldCo, thereby receiving the proceeds personally at CGT rates. Alternatively, HoldCo could sell the trading company tax free (with the benefit of Substantial Shareholdings Exemption), which will be ideal if the sale proceeds were to be re-invested.
The same is true of the development land but, surprisingly, it will also be possible for SubCo to sell that land tax-free since the base cost of the land has been ‘up-lifted’ for CGT purposes. If SubCo is sold, the buyers still have the benefit of the base cost up-lift. This places the shareholders in a very strong negotiating position for any future sale.
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