Group and Company Reorganisations - s110 arrangements
At some time during the development of a company the directors and shareholders are likely
to see advantages in diversifying the ownership of business activities. There are many
reasons why a reorganisation of a company's activities is desirable. More often than not the
desire is either to protect one or more business activities or to divide business assets so that
shareholders may go off in different directions.
The presence of potential tax liabilities can often be a deterrent. With careful planning, however, the commercial advantages of a reorganisation of business activities or shareholdings can be realised without triggering a significant (or in some cases any) tax bill.
There are two principal ways of achieving this - through a statutory demerger or by using Section 110, Insolvency Act 1986. Provided the necessary criteria (eg not for the puposes of a sale or cessation of trade, not an investment buiness) are met, a statutory demerger can offer a relatively straightforward means of separating two trades. In our experience the criteria are such that most private business separations are made using the provisions of Section 110.
In this blog I explain how a solvent liquidation and Section 110 allow businesses to achieve their goals in this area.
The commercial justification driving a reorganisation will often be a wish to separate the business assets or activities so as to minimise risk to other parts of the business, or to allow shareholders to take greater ownership of the part of the business they wish to develop. Equally, though, it is possible that the management want to sell part of the business, whilst retaining the remainder. Examples of reorganisations on which we have recently advised include:
- A typical (pyramid) group with three activities (pubs and restaurants, hotels
and hotel management) was demerged into three separate groups reflecting
the separate trades.
- Shareholders in a company owning nursing homes wished to separate the
business assets between them so that they each could further develop part of
the business, as they wanted. The properties were separated out into new companies.
- A commercial property was split from a company's trading activity and transferred to a new company, so increasing the chances of a tax efficient sale of the trading business at a later date.
- A company carrying on two trades was approached by a potential purchaser who wanted only one of these trades. The trades were separated and the business wanted by the third party was sold.
In all of these cases, the reorganisation involved a Section 110 liquidation.
Company reorganisations are fraught with tax issues. These include capital gains tax (CGT), income tax on potential distributions or employment related transfers (benefits in kind), inheritance tax (IHT) - if there is a gift transferring value between shareholders - and stamp duty land tax (SDLT).
The prospect of facing significant tax liabilities will often be a deterrent to a reorganisation, particularly for the smaller business. However, HM Revenue & Customs (HMRC) recognise the procedure under Section 110 and will give tax clearances (where possible), confirming that the reorganisation is being carried out for genuine commercial reasons and that the various tax reliefs associated with a reorganisation are available. Provided that the reorganisation then follows the route advised to HMRC, the tax liabilities should be kept to a minimum.
Under Section 110 a liquidator may, with sanction, receive shares, policies or like interests in a transferring company for distribution among the members of the transferor company.
A typical Section 110 scheme will involve the creation of a new holding company (Newco H), which will, as part of the reorganisation, be placed into liquidation. This has a number of benefits, including the fact that Oldco is not associated with the liquidation.
Existing shareholders will exchange their shares for the issue of shares in Newco H in proportion to their present shareholding. The assets of Oldco will then be reorganised into the appropriate segments that will make them easily transferrable out of the group. This is likely to involve either
the transfer or distribution of assets or shares up to Newco H prior to liquidation.
Two or more new companies are then formed (Newco A and Newco B, etc). Newco H is placed into solvent liquidation and the liquidator tasked under Section 110 with distributing the assets of Newco H, in exchange for shares to be distributed to the shareholders of Newco H. The shareholdings in Newcos A, B etc need not necessarily be in the same proportion of the shareholdings in Newco H if, for example, the reorganisation is to enable shareholders to take ownership of different parts of the business. However, it will be critical, to avoid a tax charge, that
shareholders inherit shares with a value proportionate to their pre-reorganisation value.
Though comparatively rare, it is possible to carry out a Section 110 scheme or reorganisation without forming Newco H. However, creditors of the company to be liquidated will have to be settled either before or as part of the liquidation process.
There are some complicated tax rules where properties are being transferred and then leave a group, as well as SDLT considerations. Where the reorganisation involves properties, the tax planning and advice will be more involved.
In conclusion, the commercial justification to reorganise the business assets, activities or shareholders' interests within a company should not be frustrated by potential tax liabilities. HMRC recognise what can be achieved by a Section 110 reorganisation. Tax planning is critical, as is the drafting of the legal documentation covering the reorganisation.
Date: 22nd May, 2008
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