Section 110 liquidation demergers

Transcription

1 Version 1.0 Section 110 liquidation demergers A guide to legal, tax and practical Issues

2 Table of Contents Acknowledgements Important Notice Introduction who is this guide for? What is a demerger? What is a section 110 demerger? Why would I want to demerge part of the group s business? What are the main workstreams within a section 110 demerger project? What are the potential showstoppers? How does it work and how long does it take? Who will I need to involve? A demerger case study Overview of legal feasibility issues About LCN Legal Free LCN Legal Resources LCN Legal Testimonials Legal implementation of corporate structures Page No LCN Legal Limited

3 Acknowledgements This guide has been prepared by LCN Legal with contributions from Paul Smith of Blick Rothenberg and Ben Woodthorpe of ReSolve from a tax and liquidator s perspective, respectively. Blick Rothenberg is a market leading accountancy practice providing audit, assurance and business advisory services as well as providing advice on corporate and personal tax matters. ReSolve is an award winning corporate advisory firm combining both its own capital and experience in advising and funding financially distressed businesses, and providing corporate restructuring expertise. We would like to thank Paul Smith of Blick Rothenberg and Ben Woodthorpe of ReSolve for their time and kind contributions to the content of this guide. Legal implementation of corporate structures LCN Legal Limited

4 Important notice This guide is provided on an as is basis. Readers should take their own professional advice, and this document should not be relied upon as a substitute for the same. No responsibility is accepted by LCN Legal Limited or any other contributors, or any of their respective directors, partners, employees, agents or representatives for any cost, loss or liability, however caused, incurred by any person by reliance on it. Legal implementation of corporate structures LCN Legal Limited

5 Introduction Who is this guide for? This guide is for anyone who wants to know more about separating businesses within a corporate group by way of a section 110 liquidation demerger. Of course, there are many other ways to separate the businesses and assets of a group, whether by distribution in specie of the relevant assets, a court approved reduction of capital, a scheme of arrangement, a cross-border merger or an intra-group business sale. However, these methods are outside the scope of this guide and are featured in other LCN Legal resources available on our website. Here we will focus on the rationale, the key considerations and risks, and the main steps required to implement a typical section 110 liquidation demerger. The content of this guide is aimed at tax, finance and legal professionals (inhouse and in private practice) who may be considering or become involved in a section 110 demerger, or who just want to understand more about how they work and why they might be considered a useful method of separating businesses. Legal implementation of corporate structures LCN Legal Limited

6 What is a demerger? As a company or corporate group may operate a number of different business units, each utilising different assets. For a number of reasons, it can be beneficial to segregate these units or assets by transferring certain businesses or assets into separate entities. The term demerger usually describes the separation of assets, initially held under common ownership, into separate companies or groups of companies. As already mentioned, there are a number of different methods to demerge businesses or assets within a group. This guide focuses on the legal steps required and the common tax and liquidation issues to consider when implementing a section 110 liquidation demerger. Legal implementation of corporate structures LCN Legal Limited

7 What is a Section 110 demerger? A section 110 liquidation demerger involves the liquidation of a holding company and the transfer of shares or assets to two (or more) newly incorporated companies (for the purposes of the guide, called NewCos ). The liquidator exercises discretion under section 110 of the UK s Insolvency Act 1986 to accept the shares in the NewCos as consideration for the transfer of the relevant assets by the holding company to the NewCos. The liquidator then distributes these shares to the ultimate shareholders in satisfaction of their rights in the holding company s liquidation. It is also possible to simplify the process by the NewCos issuing shares directly to the ultimate shareholders. The end result is that the NewCos are held directly by the ultimate shareholders as are their respective demerged businesses. Legal implementation of corporate structures LCN Legal Limited

8 Why would I want to demerge part of the group s business? Reasons for wanting to demerge a business or assets within a group vary widely and might include any of the following reasons: To ring-fence certain assets from risks associated with other assets or businesses within the group To set up a new business division which will operate independently from the remaining business of the group To package part of the group s business for sale to a third party To separate businesses or assets following a dispute between the group s ultimate shareholders To form part of succession or inheritance planning Legal implementation of corporate structures LCN Legal Limited

9 What are the main workstreams within a section 110 demerger project? Typical workstreams are as follows: Agreement on the valuation of the assets to be demerged (if the share split will not be identical across the demerged companies) Legal due diligence of contractual / regulatory / third party consents Tax advice and tax clearances Shareholders agreements for the demerged companies (if they will have more than one shareholder) Liaising with the proposed liquidators and getting them comfortable with the planned transactions Corporate structuring, legal documentation and implementation Post-completion matters and company filings Legal implementation of corporate structures LCN Legal Limited

10 What are the potential showstoppers? Examples of potential showstoppers or sources of major delay / cost overrun are as follows (also see the Overview of Legal Feasibility Issues on page 21 of this guide): Disagreement on the valuation of assets HMRC questions on clearance applications or conditions attaching to approvals Shareholder objections Change of control issues with commercial counterparties Banking releases and regulatory consents Liability issues in the company to be liquidated (if this is not a new holding company see Step 1 below) Changes to the proposed structure during implementation of the project, etc. Legal implementation of corporate structures LCN Legal Limited

11 How does it work and how long will it take? The time needed to complete a demerger will depend on a number of factors, including: whether the companies or assets involved in the demerger are subject to mortgages or other third party charges; whether all required advisors have been instructed from the outset (including the legal, tax accounting and liquidator roles); and the type of assets and the complexity and history of the business being transferred. For example, are third party consents required to transfer the assets or the business? Will employee consultation be required? In our experience, these types of projects usually complete within 2-6 months, however, if proper due diligence is not carried out from the outset, they can take in excess of 12 months to complete. Legal implementation of corporate structures LCN Legal Limited

12 Who will I need to involve? Typically the outline structure of the demerger will be put together by the stakeholders in the business, legal advisers and tax advisers. A member of the project team will need to be appointed to negotiate any re-financing arrangements or third party consents required to complete the demerger. A liquidator will need to be appointed and should be consulted early on the structure and the detail of the proposed liquidation demerger steps. Leaving this to the end may delay the project significantly. What are the risks I should be aware of? In the demerger case study set out on pages 13 to 20, we have included commentary on the key risks and issues to be considered by your project team, including from a tax, legal and a liquidators perspective. Legal implementation of corporate structures LCN Legal Limited

13 A Demerger Case Study Before and After The following pages illustrate the typical steps taken in a section 110 liquidation demerger. The corporate structures opposite show the present structure and the proposed future structure following completion of the demerger. In this case study, the main driver for the demerger is to separate and ring-fence two businesses currently operated within an existing company (TradeCo 1), with a view to incentivising the management of each business separately through the introduction of share participation schemes following completion of the demerger. This may be to incentivise management to grow the respective businesses for proposed future sale. After Before Shareholders Shareholders Shareholders NewCo 1 NewCo 2 TradeCo 1 100% All the companies involved are UK companies. TradeCo 1 100% TradeCo 2 Any third party consents required for transferring customer, supplier or other third party contracts, together with secured creditors consents or regulatory approvals will need to be sought in advance of the demerger. Legal implementation of corporate structures LCN Legal Limited

14 A Demerger Case Study Step 1 Legal Steps A new UK holding company ( New HoldCo ) is inserted on top of TradeCo 1. The reason for this is to have a clean company in the structure in order to allow the liquidator to implement the demerger immediately upon commencement of the members voluntary liquidation in step 5. Liquidating trading companies can prove more complex, time consuming and costly, as a result of potential lack of corporate memory, hidden indemnities, warranties or other exposure, and unknown personal injury claims, for example. This step is carried out by way of a share for share exchange in which all current shareholders of TradeCo 1 transfer their shares in TradeCo 1 to New HoldCo in exchange for new shares (with equivalent rights) in the new holding company. New HoldCo should have a name not associated with that of TradeCo 1. Even though the liquidation is a solvent (i.e., a good ) liquidation, by association it may bring unwelcome attention when advertising the liquidation if the names are too similar. Shareholders New HoldCo New HoldCo is incorporated and inserted above TradeCo 1 100% Tax issues: Technically, the shareholders dispose of their shares in TradeCo1 and, as consideration for the sale, they receive shares in New HoldCo. Under general tax principles such a disposal could result in the shareholders having a liability to tax on any capital gain that might arise on the disposal when calculated by reference to the market value of TradeCo 1, at the time of the transaction. However, in almost all cases, no actual tax liability will arise, provided the transaction is being undertaken for bona fide commercial reasons. A tax clearance application is typically submitted to HMRC in advance of the transaction in order to obtain HMRC s confirmation on this matter. This ensures that there is no unexpected tax liability arising on the shareholders, as a consequence of their transfer of the TradeCo 1 shares to New HoldCo. In practice a combined clearance application will be made to address this matter and similar issues arising in the subsequent steps. The combined clearance will include a clearance under section 138 TCGA 1992 and section 701 ITA 2007 to confirm that no tax liability arises on the shareholders, as a consequence of Step 1. TradeCo 1 LCN Legal Limited 2017 Legal implementation of corporate structures 14

15 A Demerger Case Study Step 2 Legal Steps A new UK subsidiary company ( TradeCo 2 ) is incorporated as a 100% subsidiary of New HoldCo and sister company to TradeCo 1. An existing subsidiary could equally be used for this purpose but may require additional restructuring steps to reflect the corporate structure shown opposite. Shareholders The business or assets to be demerged are then transferred to TradeCo 2. If the assets are sold by TradeCo 1 to TradeCo 2 this may be at book value if TradeCo 1 has sufficient distributable reserves (net realised profits). The consideration for the transfer might be left outstanding as a debt payable by TradeCo 2. Tax issues: The transfer of the business or assets to be demerged will be a disposal from TradeCo 1 to TradeCo 2 for tax purposes and tax liabilities could potentially arise. However, to the extent that the assets transferred are capital assets (i.e., capital gains assets or intangible fixed assets) then the combined clearance application to HMRC (referred to at Step 1 above) will seek confirmation from HMRC that the transaction is being undertaken for bona fide commercial reasons. If HMRC agrees that this is the case then the capital assets are transferred for tax purposes at their tax base costs (i.e., no corporation tax liability will arise as a consequence of this step). Unfortunately, there are no provisions that enable stock in trade to be transferred without triggering an immediate liability to UK corporation tax. However, as the nature of stock in trade is that it is to be sold in the short term, then in most cases this represents only a modest cash flow disadvantage. If land / buildings are included in the assets being transferred then stamp duty land tax can typically be avoided by electing for group relief to apply to the transaction. Tax advice should be sought to avoid inadvertently triggering a tax liability. The combined clearance will include a clearance under section 139 TCGA 1992 to confirm that no tax liability arises on the shareholders as a consequence of Step 2. Legal implementation of corporate structures New HoldCo as formed in step 1 New HoldCo TradeCo 2 is incorporated as a 100% subsidiary of New Holdco 100% 100% TradeCo 2 TradeCo 1 TradeCo 1 sells the relevant business / assets to TradeCo 2 LCN Legal Limited

16 A Demerger Case Study Shareholders NewCos 1 and 2 are incorporated Step 3 Legal Steps The next stage of the demerger process is usually to establish two new companies which are incorporated on behalf of each of the shareholders and are held by the shareholders in the same proportions as the original holdings in TradeCo 1. In our example, these are NewCo 1 and NewCo 2. At this stage, only subscriber shares are issued by the NewCos to the shareholders because the remaining shares are used as consideration for the transfer of the TradeCo 1 and TradeCo 2 shares in step 5 below. NewCo 1 New HoldCo TradeCo 1 NewCo 2 TradeCo 2 100% Legal implementation of corporate structures LCN Legal Limited

17 A Demerger Case Study Step 4 Legal Steps Shareholders The shareholders pass a special resolution to commence the members voluntary liquidation ( MVL ) of New HoldCo and a liquidator is appointed. If the MVL is commenced, the liquidator effectively holds two assets i.e., the two wholly owned subsidiaries of New HoldCo, being TradeCo 1 and TradeCo 2. New HoldCo NewCo 1 NewCo 2 The placing into liquidation of New HoldCo and the appointment of a liquidator does not in itself trigger any tax charge. TradeCo 1 TradeCo 2 100% Legal implementation of corporate structures LCN Legal Limited

18 A Demerger Case Study Step 5 Legal Steps A demerger agreement is entered into between the liquidator, the shareholders, NewCo 1 and NewCo 2. This agreement provides for the liquidator to distribute the shares of TradeCo 1 to NewCo 1 and the shares of TradeCo 2 to NewCo 2. In consideration, NewCo 1 and NewCo 2 issue new shares to the shareholders. Tax issues: Provided the transaction is being undertaken for bona fide commercial reasons, then no corporation tax liability should be triggered in New HoldCo, when its shares in TradeCo 1 and TradeCo 2 are distributed by the liquidator to NewCo 1 and Newco 2, respectively. Those shares are treated for tax purposes as if they had been disposed of by New HoldCo, and as acquired by NewCo 1 and NewCo 2, respectively, at their tax base costs. The combined clearance will include a clearance under section 139 TCGA 1992 to confirm that no tax liability arises on New HoldCo, as a consequence of its disposal of shares in Trade Co 1 and Trade Co 2 by the liquidator. NewCo 2 issues new shares to the relevant Shareholders NewCo 1 issues new shares to the relevant Shareholders Shareholders TradeCo 1 New HoldCo / Liquidator transfers the shares in TradeCo 1 to NewCo 1 New HoldCo NewCo 1 Legal implementation of corporate structures NewCo 2 TradeCo 2 100% New HoldCo / Liquidator transfers the shares in TradeCo 2 to NewCo 2 LCN Legal Limited

19 Step 5 Tax issues (continued): There should also be no tax liability for the shareholders, as reconstruction relief should be available. The shareholders tax base costs in their shares of NewCo 1 and NewCo 2 should be equal to their tax base cost in New HoldCo (which was equal to their tax base cost in the shares of TradeCo 1 before the reorganisation). This puts the shareholders in the same tax position as they were before the reorganisation with their tax base cost now split between the two NewCos. The combined clearance will include a clearance under section 136 TCGA 1992 to confirm that no tax liability arises on the shareholders as a consequence of this step. Although TradeCo 2 leaves the group within six years of an intra-group transfer of assets to it, no capital gains de-grouping charge arises because that event is as a consequence of a member of the group ceasing to exist (section 179(1) TCGA 1992 and section 788(1) CTA 2009). A clawback of group relief for stamp duty land tax should also not be triggered because the de-grouping is a consequence of a winding up of the vendor or another company that is above the vendor in the group structure (Para 4(4) Schedule 7 FA 2003). The transaction is also likely to qualify for reconstruction relief from stamp duty for the transfer of the shares of TradeCo 1 and TradeCo 2 provided the reorganisation is not part of an arrangement to transfer the ultimate ownership to one or more identified third parties (Sections 77 & 77A FA 1986) Legal implementation of corporate structures LCN Legal Limited

20 A Demerger Case Study Post-Liquidation Structure As a result of the conclusion of step 5, TradeCos 1 and 2 will have been split into two segregated businesses both of which can function independently and each of which are held by different shareholders. For the purposes of our case study, each of TradeCo 1 and TradeCo 2 can subsequently issue employee participation shares to their respective management teams as a means of incentivising the teams to grow the respective business with a view to a potential future sale of one or both of the demerged business. Shareholders Shareholders NewCo 1 NewCo 2 TradeCo 1 TradeCo 2 The liquidator will then proceed to finalise the liquidation of New HoldCo. As there is no trading history attaching to this company, tax clearance will not likely be required and the liquidator will seek to hold a final meeting of the shareholders prior to moving it to dissolution as quickly as possible. Relationship between TradeCo 1 and TradeCo 2 If required, a services agreement may be put in place between TradeCo 1 and TradeCo 2 to govern the provision of services (if any) from one to the other. Tax issues: The shareholders are in the same position as they were prior to the demerger. In particular, they are still taxed on dividends and gains in exactly the same way as they were before the reorganisation except that they now have two investments instead of one. Legal implementation of corporate structures LCN Legal Limited

21 Overview of legal feasibility issues 1. Dissenting shareholders Although it is possible to implement a demerger with dissenting shareholders in the current holding company, it is generally more complicated and costly. Additional procedures may be needed, such as a court-approved scheme of arrangement. 2. Distributable reserves in the current holding company As we have seen, a typical section 110 demerger involves inserting a new company on top of the existing holding company, by means of a share-for-share exchange. The existing holding company would then hive up assets or shares to the new holding company by way of a distribution in kind. The existing holding company must have sufficient distributable reserves to do this. It would also need to have authority in its articles of association to make a distribution in kind. Each of these points should be checked well in advance of implementation of the demerger. 3. Indemnities in favour of liquidators Usually, the demerger happens soon after the liquidation of the new holding company is commenced. This means that the liquidator will not have completed the usual process of advertising for creditors. The liquidators will therefore typically require indemnities from the ultimate shareholders against claims made by any creditors. In practice, this is not usually an issue because, by definition, new holding company has not previously traded. Sometimes the indemnity might include third parties and agreement on the terms of all indemnities would be sought prior to the liquidator s acceptance of the appointment. 4. Consents from third parties The consent of banks or other third party lenders may be required in order to implement the demerger and should be considered well in advance. If a trade or asset is to be transferred as part of the project, then third party consents may also be required. For an overview of typical consents, see the following article on the LCN Legal website: Legal feasibility checklist: Intra group transfer of UK trade and assets 5. Change of control issues on a transfer of shares Where shares are being transferred as part of the project, there may be change of control issues to consider, even if the ultimate ownership of the companies concerned is not changing. For example, a subsidiary company may be a party to a joint venture. The shares in that subsidiary may be transferred by the existing holding company to a new holding company as part of the demerger. That change in shareholding may trigger change of control provisions in the joint venture documentation. 6. Large numbers of shareholders If there is a large number of shareholders in the existing holding company, consider whether the demerger will involve an offer of securities to the public for the purposes of the Financial Services and Markets Act Typically, the view is taken that it should not, but that will depend on the specific circumstances involved. In practice, if a large number of shareholders is involved, then it also becomes important to anticipate the possibility of shareholder dissent and to put in place contingency plans. Legal implementation of corporate structures LCN Legal Limited

22 About LCN Legal LCN Legal is a boutique law firm, established in 2013 and regulated by the Solicitors Regulation Authority in England & Wales. In addition to its focus on funds and property investment structures, LCN Legal also advises large corporates and Chinese and other overseas investors on domestic and international corporate and investment structures. One of our co-founders, Paul Sutton, was previously a corporate partner in the London office of Pinsent Masons, and before that a Director in KPMG s law firm in London. Our other co-founder, Xiaofang Sutton, studied law in Beijing and Edinburgh. She then helped the London Chamber of Commerce and Industry to establish its Chinese Business Association. During that time, Xiaofang worked with many Chinese state-owned and family-owned businesses. Our senior lawyers have trained and worked at international law firms such as Linklaters and Baker & McKenzie. Collectively, our team has over 50 years experience of the legal implementation of group reorganisations and international corporate investment structures. We have acted on the legal implementation of group reorganisations for household name clients in a range of sectors including telecoms, electronics, retail, financial services, IT, consulting and outsourcing. This has involved projects including corporate migrations, cross-border mergers, share and asset sales and acquisitions, business sales, corporate streamlining, transfer pricing compliance, eurobond listings, removing of dividend blocks and the unwinding of tax planning which is no longer appropriate. Legal implementation of corporate structures LCN Legal Limited

23 Free LCN Legal Resources We regularly publish articles and guides for finance, legal and tax professionals. us at or call us on to order your free copies or visit our website ( for access, including to the following articles and guides: Legal feasibility checklist: Intra group transfer of UK trade and assets Free Guide: Group Reorganisation Planning Form How to implement a Cross-border Merger in a group reorganisation Please also feel free to sign up for free on our website to subscribe for other free materials and alerts to upcoming training events and discussion groups on corporate reorganisations and other topics. To subscribe, us at info@lcnlegal.com or call us on. Legal implementation of corporate structures LCN Legal Limited

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