How to separate a business through a demerger

A company or group can contain separate assets or businesses that no longer fit together. Simply extracting assets at the shareholder level can give rise to significant tax liabilities, though, for both the company and the owners. In some cases, a tax-efficient reorganisation, known as a demerger, can be implemented to achieve separation.

What is a demerger?

A demerger is a restructuring process in which a company or group separates its activities or assets into separate companies, resulting in two or more standalone groups. The process allows each company to operate independently going forward.

Different types of demergers

There are several types of demergers, and the right one to implement will depend on your particular circumstances. These include:

Statutory demerger  

These are only available to companies with more than one trade which require separation. It generally cannot be used where there are no trading aspects to separate. There are a series of specific conditions to meet, and there can be tax implications if certain events take place within five years of a statutory demerger. However, these can work well for trading businesses. 

Liquidation demerger

This involves a liquidation exercise to separate out a business. These types of demerger can be effective, but there can be some market misconceptions about liquidations, which may make them unappealing commercially. Winding up a company can also be expensive.

Share Capital Reduction demerger  

This type of demerger involves inserting a new holding company above an existing one, followed by rearranging the companies and assets beneath. Some of the new shares are then cancelled in such a way that results in a company being transferred out of the group.

Whilst this is a more complicated route, it is available in situations where other methods of demerger (e.g. statutory) are not possible. If undertaken correctly, they can be a tax-efficient way of separating out assets.

Why would you implement a demerger?

There are a variety of reasons why a demerger might be considered, including:

Succession planning

Shareholders may want to eventually pass different parts of a business to different people.

Partition

Sometimes shareholders can seek a demerger following a shareholder dispute or in order to avoid a dispute if different parties wish to pursue different business paths or interests.

Future sale

There may be a potential purchaser for the business, or that an eventual sale is envisaged, but that the purchaser would only wish to acquire the trading company and would not want to acquire any investment properties or even trading premises that sit within the group. A demerger may be used to separate the activities into a trading group and a property investment company or group (for example).

Regulatory or funding requirements

In some industries it may be beneficial to separate regulated and non-regulated activities, or to separate out ventures in cases where funding is only available for one part of the business.

De-risking

It may be desirable to separate higher-risk trades from less risky trades in order to protect assets.

Efficiency

Separating out different parts of a business could enable a greater focus on each company’s core activity, increasing efficiency.

Incentivising employees

It may be possible to reward employees in different companies in ways that are more appropriate for each business.

These are just some areas in which demergers can support business strategy.

Real-life examples of business demergers

The following examples highlight how a demerger can help separate businesses that no longer fit together:  

eBay and PayPal

In 2015, eBay demerged its PayPal payments division so it could be an independent, publicly traded company on Nasdaq. eBay originally acquired PayPal to support the business's e-commerce transactions, but the e-payment provider grew exponentially. Although this was a US transaction, it is an example of why a business was demerged into different separate aspects.

The business structure hampered PayPal's growth against its expansion strategy over time, particularly with eBay's direct competitors and other mobile wallet providers launching around this period. 

Severn Trent Water and Biffa

After acquiring Biffa Waste Management in 1991, Severn Trent Water demerged from the business in 2006. Severn wanted to focus solely on being a water utility and found the nature of the waste management industry Biffa operated within contrasted with the Severn Trent Group's business strategy. Biffa became its own standalone listed company on the London Stock Exchange.

Pros and cons of separating a business through a demerger

Whether a demerger is right for your circumstances can depend on a variety of factors. In general, there are specific advantages and disadvantages to separating your assets through a demerger:

Tax considerations

Whilst there can be strategic benefits in demerging activities into distinct companies, these transactions can trigger significant tax liabilities for the business and the shareholders if undertaken without proper planning. It is imperative to ensure the method, as well as the detailed steps, are implemented correctly in order to minimise these tax liabilities.

How we can help

Demergers can be complex, but when done right, they empower the parent company and new entity to enjoy improved strategic focus, streamlined operations and more aligned leadership in the long term. Shorts' Business Taxes team have extensive experience planning demergers for business leaders, ensuring they're tax-efficient and support the organisation's goals. 

FAQs

Is a demerger good or bad for shareholders?

A demerger can be positive news for shareholders, but they do come with some risks. If done incorrectly, there can be adverse tax implications, but providing a demerger is implemented appropriately, the key benefit for shareholders is that businesses can be separated, allowing them to prosper separately going forward. 

What are the key steps in the demerger process?

Demergers can be complex, but the process can be broken down into various stages: (1) feasibility, whether this is appropriate for your circumstances, (2) detailed step plan, covering tax considerations in particular, (3) HMRC clearance (if applicable), (4) legal implementation, including asset transfers, insurance, contracts etc.

Do you need HMRC clearance for a demerger?

HMRC clearance is technically optional, but we strongly recommend acquiring it (where applicable). Gaining advance confirmation that the demerger is being done for genuine commercial purposes can help avoid unexpected tax bills or penalties. 

What is the tax impact of a demerger?

A demerger can generally be tax-neutral, but only if the process is planned carefully. Poorly planned demergers can trigger significant Income Tax, Capital Gains Tax, and even Stamp Duty/SDLT costs 

What happens to shareholders in case of a demerger?

Usually, an existing shareholder will receive shares in the new entity whilst retaining shares in the original entity (possibly indirectly via a new company).