As companies grow, they often accumulate surplus funds, which may be invested in non-core assets, such as buy-to-let properties. For example, a publishing company might invest in a property for rental income or long-term capital growth. While such investments can appear prudent, they may introduce challenges, particularly concerning tax reliefs. These include restrictions on Business Asset Disposal Relief and Gift Relief for Capital Gains Tax Purposes, and Business Property Relief for Inheritance Tax purposes.
In such cases businesses often opt to either sell the property or transfer it to a newly formed company. Such actions can trigger a corporation tax liability (at a rate of 25%) on any gain however.
There are fortunately strategies to extract property from a company in a tax-efficient manner. One effective method is a Capital Reduction Demerger, which separates parts of a business such as trade or investments into independent entities, while leveraging specific tax reliefs to minimize immediate tax liabilities.
How Does It Work?
A capital reduction demerger involves several key steps:
Declaration of Solvency
Directors must make a declaration of solvency confirming that the company can satisfy its liabilities as they fall due over the next 12 months.
Creating a Holding Company
A holding company is established above the existing company via a share-for-share exchange whereby shareholders exchange their current shares for new shares in the holding company. The share capital of the holding company then reflects the market value of the original company.
Classifying Shares
The share capital of the holding company is divided into separate classes, such as A Ordinary Shares and B Ordinary Shares, with each class linked to a specific asset (e.g. Class B shares linked to the property).
Transferring the Asset
The holding company declares a dividend in specie, transferring the property to a newly created company. The corresponding shares (e.g., Class B shares) are then cancelled.
Independent Entities
The original shareholders now hold shares in two companies:
The holding company (retaining the trading business)
The new company (owning the demerged property)
Both entities can operate independently with separate management and shareholder structures.
Tax Implications and Reliefs
For Shareholders
As long as the distribution does not exceed the reduction in share capital, and the demerger is classified as a capital distribution (rather than income), no Income Tax charge arises for shareholders.
There is no disposal for CGT purposes as shareholders are treated as continuing to hold their shares.
For Companies
Reconstruction Relief may apply thereby preventing an immediate tax charge for both the holding and new company.
Stamp Duty Relief may be available provided the demerged companies remain under common ownership.
Common Applications
Separating Trading and Investment Activities: ideal for enhancing tax efficiency by isolating non-trading assets.
Facilitating Shareholder Objectives: enables businesses to divide assets between shareholders with differing goals.
Preparing for Sale or Restructuring: helps isolate specific business components in preparation for a sale or reorganisation.
Challenges and Considerations
HMRC Clearance
Obtaining advance clearance from HMRC is crucial to confirm the applicability of tax reliefs and to ensure the demerger does not trigger a tax charge.
Stamp Duty Tax
Stamp duty may apply if the transferred assets move to a company with a different ownership structure.
Accurate Valuation
Precise valuation of assets and the declaration of solvency are critical for a successful demerger.
Speak to an Expert
A capital reduction demerger can be a highly effective and tax-efficient way to extract property or other non-core assets from a business. However, the process is complex and requires expert tax and legal advice to navigate potential pitfalls.
If you are considering extracting an investment from your business in a tax-efficient manner, get in touch with our London Tax Team. We’ll be happy to guide you through the process.
Authored by: London Tax Team
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