What is a split
So, what is a split?
Spin-off is a somewhat catch-all term for any situation in which a company or group of companies splits into two or more parts.
This could be due to several reasons…
Part may need to be sold and part kept
Shareholders may have agreed to part ways
It is simply necessary to keep certain groups of assets entirely separate from each other.
Whatever the reasons, there are a number of different options, some of which are simpler than others. All may be fully or largely tax-free, but all are also surrounded by a series of conditions that must be met in order to avoid unexpected liability.
Case study
Janet and John are shareholders in a holding company (J&J Holdings) which has two trading subsidiaries – Ladybird Ltd and Penguin Ltd. The group has been in place for many years and both companies are operating successfully. However, as some clients became concerned about collective ownership of the two companies, Janet and John decided that, from a business perspective, it made more sense for them to hold more direct ownership of Ladybird Ltd and remove it of the holding company.
Direct statutory split
This is the simplest demerger situation – known as a “direct statutory demerger”. If the conditions are met, J&J Holdings can simply “distribute” the shares of Ladybird Ltd to Janet and John tax-free, so that they now directly own the shares of J&J Holdings which owns Penguin Ltd, and at the same time , they own the shares of Ladybird Ltd directly. Specific rules mean there are no capital gains or income tax issues for Janet & John.
The key criteria here are (1) that the demerger cannot take place in anticipation of a sale, (2) the demerger must take place for the benefit of one or more of the businesses (3) the company being distributed must be a corporation commercial. and (4) the company making the distribution must be either a trading company or the holding company of a trading group.
As the distribution is direct to Janet and John, this will be a disposal of the shares in Ladybird Ltd for corporation tax purposes. Normally this would be at market value, but as the group has been in existence for some time the substantial shareholding exemption should make the gain tax free…
Stamp duty can be an issue on demergers (see below), but in this case the shares are transferred by way of a “cash distribution” without any consideration, so stamp duty should not be a problem.
From a company law perspective, the amount of the distribution can be set at the book value of the Ladybird Ltd shares. So, provided J&J Holdings has the distributable reserves to cover this book value, there should be no accounting or corporate law issues. point of view.
Indirect statutory split
Let’s make a slight change to the situation. Rather, the Penguin and Ladybird trades are operated within the same company, which is directly owned by Janet and John. Surely the simplest option would be to transfer the Ladybird business into a new subsidiary of the current company and then do a direct demerger as outlined above?
On the face of it, yes, but the existing company is still in the process of disposing of its shares in the new Ladybird Ltd and this will be a sale at market value for corporation tax purposes. Given that no group has previously existed and the new Ladybird company will not have been held for more than 12 months, the substantial shareholding exemption will not apply and the market capital gain will therefore be taxable in the company existing.
This is where an indirect split comes into play. Instead of distributing the new Ladybird Ltd directly to Janet and John, they formed a new holding company which they acquired in the same proportion as the existing company – let’s call it J&J Holdings 2024 Ltd. The existing company then distributes the shares of Ladybird Ltd, but not to Janet in John. Instead, they arrange for the distribution to be made to J&J Holdings 2024 Ltd in exchange for that company issuing new shares.
This may seem like an odd way to go, but it allows us to access the tax-exempt provisions of corporate reorganization, meaning we don’t need to rely on the substantial holdings exemption to make the tax-exempt sale of Ladybird Ltd.
The rest of the analysis is quite similar, except that some consideration has been given to the distribution of Ladybird Ltd (the new shares issued). We must therefore rely on the stamp duty reorganization provisions to ensure that no stamp duty exists on the transaction.
Statutory partitions
If Janet and John have decided to split up and one wants Penguin while the other wants Ladybird, either of the above options can still work for them – this is called a partition split. This situation hardly changes, except that in the event of an indirect legal split, it is likely that stamp duty will be imposed because there is no exact mirror in the shareholdings before and after the transaction.
Non-statutory splits
As can be inferred from the above, there will be many occasions where a legal split will not be appropriate. This may be because one of the demerged companies is not engaged in trading activities, or perhaps because the transaction is being undertaken in anticipation of the sale of one of the companies. In either case, the conditions for a tax-free demerger will not be met and significant tax liabilities could therefore arise.
In the past, the only practical route available was a liquidation demerger, as discussed briefly below. However, developments in company law around capital reductions mean that a demerger by capital reduction now constitutes a viable alternative in many situations.
Liquidation-split
A liquidation split does pretty much what it says on the tin. The company (or more often a new holding company) went into liquidation and the liquidator distributed the subsidiaries to new holding companies owned by the shareholders. In exchange, the new holding companies will issue new shares to shareholders.
As mentioned above at one point, this was really the only viable alternative when a tax-exempt legal split was not available. However, this is not without complications. There may be SDLT issues, there is the cost of liquidators to consider and emotionally some business owners still associate the term liquidation with insolvency (even though it is not actually the case).
There may still be a preference for liquidation splits, but they are increasingly rare. The tax world may not be known for being a devoted follower of the fad, but one newcomer has been grabbing all the attention in recent years: the capital reduction split.
Capital reductions, splits
In the distant and obscure past, the process by which a company could reduce its capital was lengthy and expensive and should not be approached lightly. More recently, corporate law reforms have made the procedure much simpler, at least for private companies.
The process is rather complex and the precise steps will depend on the objective of the restructuring. However, at its most basic level, the transaction involves the holding company of a group entering into a reduction of its share capital, but instead of paying money to shareholders, it transfers the assets to be split to a new company held by all or part of the shareholders. shareholders. One of the key requirements from an accounting perspective is that the holding company must have sufficient share capital to cover the market (not book) value of the distribution – if this capital does not currently exist, it can be created but restructuring can’t happen without that.
From a tax perspective, a number of provisions interact to allow the restructuring to proceed without any capital gains tax, income tax or corporation tax consequences. To be effective, each must meet a number of conditions, but with careful planning, all of this is achievable. The overarching requirement from a tax perspective is that there must be a good business reason for the transaction and we always recommend asking HMRC to confirm this in advance.
There may still be stamp duty complications when shareholders separate and/or properties are divided. So it may not be a completely free process, but compared to the tax costs of not using the approach to achieve a division, it makes the structure very economical. If structured correctly, HMRC tends to be comfortable with this approach, even in anticipation of a sale in the short term.
Are splits by capital reduction complex?
Yes, they are relatively so, but with careful planning and appropriate tax, legal and accounting advice they are eminently achievable and generally represent the most effective approach to breaking up a group where the restrictive conditions for statutory demergers are not met. .
Next steps
A top tip though: the process can take at least three months from start to finish, so early planning is essential to avoid disappointment! Now that you know, contact us today!
