Amongst the more (generally) positive proposed changes being considered as part of HMRC's consultation on modernising the distributions rules are those relating to the statutory demergers code in Chapter 5 of Part 23 of Corporation Tax Act 2010. Designed to facilitate corporate restructurings, the rules here (and related rules in the capital gains regime) in theory allow for the division of different businesses carried on within a single corporate group into separate holdings by the same owners without any up-front direct tax cost. 

Types of demerger

Demergers may be effected in a number of ways, perhaps the simplest being a direct dividend demerger, whereby shares in a subsidiary carrying on a separate business are distributed to the owners of the parent company of the group so as to be held by them directly. Alternatively, an indirect (or "three-cornered") demerger may be effected by having one company declaring a dividend to be satisfied by the transfer of a trade to a second company, in return for which that second company issues shares to the owners of the first. Absent any special rule, the value of such shares in either case would in principle be taxable as a distribution in the hands of the receiving shareholders, giving them a dry tax charge on receipt of the shares. 

Inevitably, the benefit of exemption from such treatment comes with a number of conditions attached. Furthermore, where a demerger meets the basic conditions for exemption, there is an ongoing five-year requirement to monitor for anything that might count as a "chargeable payment" - essentially, value (in cash or otherwise) extracted from either the distributing or distributed company to its members within that period which do not themselves fall to be treated as distributions, and which have a purpose of avoiding tax - as such amounts are then deemed to be distributions and taxed accordingly on the recipient. 

Proposed changes to conditions

What is now proposed is a number of alterations to the basic conditions, summarised as follows:

• The scope of the regime is expanded: the requirement for the companies involved to be resident in the UK or an EU member state will be removed, opening up the regime to a wider range of international groups; and the requirement for the distributing and distributed companies to be carrying on a trade (or be part of a trading group) will be relaxed to allow also for companies carrying on other activity, such as investment business.
• There is currently a requirement that the demerger must be wholly or mainly for the purposes of benefitting some or all of the business activities of the companies involved. This has always been a somewhat uncertain and subjective condition, requiring the transaction to be justifiable principally from the perspective of the particular business or businesses affected by the demerger (rather than, for instance, maximising shareholder value or broader strategic objectives of the group) and of having to sell the merits of that not only to investors and stakeholders familiar with the business, but potentially also to a HMRC inspector looking at it for the first time. Happily, the proposal now is for that condition to be removed entirely; this is apparently on the basis of its "redundancy", although other adjectives may spring to mind.
• The stipulation that the distributing company should retain no more than a minor interest in any trade that is transferred will also be removed, providing further welcome simplification.
• It is a condition for exemption that the distribution does not form part of a scheme or arrangement that has a main purpose of any of the following: avoiding tax, the making of a "chargeable payment", an acquisition by a third party of either company, or the sale or cessation of a trade. HMRC proposes to introduce a five-year cut-off for third party acquisitions and onward sales, so that a transaction contemplated after the five year point would not breach the condition - the example of "normal succession planning in family businesses" is cited here; in other contexts, presumably a credible business plan envisaging a minimum 5 year hold period would also suffice. Similarly, the cessation limb would be replaced with a prohibition on there being any voluntary dissolution or winding up of the relevant company within five years of the exempt distribution.
• In the case of an indirect demerger, there is currently a requirement that the only or main activity of the second company, i.e. the transferee of the trade, is the carrying on of that trade - without it being specified how long that state of affairs must last. The proposal now is to tweak that condition so that it expressly applies only immediately after the transaction.
• Also in the indirect demerger scenario, the first (i.e., the distributing) company must remain a trading company or as part of a trading group following the demerger. Currently, this condition does not apply either where (1) the first company is a 75% subsidiary of another, or (2) where there are two or more transferee companies and the first company is dissolved without leaving any net assets. These will be replaced with a single exception which will apply where the first company is dissolved "provided that it contains no assets including cash or loans". Query whether this is essentially a version of current exception (2) but without the requirement for there to be multiple transferee companies, or a more general relaxation allowing for dissolutions where there are net assets of the first company which do not include cash or loans.
• On the less positive side of the ledger, the condition relating to the shares in the distributed company (or transferee company, in the case of an indirect demerger), which currently requires those shares to constitute "all or substantially all" of the ordinary shares and voting rights in that company, is to be tightened to "all". The existing leeway is to be removed, we are told, in the interests of "clarity"; what is clear is that it could give rise to problems in practice where there is a minority holding (for instance, employee shares).
• Finally, two conditions which are specific to the scenario where the distributing company (in either a direct or indirect demerger) is itself a 75% subsidiary of another company - i.e. where the demerger is effected intra-group - are to be removed on the basis that distributions to corporate shareholders will usually benefit from the broader dividend exemptions (i.e. those in Part 9A of Corporation Tax Act 2009, which include what is in effect the UK's version of a participation exemption).

Whilst these changes are in themselves broadly positive, they do of course need to be read in the wider context of the proposals in the consultation - in particular, the proposed effective removal of the non-statutory demerger route which as noted in our previous post, HMRC’s consultation on distributions: A fundamental reset?, will increase reliance on the statutory demerger code. And as a final quid pro quo for the positive changes, the automatic right of appeal to the tax tribunal against a refusal by HMRC to provide statutory advance clearance for a demerger is to be removed.