DFK UK & Ireland

Company Separation: Is it an expensive exercise?

It is often the case when shareholders wish to sell their company that either they wish to keep some of the company’s assets or the purchaser does not wish to buy all of the assets that the company owns. The question then arises of how these assets can be separated from the company without incurring substantial tax liabilities.

Problem
Generally, on a sale, the shareholders will wish to sell shares to prevent a double tax charge arising and the purchaser would like to buy assets because they do not carry the company’s history with them and greater tax allowances are likely to be available in the future, particularly on purchasing goodwill. If it were not for the “double charge”, being the capital gain arising in the company on the sale of assets and/or the business plus the charge for extracting the net cash by way of liquidation or dividend, the separation of assets would be easier.

Demerger Provisions
The tax legislation contains provisions for “demergers”, which at first sight appear to cover exactly this situation. However, on closer examination it is very difficult to get within the conditions laid down, in particular that this route cannot be used when a sale is anticipated.

Alternative Option
There is, however, an alternative to the statutory demerger legislation and that is carrying out a “reconstruction through liquidation”. What this involves, in essence, is reorganising a company or group of companies so that the same shareholders own the same assets in the same proportions through different corporate vehicles with no assets or cash coming out of a company to the shareholders personally. As soon as any value is extracted from a company to a shareholder, tax is likely to become payable.

Example
This is best understood through an example. What happens if, say, a group of companies owned by a non-trading holding company (A) is being sold, but the purchaser does not want to buy one of the subsidiaries? Instead of the shareholders being given shares in the unwanted subsidiary as a dividend and thus paying tax, a reconstruction takes place. The reconstruction route involves putting A into liquidation with the liquidator agreeing with the shareholders that he will distribute, in the course of the liquidation, the shares in the subsidiaries to be sold to a new holding company (B) in return for an issue of shares in B to the shareholders. He also agrees with the shareholders that the shares of the subsidiary to be retained will be distributed to another holding company (C) in exchange for an issue of shares in C to the shareholders. The shareholders have effectively exchanged their shares in A for shares in both B and C. The shares in B can then be sold to the purchaser and the shareholders retain the shares in C.

Tax Clearances
Whilst that seems relatively straightforward, it is necessary to obtain clearances from HM Revenue and Customs to the effect that they accept that the transaction is being carried out for bona fide commercial reasons. It is also necessary to obtain a stamp duty exemption for the transfer of the shares to the new holding companies. As well as the clearances, there is a very substantial volume of company secretarial documentation to be dealt with and every step must take place in the correct sequence if the tax exemptions are to apply.

What is the result?
Having gone through this process, what tax is payable? If the series of transactions has been correctly planned and executed there should be no tax charge arising to the company disposing of a subsidiary, no charge on the individual shareholders until they sell their shares and no stamp duty on the movement of the shares. The individual shareholders are deemed to have received shares that equate to the original holding.

Whilst this is a simple example, it is possible to use the same principles in more complicated cases such as where the holding company has a trade of its own, to separate assets (for example removing a company’s freehold property before a sale), to retain complete trading divisions where a company has more than one trade or to retain sub-subsidiaries on a sale. However, the more complicated the transaction, the more care has to be exercised to ensure unwanted tax liabilities arise do not arise. In particular de-grouping charges can occur where a company leaves a group within six years of having had an asset transferred to it from another group company resulting in a capital gain arising in the exiting company.

Reconstructions represent a highly complex area of tax and expert professional advice should always be taken before entering into any transactions. For further information please contact::

Graham Goodbody
Director
Tax Consultancy Services
Tel 020 7509 9485
Email: ggoodbody@cvdfk.com

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