A company may decide to undertake a reorganisation for wide range of commercial reasons, such as effecting a takeover, succession planning for family-run businesses or restructuring a group to maximise efficiency and savings. This article considers the commercial objectives that company reorganisations can achieve and the various models that can be implemented to realise these aims.
What is a “company reorganisation”?
Generally, the terms “company reorganisation” or “company restructuring” encompass situations where a company materially modifies its ownership or operations to achieve specific commercial objectives. There are various routes which a company (or group) can undertake to reorganise its business, such as introducing a new holding company, splitting commercial or ownership interests by demerger or by a sale of shares. All of these methods will have different positives and drawbacks depending on the status and position of the existing company prior to the reorganisation.
Given that reorganisations can be complex and can have significant tax implications for a company, it is important that from the outset of the matter, all parties have a comprehensive understanding of the current company (or group) structure and identify the commercial aims the restructuring is to address. Confirming this information ensures that we can discount the routes that would not achieve the desired outcomes and focus on the best solution for the company.
Why undertake a reorganisation?
As noted above there are many different reasons why a reorganisation or restructuring might be beneficial to a company.
A) Succession planning
According to Companies House, there are 4.8 million family-run businesses in the UK, which make up 88% of all businesses. These businesses are usually run by passing down knowledge and expertise through the generations. It is therefore vitally important that the company structure protects the future growth of these companies and allows the next generation to step into management when the time is right.
Transferring ownership can be a highly pressured and emotional task, which can lead to uncertainty and complications that affect the business. Putting in place a structure that promotes smooth transitions not only protects the business from any disruption but, more importantly, also helps to prevent any disputes arising within the family.
By discussing succession plans, current owners can also determine how they would prefer ownership to be transferred. It may be preferable for the incoming owners to buy all of the existing shares at once, or alternatively the current owners may prefer a gradual transition, whereby ownership is transferred in stages depending on the continued success of the company. By implementing a well-planned reorganisation, these succession preferences can be accommodated into the company structure.
Overall, understanding client priorities and careful planning of corporate structures can ensure that companies remain within the family in the most tax efficient and advantageous manner.
B) Shareholder disputes
Unfortunately there are instances where a company reorganisation is required to break shareholder deadlock. Disagreements can arise in relation to the running of the company or differences in the direction that each shareholder wants to take the business. This can often lead to disruption for the company and can have a severe impact on the overall profitability of the business.
Although it is usually a method of last resort, nevertheless, a company reorganisation can be an effective way to end shareholder disputes and ensure the company remains unaffected. This can be achieved in a number of ways, usually by one shareholder buying out another shareholder.
C) Acquisition of target companies
An acquisition is where a company purchases all or majority of a target company, with the aim of taking control over that company. The target company may be a competitor, provide supplementary services or may be an opportunity for the acquiring company to diversify its market and trade.
An acquisition is usually achieved by a share purchase of either the target company itself or its holding company. Often the purchasing company will need to consider whether the target company will become its subsidiary or whether it would be beneficial to install a holding company above each of them.
Alternatively, the parties could agree to undertake an asset sale. In this transaction the purchasing company acquires the business by buying the assets and liabilities of the target company that it wants. The purchasing company would not acquire the target company itself, but it still may need to consider whether its current structure is best suited to maximise the benefits of the sale or whether organisational changes are required to accommodate the new assets and liabilities.
The target company may also need to consider whether its existing structure allows for the type of sale it wants in the most tax efficient manner. As such, the target company may need to undertake corporate reorganisation with the future sale in mind.
A demerger is type of corporate restructuring whereby a corporate group or company is split into separate entities, usually maintaining the same shareholders.
There are many commercial reasons why a group (or a company) would want to undertake a demerger. Sometimes a demerger is required to separate the different types of business being carried on, for example splitting a tradeable arm from a riskier investment side. A company may wish to demerge to protect the individual brands under their group, especially where one brand could negatively affect the reputation of others. A demerger can also be a mechanism to create a separate company owned by existing shareholders, where a future sale is anticipated.
How can a company undertake a reorganisation or restructure?
There are many ways in which a corporate reorganisation can be implemented, this article considers the following approaches.
A) Share reorganisations
Share reorganisations can cover a wide range of transactions such as alterations of rights, capital reductions or simple purchasing of existing shares.
Alterations of share rights may be undertaken for various commercial reasons, for example the issue or reclassification of different shares classes may be required to vary the existing voting rights of the shareholders or enable a future demerger. It may also involve the issue or conversion of ordinary shares into preference or redeemable shares, which may be more attractive to incoming investors. An alteration of share rights is usually tax neutral for chargeable gains purposes, therefore it may be a good solution where shareholders want to implement different rights within the company for different shareholders.
In relation to shareholder disputes or succession planning, consideration may first be given to a simple purchase of the existing shares. Whilst this has the advantage of being a relatively straightforward process, careful consideration needs to be given as to whether the purchasers have sufficient capital to purchase the shares, and if not, whether they would be happy to incur additional loans to cover any shortfall. This type of transaction may also raise capital gains tax (“CGT”) liability on any chargeable gains made on the disposal of the shares and stamp duty may also be chargeable on the purchase, depending on circumstances.
An alternative to the share purchase may be a company buy back of shares, where the company can then cancel the shares after purchasing them. However a company needs to have sufficient distributable funds in order to undertake this route and so shareholders need to review up-to-date account information to understand if this is a viable solution. It should also be noted that the selling shareholder will be liable to income tax on the amount received. It will be treated as and taxed in the same way as a dividend payment.
However the sale can qualify as a capital disposal which will be chargeable to capital gains tax if:
- the shareholder has owned the shares in the company for at least 5 years;
- the company is a trading company;
- the buyback is for the benefit of the business; and
- the shareholder sells substantially all their shares and ceases to be connected with the company.
Luckily we can apply for pre-sale tax clearance from HMRC that the above conditions are met.
The company will also need to consider any stamp duty implications on the purchase of shares.
B) Corporate group structure
In some circumstances it may be suitable to implement a new corporate group structure, for example placing a holding company above an existing company where there is an anticipated sale. In relation to succession planning, it may be beneficial to incorporate a new company that can acquire the shares of an existing company, either by share-for-share exchange, cash or loan notes. If existing shareholders subscribe for shares in NewCo, then providing there is a share-for-share exchange, the qualification periods for entrepreneurs relief (CGT) and business property relief (inheritance tax) will be preserved.
There must be clear commercial reasons for structuring a reorganisation in this manner to ensure that it does not fall foul of the transaction in securities rules. The rules apply if the main purpose, or one of the main, is to obtain a tax advantage and they give HMRC the ability to counteract any tax advantage received. As such, it is advisable to seek HMRC clearance before undertaking any such transaction.
As discussed above, a demerger splits an existing corporate entity into separate companies. The simplest way to achieve this is via an exempt demerger (direct or indirect) which are a statutory procedures under the Companies Act 2006 and are exempt from de-grouping corporate tax charges.
This type of demerger is undertaken as a dividend in specie, whereby the shares are paid as a dividend (rather than cash) in the company to be separated. In a direct demerger all or any of the existing shareholders will receive shares in the company to be separated, whereas in an indirect demerger the shares are acquired by a new holding company which is owned by the existing shareholders. In order to qualify as an exempt demerger there are several requirements that must be satisfied, for example the original company must be a trading company (or holding company of a trading group) and the shares in the demerged company must constitute the whole or substantially the whole of the original company’s shareholding and voting rights.
The provisions will also not apply or will be withdrawn where a “chargeable payment” is made within 5 years of the demerger (i.e. where shareholders receive a payment for non-commercial reasons or tax avoidance arrangements). In these circumstances the disposal may be subject to de-grouping charges or corporation tax liability. A transaction may also be caught by the transaction in securities rules and so it is important to consider the reasons why a demerger is to be undertaken, to carefully analyse all parts of the demerger to ensure it doesn’t fall foul of these provisions. Again, it is recommended that HMRC clearance is obtained prior to the completion of such matters.
Other routes for demergers also include:
- liquidation under the Insolvency Act;
- demerger by way of capital reduction; or
- court-approved capital reduction schemes.
These are usually considered when the direct demerger is not available. Careful planning is required to ensure the statutory procedures are correctly followed.
As discussed above, many of the structures for company reorganisations can be liable to CGT where a gain is made on the chargeable disposal. In these circumstances, entrepreneurs’ relief may reduce the rate of CGT from 20% to 10%, providing the conditions are met. Very broadly, the requirements for ER on sale of shares are that for the qualifying period of 2 years:
- an individual must hold at least 5% of the ordinary share capital and voting rights;
- an individual must an employee or office holder of the company; and
- the company’s main activities are in trading
There is a personal lifetime limit for this relief of £10,000,000, so individuals also need to take into account any previous gains that benefitted from this relief to ensure they are within this limit. Given the potential benefits of this relief, it is important to consider if a corporate reorganisation can be structured in a way to take advantage of this relief where applicable.
How can we help?
We have significant experience in company reorganisations and restructuring. We work closely with all relevant parties to gain a comprehensive understanding of the commercial objectives and identify any areas of concern that need to be fully accounted for during the restructuring process. Our aim is to provide the best solution for your company at the minimum tax cost by carefully planning the appropriate corporate structures and making use of available reliefs.
To ensure you are fully informed we can prepare detailed tax structuring advice papers; obtain relevant tax clearances from HMRC and work closely with our corporate colleagues to deliver the best solution for your company.
Please note that any reference to the law is correct at the date of this article however legislation and rates of tax do change from time to time and we recommend that you obtain tax and legal advice before embarking on any of the transactions considered in this article.