How to Navigate a Demerger: A Complete Guide for UK Businesses

The most common reason for a demerger is to increase shareholder value, particularly when there is excess cash in the business and shareholder funds.

Often, a successful business can be undervalued by its association with a struggling part of the business.

Therefore, a company may perform better as two separate legal entities than one, and the aggregate value of the shares of the two separate companies can often be more valuable than the value of the original single company’s shares. 

However, the decision to demerge a company can be influenced by a variety of different reasons, including:

1. Dividing a company or group between shareholders in dispute or who have agreed to go their separate ways;
2. Separating businesses between different business sectors to focus on specific markets;
3. Freeing one business from the regulatory or financial requirements imposed by another business;
4. As an alternative to a sale, i.e. where the company or its shareholders are struggling to sell the business/part of it;
5. Dividing a jointly owned group; 
6. To facilitate the sale of part of a business to a third party;
7. Ringfencing liabilities;
8. Separating business assets to either ringfence or make them attractive to a potential buyer, i.e. separating substantial property assets from a trading business; and
9. Extracting a subsidiary business from a group so that individual shareholders can benefit from tax reliefs (such as Business Asset Taper Relief).

There are different methods of affecting a demerger in the UK, each with its own advantages and disadvantages.

The method chosen is often influenced by tax considerations, the value of the company being demerged and the availability of distributable profits in the company.

Direct dividend

This is the most straightforward type of demerger. The process involves the parent company declaring a dividend in specie (i.e. a distribution of assets rather than cash) of the shares of the subsidiary to be demerged to its shareholders. This transfers ownership from the parent company to its shareholders.

However, in order to effect this kind of demerger, the parent must have distributable reserves at least equal to the book value of the assets being demerged.

In addition, it is not often a tax efficient structure as there will likely be tax consequences for the recipients of the distribution in specie.

Indirect dividend or three-cornered dividend

This type of demerger involves the parent company declaring a dividend in specie of the shares of the subsidiary (or of the assets of a business) to be demerged to a new company set up (or existing third-party company). The newco then subsequently issues shares to the parent company’s shareholders.

An indirect dividend can qualify as a scheme of reconstruction and can offer substantial tax relief advantages over a direct dividend structure if structured correctly.

If a demerger is not planned carefully unintended tax consequences may result from the transaction including stamp duty, capital gains tax payable by the original distributing company and shareholder chargeable gains and income charges payable by the shareholders on the distribution receive.

Careful tax planning is therefore vital to save substantial costs.

You will need to consider possible stamp duty implications, particularly for share transfers and property transfers.

It is essential that prior tax advice is obtained before embarking on a demerger to ensure that the demerger is structured appropriately from a tax perspective and to obtain any available tax clearance.

There may also be ongoing tax implications post-demerger which will need to be considered when considering the structure.