Company demerger–what to consider before splitting up your business

A demerger is a legally regulated division of a limited company in which assets, rights and liabilities are allocated between the original company and one or more other companies. Demergers are typically used to focus on specific business areas, prepare for a sale or reduce risk – but the process is strictly regulated, and mistakes can be costly. In this article, we’ll go through what a demerger involves, the requirements for the process, and how to ensure your demerger is tax-free.

What is a company demerger?

A demerger is the division of a limited company whereby assets, rights and liabilities are allocated between the original company and one or more other companies. Under Chapter 14 of the Companies Act, a demerger is subject to specific rules when the company’s assets, rights and liabilities are to be allocated between the company itself and one or more acquiring companies, in return for which the shareholders of the transferring company receive consideration in the form of shares in the acquiring company or companies. You can either transfer part of the business to a new or existing company, or split the entire company into several entities. A demerger is often used when a company has several business areas with varying levels of risk, or when the owners wish to go their separate ways.

Why should you consider a demerger?

You should consider a demerger when the business has grown in different directions and you want clearer lines of responsibility. By spinning off property, a high-risk line of business or a business area into a separate company, you isolate the risk and make it easier to sell, further develop or wind-up parts of the business separately. A demerger is also relevant in the event of a disagreement between owners, where a split allows each owner to continue with their part of the business without having to sell or start afresh. It can also be useful during a generational handover when the next generation wishes to take over different parts of a business or different assets, whilst avoiding the triggering of exit taxation.

How is a demerger carried out step by step?

The process follows a set pattern for which you’ll need to set aside time:

Allow plenty of time for each stage – a demerger normally takes several months from planning to completion. However, it is usually the preliminary process that takes the longest: deciding whether to carry out a demerger and, if so, how the company should be split up. It may be advisable to consult lawyers with experience of demerger processes early on in the assessment.

What should the demerger plan contain?

The demerger plan is the very heart of the process, and it must be precise. Among other things, it must describe which assets, rights and liabilities are to be transferred to each company, how the shares in the transferring company are to be exchanged for shares in the new or acquiring companies, and what articles of association the new company is to have. An incomplete or imprecise allocation in the plan is one of the most common sources of error – ambiguities can lead to disputes between the new companies afterwards. Ambiguities can also result in errors being made in the practical follow-up after the demerger, meaning that, in reality, unplanned transfers of assets take place. Such errors may give rise to a tax liability.

Is a demerger always tax-free?

No, but most ordinary demergers can be carried out tax-free provided the conditions are met. A limited company may be demerged without the company or its shareholders being taxed if the demerger is carried out in accordance with Chapter 14 of the Companies Act, tax legislation and accounting legislation. For example, the tax exemption does not apply to demergers within a group where the consideration consists of shares in another subsidiary. Furthermore, it is important to assess the company’s true values so that the allocation ratio is calculated correctly. In addition, the tax exemption requires full tax continuity to be maintained. The acquiring company must carry forward the tax values and dates of acquisition for the assets, rights and liabilities being transferred, and the transferring company’s other tax positions must be taken over unchanged. If you breach the requirements for proportional allocation and continuity, you risk the demerger effectively becoming a taxable realization.

What happens to creditors in the event of a demerger?

Creditors must be notified and are entitled to lodge objections within a creditor period. If a creditor does not receive payment or adequate security, their objection may halt or delay the demerger. You should therefore thoroughly review the company’s liabilities in advance to avoid any surprises during the creditors’ objection period. If the company has loans with covenants or other agreements requiring consent for changes to the corporate structure, you must also clarify this with the lender or contracting party before the demerger is initiated.

What practical pitfalls should you avoid when carrying out a demerger?

The most common mistakes in a demerger are:

• Unclear allocation of assets and liabilities between the companies in the demerger plan

• Failure to clarify consent requirements with the bank or other contracting parties

• Incorrect valuation leading to unfavorable tax consequences

• Delayed commencement, meaning that processing times at the Register of Business Enterprises and the six-week deadline delay the timetable for an impending sale

Clarifying these points at an early stage will save you a great deal of time and worry later in the process.

Also read: Why and how to conduct a valuation of your company

How do you ensure the demerger is carried out safely?

You ensure a smooth implementation by planning the demerger well in advance, identifying all agreements and obligations before the demerger plan is drawn up, and ensuring that the continuity requirements under the Tax Act are fully met. Involve your accountant and solicitor at an early stage, so that the demerger plan is legally and fiscally sound before it is submitted to the general meeting.
An accountant or solicitor can assist in drawing up all necessary documents, whilst limiting the documentation to what is strictly required, as there are a number of exemptions that can be utilized if one has experience in this area.

See also: How are transaction costs treated for tax purposes?

How to get started with a secure demerger?

A demerger can give you a clearer corporate structure, reduced risk and better prospects for further growth or a sale – but only if the process is carried out correctly from the outset. With thorough planning of the demerger plan, good dialogue with creditors and correct handling of tax rules, you can avoid the most common pitfalls.

Are you considering demerging parts of your company? Get in touch with our commercial lawyers today, and we’ll help you draw up a secure plan for the process.