Structuring your business to make the most of the tax reliefs available
Trading businesses attract valuable tax reliefs such as Entrepreneurs’ Relief on sale and Business Property Relief on death. Investment activities within a business can put these tax reliefs in jeopardy and it is often desirable to remove investment activities from the trading business. This separation can be structured as a demerger.
Demergers can also be advantageous to allow shareholders to separate a business with certain shareholders gaining sole control of some parts of a business and other shareholders gaining sole control of other parts. Each can take their part forward as they see fit.
If shareholders do wish to obtain sole interest in part of a larger business there are certain demerger processes which are enshrined in legislation to make the separation tax efficient. However, they do not work if the business has investment income or there is a share sale on the horizon. In these cases the demerger requires the liquidation of a company and transfer of its assets to new companies. Commercially it is often felt disadvantageous to liquidate an active business and therefore a newly incorporated company would often be inserted above the active company and it is that newly incorporated parent which is liquidated. The use of a Newco prevents the practical difficulties of liquidating an active company and the negative perception associated with active companies being put into liquidation.
One of the disadvantages of an insolvency demerger is the Stamp Duty Land Tax costs associated with the transfer of property. With SDLT rates rising this is becoming more of a drawback to the insolvency based demerger.
The Companies Act 2006 made the process for private companies wishing to reduce their share capital much more straightforward. This has led to an increase in the popularity of a capital reduction demerger.
A liquidation demerger requires the liquidation of a company and its assets (typically shares in subsidiaries and property) to be transferred to new companies with stamp duty/stamp duty land tax charges payable. A capital reduction demerger also involves insertion of a new company above the existing active business. That company then has its capital reduced and only some of its assets are transferred to a new business. The other assets remain within the existing group with each business under different ownership. This process can reduce the stamp duty/stamp duty land tax charges which would be payable on an insolvency as fewer assets are leaving the group. It can save considerable SDLT as assets subject to the tax would normally be retained in the existing group and it is assets subject to (the lower rates of) stamp duty which are transferred to the new ownership at the time of the capital reduction.
In order to be tax efficient the transaction should be for commercial purposes and certainly not part of a scheme of tax avoidance. It is in order to ensure that HMRC feel that the matter is commercial that tax clearance should be obtained before implementing the demerger.
In conclusion, the differential of rates between trading business and non-trading businesses has led to an increase in demerger activity. This is not the only reason for a demerger with separation of shareholder ties another common reason. Demergers can be free of direct taxes when appropriate clearances are obtained. Stamp duty and stamp duty land tax is often payable on demergers. By application of a capital reduction demerger fewer assets are transferred out of the existing business and therefore lower stamp duty/stamp duty land tax is payable. By careful consideration of the assets being transferred it is possible to dramatically reduce these costs by transferring assets subject to stamp duty out of the group and retaining properties (which would otherwise attract the higher rates of stamp duty land tax) within the current structure.