Fairly regularly we come across situations where a company reconstruction is required in order to split apart different activities. For example to separate the ownership of investment assets from a trade to protect them from commercial risks. Another example would be to facilitate the sale of part of the company’s business or trade.
This can usually be done with the benefit of various tax exemptions. This is subject to HMRC being satisfied that the transactions are not part of a tax avoidance arrangement. HMRC will give their view on this point in response to a formal application for clearance.
Capital reduction demergers
When a reconstruction is needed we will usually seek to use the direct demerger route first. The limitations of this option, however, are well known. Essentially that there needs to be one trade being split from another and not in contemplation of a sale of either part.
Where there is a sale in mind or where the business does not amount to a trading activity we have had to look elsewhere. Historically this has meant a “section 110” reconstruction involving a solvent liquidation of a company and an agreement with the liquidator to distribute the different assets to new companies.
For a while now we’ve been able to effect various types of reconstruction, using the rules in Companies Act 2006 to reduce share capital. This has taken over as the preferred option when compared to s110 because it offers the following advantages
- There is no need to involve a liquidator. This means there is no record at Companies House of the director being involved in the liquidation of a company, albeit a solvent one. It also means that the professional fees can be significantly less.
- In many cases, there is scope to achieve a tax-free uplift in the base cost of tangible fixed assets.
- Lower levels of stamp duty in most cases.
Leonard is the 100% owner of Cohen Ltd, a company with a trade of selling musical works. There is also a smaller trade of selling poetry books. Over recent years he has been approached by various companies wishing to buy the music trade. After reviewing his pension arrangements, Leonard decides that he will succumb to their advances. However, he wants to retain the poetry trade and it is decided that the tax cost of selling the entire Cohen Ltd company intact and then buying back the poetry trade would be significantly higher than if the two trades can be separated in a company reconstruction that would allow just the music trade to be sold.
This would probably proceed as a capital reduction demerger which would produce an endpoint as follows.
Subject to HMRC approval this would proceed largely tax-free1. The company reconstruction would allow Leonard to sell the music trade which is now in a “clean” company.
Mary and Paul are each 50% shareholders in GBB Ltd, a company that gives cooking lessons to the public. It also owns a number of very valuable marquees that it uses in its own trade. It also hires out to other customers. They have now decided to split with Mary retaining the cooking business and Paul taking the marquee hire business.
This partition could potentially proceed as a direct demerger, unless, Paul decides that he might sell out to a commercial rival. Even if this were not the case it would be useful to compare the direct demerger route with the capital reduction alternative.
The first stage would be to evaluate all available options and set out the pros and cons of each. Once this is done we would apply to HMRC for clearance that they agree that the company reconstruction is being done for bona fide commercial purposes. Finally, we would instruct solicitors to draft the necessary documentation and review this to ensure that it is suitable.
1 There would only be stamp duty to pay, this at the rate of 0.5% on the value of the Newco 2 shares transferred to Newco 3.
Please do not hesitate to contact me or the Albert Goodman tax team for more information on company reconstruction.