Demerger & HMRC Clearance applications

Splitting a Company

TA demerger typically involves the splitting of a company’s business into two or more parts.

There are many reasons why a company demerger may be desirable. Some of these examples include:

• The shareholders of the business may wish to part ways and run their ‘parts’ of the business via separate entities.

• The shareholders wish to incentivise employees of different service lines and
  for commercial purposes, view it is as more beneficial to do this under separate entities.
• The business is serving separate market segments. The directors believe that these would serve best under different management and via separate entities.

There are typically three routes to achieving a demerger:

• Statutory
• Reduction of share capital
• Liquidation

Recommendations are that you obtain HMRC clearance prior to implementing a demerger. Typically, this is why it is you request HMRC’s approval of the bona fide commercial purpose test in relation to the transaction.

Statutory demergers provide a relatively simple method of separating a company’s activities. They allow shareholders the flexibility to split their trading activities and assets without generally crystalling tax liabilities. Statutory demerges have strict conditions associated with them, which can make them unattractive or indeed unfeasible in certain circumstances.

For example, one of the conditions associated with statutory demergers is that there must not be a ‘chargeable payment’ for five years following the demerger. These rules state that the demerger must not form part of an arrangement. One of the main purpose of this is the making of a chargeable payment.

The definition of chargeable payment is broad. You catch scenarios where there is a sale of the demerged business post demerger. So, the main reasons for undertaking this action is to dispose of the business post demerger.

Therefore, in scenarios where there is an impending sale of the business soon after the demerger, statutory demergers would not be a feasible option.

Clearance request

We recently came across a scenario whereby a client in the pharmaceutical industry had requested clearance from HMRC under the statutory demerger provisions. There was an intention to sell one of the pharmacies post demerger. One of the reasons for undertaking the demerger was to be able to sell the pharmacy separately. So this course of action for the pharmacies into separate companies was considered an appropriate commercial route. Unsurprisingly, the clearance was refused by HMC under the chargeable payments rule set out above.

We carried out detailed analysis, redrafted and submitted a new clearance application to HMRC under a different set of provisions (in this case the reduction of share capital demerger rules) which HMRC accepted. We had to ensure that the mechanics of the transaction was amended in order to meet the detailed criteria of the demerger provisions, which did not prove to be too onerous for the client from a commercial viewpoint.

Demergers are a complex area of tax law and it is important that you seek specialist tax advice, both from tax and legal viewpoints. Our specialist corporate tax team has many years of Big Four and Top 10 experience of advising on all aspects of demergers. Get in touch today.