Demergers - what, why and how

What is a demerger?

A demerger is a flexible corporate restructuring process in which a company separates one or more of its business operations into a new, independent entity. For private companies in the UK, a demerger can be an effective way to streamline operations, ring-fence risks, or facilitate succession planning or exit strategies.

There are several legal and tax-structured methods to implement a demerger, including statutory demergers, capital reduction demergers, and liquidation demergers. Each route carries different legal, tax, and regulatory implications, and the choice will depend on the specific goals and structure of the business.

Our experienced commercial lawyers can guide you through the legal and commercial aspects of a demerger process, from initial planning to post-demerger compliance.

Reasons for demergers

Common reasons for considering demerging include :-

• Capital release and increasing shareholder value - unlocking value by separating non-core assets and returning capital to shareholders.

• Facilitating investment - attract investment for specific separated parts of your business.

• To allow sale of part of the business.

• Shareholder protection - enhancing shareholder value by capital reduction and mitigating risks by isolating liabilities or focusing on core competencies.

• Tax efficiency - can offer tax advantages, such as capital gains tax relief or stamp duty land tax savings.

• Inheritance structuring for family-owned businesses – different parts of a business can be spun off to different members of a family owned business.

Types of company demerger

There are a number of typical procedures that are used by lawyers and accountants based on the Companies Act 2006 in order to achieve a demerger and restructuring. These include the following for private limited companies:-

• Statutory demerger – this is a process governed by the Companies Act 2006, which Involves transferring assets and liabilities to a newly formed company and requires shareholder approval and court sanction. Suitable for separating trading activities into 2 or more independent companies, with potential CGT advantages and more often used with large-scale, complex demergers.

• Capital reduction demerger - a less formal process involving unlocking value for shareholders. Commonly used for private companies because with a statutory demerger, the parent company needs to have distributable reserves equivalent or greater than the market value of the demerged assets. The main benefit of a capital reduction demerger is tax efficiency - it allows shareholders to receive shares in the new demerged company without triggering an immediate tax liability, as it's treated as a return of capital rather than a dividend distribution. This structure is particularly useful when a company wants to separate its businesses while preserving value for shareholders in a tax-effective way.

• Restructuring based demergers - which may be a voluntary liquidation scheme or scheme of arrangement with members or creditors.

• Three cornered demerger – involves the parent company declaring a dividend in specie of the business, or shares in its subsidiary, to a newco, and newco will issues shares to the shareholders of the parent.

In addition, a number of other tools and techniques may be used in the demerger and restructuring process including share for share exchange, the issue of new shares, and new classes of shares.

Legal process and work needed

• Strategic planning - consider the most suitable structure and assess the legal, tax, and financial implications and develop a detailed implementation plan. Determine the fair market value of the assets and liabilities.

• HMRC clearance application - seek clearance from HMRC to ensure that the demerger will not trigger unwanted tax consequences. Prepare a comprehensive application, addressing all relevant tax issues and respond to any HMRC queries or requests for additional information.

• Board and shareholder approval - the board of directors of the parent company must approve the demerger and obtain shareholder approval for the demerger, typically through a special resolution.

• Establish new corporate entity - set up a new holding company and any necessary subsidiaries.

• Share for share exchange agreement - key considerations will include how shares in the new company will be allocated among the shareholders of the parent company, the methodology for valuing the assets and liabilities to be transferred to the new company, tax implications, financial adjustments, tax covenants or tax indemnity.

• Asset Transfer - transfer assets and liabilities to the new entity, obtain necessary third-party consents, such as from landlords, lenders, and suppliers. Update relevant records, including property registers, bank accounts, and insurance policies.

• Stamp Duty Land Tax (SDLT) - assess SDLT implications, particularly for share transfers and property transfers. File the necessary SDLT returns and pay any applicable taxes.

• Employee transfers - transfer employees to the demerged companies, complying with employment law.

Is HMRC clearance needed or advisable?

HMRC clearance is not strictly compulsory for a demerger but we strongly recommend that it is obtained. In this way you can get clearance for the demerger, restructuring, and the tax implications.

If you proceed with a demerger without seeking HMRC clearance, HMRC may challenge the tax treatment of the demerger, leading to unexpected tax bills, penalties and Interest.

Solicitors for demergers

We work closely with clients to develop tailored demerger strategies that align with their business objectives. We draft and review all necessary legal documents, including agreements, transfer documents and board resolutions, employment law and regulatory issues and post-demerger obligations.