For parties going through a corporate divorce where the aim is to split two or more businesses, traditional solutions – whether buyouts, buybacks or sales of part of an enterprise – often flounder on the rocks of valuation, funding issues or taxation. But the happy ending can be a Section 110 solvent reconstruction (Insolvency Act 1986), otherwise known as a de-merger.
De-mergers can be a neat way of resolving shareholder/management disputes and for separating two or more businesses, especially where operating the businesses together is not working and they will perform better under separate ownership. Therefore, commercial motivation is usually the key, but tax is also a big driver as solvent reconstructions can offer taxefficient solutions.
Without a de-merger, transferring corporate assets to individual shareholders can be expensive in tax terms. Corporate tax chargeable at 30% and personal tax rates between 18% and 40% may be costly, especially where there is no cash to pay the bill without selling the assets concerned.
A formal Section 110 reconstruction allows corporate assets, such as shares, land and buildings, goodwill and businesses to pass directly to the shareholders (either corporates or individuals) tax free. Typically, this involves inserting a Newco between the existing shareholders and the company to be de-merged, for which some preparatory internal restructuring and re-organisation of the share capital may be required. Newco then goes into solvent liquidation, and the liquidator distributes the corporate assets under a distribution agreement. Tax clearance should always be obtained from HM Revenue & Customs because the corporate and personal tax costs of getting it wrong can be substantial.
Sounds simple doesn't it? Well, yes and no. The devil, as always, is in the detail and in practice it requires the liquidator, accountants, lawyers, tax advisers and shareholders to work in partnership to deliver the desired result. It is not a cheap solution, so the benefits need to outweigh the costs.
De-mergers are typically considered when all the relevant businesses have significant value. After all, if the departing business is of low value, why not simply sell out for a nominal sum?
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