Capital reduction demerger overview

What is a Capital Reduction Demerger?

A capital reduction demerger involves a company (the "parent company") reducing its share capital and transferring assets to a new company (the "newco"). Shareholders of the parent company receive shares in newco proportionate to their existing shareholdings, effectively creating two separate corporate entities with the same ultimate ownership structure.

The key distinguishing feature of this demerger method is that it utilises the capital reduction procedure under the Companies Act 2006 to create distributable reserves, enabling the parent company to distribute assets or shares to its shareholders without needing to satisfy the distributable profits test.

Compared to other demerger methods (such as statutory demergers under s.110 Insolvency Act 1986 or dividend demergers), benefits of capital reduction demergers include :-

• No requirement for distributable profits

• No liquidation process required

• No court approval needed (unlike reduction of capital for public companies)

• Typically simpler than statutory demergers

A typical capital reduction demerger takes 2-3 months from planning to completion.

When to use a capital reduction demerger

Capital reduction demergers are particularly suitable in the following scenarios :-

• Insufficient distributable reserves - when a company lacks sufficient distributable profits to effect a direct dividend demerger

• Business division - when separating distinct business operations or asset classes into separate corporate structures

• Family succession planning - facilitating the division of a family business between family members

• Pre-sale restructuring - preparing part of a business for sale while retaining other operations

• Risk separation - isolating higher-risk activities from more stable business operations

• Management focus - enabling dedicated management teams to focus on specific business areas

• Investment attraction - creating standalone entities that may be more attractive to specific investors

Capital reduction demerger legal process and key steps

• Preliminary Planning and Documentation - due diligence on assets and liabilities to be demerged, prepare board papers outlining commercial rationale and process, draft shareholders' agreement and articles of association for newco.

• Incorporation of Newco

• Capital Reduction Process - including Special Resolution approving the capital reduction, amending articles of association if necessary to permit the capital reduction, directors solvency statement

• Filings at Companies House - file special resolution and solvency statement with Companies House within 15 days and submit Form SH19 detailing the capital reduction. Capital reduction takes effect when registered by Companies House.

• Asset Transfer and Share Distribution - execute asset transfer agreements between parent company and newco, transfer identified assets, contracts, and liabilities to newco, distribute shares in newco to parent company shareholders in the agreed proportions and update share registers and issue new share certificates.

• Post-Demerger Steps - notify all relevant third parties (clients, suppliers, regulators), transfer employees (if applicable) under TUPE regulations, update operating licences, intellectual property registrations, and insurance policies and implement any necessary changes to banking arrangements.

Tax Considerations (Overview)

While comprehensive tax advice should be obtained from tax specialists, key tax considerations include:

• Stamp Duty - potential stamp duty on transfer of assets, particularly real property

• Capital Gains Tax - ensuring the transaction qualifies for tax neutrality under relevant provisions

• VAT - implications for the transfer of assets as a going concern

• Corporation Tax - potential degrouping charges and loss of group relief

• Income Tax - potential income tax liabilities for shareholders on distributions

• HMRC clearance - advisability of obtaining advance clearance from HMRC