Private company demergers - what, why and how

What is a Demerger?

A demerger is a corporate restructuring technique where a parent company splits into two or more separate companies. This can be done in various ways, each with its own legal and tax implications.

The process is complex, with legal, tax and commercial considerations. Planning is vital. Our experienced team can guide you through the entire demerger process, from initial planning to post-demerger compliance.

Why would you split your businesses?

• Business restructuring - consolidating operations and simplifying the corporate structure.

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

• Strategic focus - allows your businesses to focus on core competencies and improve operational efficiency.

• Unlocking value - can unlock the value of individual business units that may be undervalued as part of a larger group.

• 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.

• Simplifying structure - reduces complexity and administrative costs.

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

The 2 types of demerger

There are 2 main types of demerger for private limited companies, which are :-

• 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 two 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 the distribution of shares in a subsidiary company to shareholders. Often used for simpler demergers where the parent company retains a significant interest in the demerged company.

Commercial and tax Issues

• Valuation - accurately valuing the assets and liabilities of the demerged companies is crucial.

• Financing - ensuring adequate funding for both demerged companies is essential.

• Employee considerations - transferring employees to the demerged companies may require consultation and compliance with employment law.

• Third-party contracts - existing contracts may need to be amended or novated to reflect the demerger.

• Tax implications - understanding the tax consequences of the demerger, including stamp duty land tax, capital gains tax, and corporation tax, is vital.

Steps involved in the demerger process

• Demerger scheme document - outlines the proposed demerger of a company, including detailed information to shareholders about the terms and conditions of the demerger, financial statements and tax implications for the parent company and the demerged business, valuation reports and projections of the financial performance of the demerged company.

• Due diligence - conduct a thorough review of the assets and liabilities of the demerged companies.

• Valuation - determine the fair market value of the assets and liabilities.

• Preparation of agreement for shareholders - drafting the necessary documents for the chosen demerger method. Key considerations in agreements between shareholders, typically a share for share exchange agreement, 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, any financial adjustments, such as cash payments or debt transfers, required to ensure a fair distribution of value and the governance structure of the new company.

• Board approval - the board of directors of the parent company must approve the demerger.

• Shareholder approval - obtain shareholder approval for the demerger, typically through a special resolution.

• Court Sanction (for Statutory Demergers) - seek court approval for the demerger.

• Filing with Companies House - file the necessary documentation with Companies House to register the demerged companies.

• Transfer of assets and liabilities - transfer legal title to assets and liabilities to the demerged companies.

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

• Third-party contractual modifications - amend or novate existing contracts to reflect the demerger.

Is HMRC clearance needed or advisable?

HMRC clearance is not strictly compulsory for a demerger. However, it is highly advisable to seek clearance from HMRC regarding the possible liability for Stamp Duty land Tax (SDLT) before proceeding with the demerger.  

Obtaining HMRC clearance provides certainty to minimise tax liabilities, optimise the demerger structure and reduce the risk of future disputes with HMRC, which can be costly and time-consuming.

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.

How we can help

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.