CG33900 - Disposals by trustees: Demergers
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CTA10/S1075 & TCGA92/S192
A demerger is a series of transactions which have the effect and purpose of dividing the trading activities carried on by a single company or group of companies between two or more companies or groups of companies. CTA10/S1075 and TCGA92/S192 provide special tax treatment if certain conditions are met. Companies may seek advance clearance under CTA10/S1091 that proposed transactions will be an exempt demerger. CTM17200 onwards gives further guidance on the action to be taken by local offices in dealing with demergers.
Direct demergers – CTA10/S1076
One type of demerger, which is referred to in these instructions as a `direct demerger’, falls within CTA10/S1076. This is where
- a company (`the distributing company’)
- makes a distribution to its members
- consisting of shares (`the demerged shares’)
- in a company (`the demerged company’)
- which is a 75 per cent subsidiary of the distributing company.
Indirect demergers – CTA10/S1077
Other types of demerger fall within CTA10/S1077. These are referred to in these instructions as `indirect demergers’. The conditions are that
- a company (`the distributing company’)
- makes a distribution to one or more other companies (`the transferee company or companies’)
- consisting of either
- a trade or trades, or
- shares in one or more 75 per cent subsidiaries
- shares (`the issued shares’) are issued by the transferee company or companies to shareholders of the distributing company.
Income Tax treatment
Where there is an exempt demerger, the distribution of the shares of the demerged company in a direct demerger (or the issue of shares by a transferee company in an indirect demerger) is not a distribution by the distributing company for the purposes of Corporation Tax and it is not dividend income of the shareholders. Therefore, there is no Income Tax liability of any kind in respect of the receipt of the shares.
The first question to consider is whether the demerged shares are capital or income in the hands of the trust. This question falls to be determined in accordance with the general principles of trust law. If the law of any part of the United Kingdom or the Irish Republic applies the position is as set out in below. If the trust is governed by the law of any other country and it is suggested that these principles do not apply guidance may be obtained from BAI Assets, Residence and Valuation (Technical).
In the case of an indirect demerger in general the issued shares are received as an addition to capital. This follows from the High Court decision in Sinclair v Lee (1993), which was not a tax case. The court held that the shares to be distributed in the proposed indirect demerger of ICI, details of which may be found in EXTEL, would be received by the trustees as capital and not as income. The court was dealing with the specific case, where the value of the issued shares was over 50 per cent of the value of ICI before the demerger. The decision is not necessarily applicable in all cases involving indirect demergers. If, in a small case, the trustees treat the issued shares is less than 10 per cent of the value of the shares in the distributing company before the demerger, or less than £5,000, the trustees treat the issued shares as income belonging to one or more life tenants.
In the case of a direct demerger, the demerged shares are generally received by the trustees as income of the trust, because as a matter of company law they take the form of a dividend paid out of the accumulated profits of the distributing company. This follows principles laid down by Lord Russell of Killowen in the case of Hill v Permanent Trustee Co of New South Wales  AC720 at pages 730-732 in the Privy Council. This was not a tax case, and strictly concerned the law of New South Wales, but the principles have been followed by Courts in England & Wales and Scotland.
Direct demergers: CGT treatment: individuals
In the case of a direct demerger where individuals receive shares in a demerged company there is no immediate chargeable gain or allowable loss. The distribution is not treated for Capital Gains Tax purposes as a capital distribution. Instead the distributing company shares and the demerged company shares are treated as a single asset acquired when the distributing company shares were acquired. See TCGA92/S127 as applied by TCGA92/S192. If a shareholder then sells shares in either of the companies, the original cost of the shares in the distributing company is apportioned between the shares in the distributing company and the shares in the demerged company
- in the case of a quoted company, by reference to the respective values on the first day on which the demerged shares were quoted, TCGA92/S130
- in other cases, by reference to the respective values at the date of the disposal, TCGA92/S129.
Indirect demergers: CGT treatment: individuals
In the case of an indirect demerger, the relieving provisions of TCGA92/S192 described above do not apply. However, transactions including the issue of shares by the transferee company normally amount to a `reconstruction’ within TCGA92/S136. Section 136 provides for the roll-over of the gain that would otherwise arise to the shareholders.
Direct demergers: CGT treatment: trustees
Where the shares in the distributing company are held by trustees, the treatment for Capital Gains Tax purposes depends upon:
- The law governing the trust (for example, England & Wales or Scotland).
- The type of interests which the beneficiaries have (interests in possession or not).
- The type of exempt demerger (direct or indirect).
- Whether the demerged or issued shares are received as income or capital in the hands of the trustees for the purposes of trust law.
In the case of a bare trust, see CG34300, the normal rules for individuals apply.
Indirect demergers: CGT treatment: trustees
Provided that the issued shares are received as capital, in the case of an indirect demerger trustees of all kinds are treated for Capital Gains Tax in the same way as individuals. If exceptionally the issued shares are received as income of the trust, then the same treatment applies as for direct demergers, subject to the following paragraph.
If exceptionally there has been an indirect demerger in such circumstances that the issued shares are received as income; because these shares are issued by the transferee company, there is no corresponding disposal and therefore TCGA92/S17 does not apply, and the cost to the life tenant is therefore nil, see CG14550+.
Direct demergers: trustees: interests in possession: England/Wales/Ireland
If the demerged shares are received as income of the trust, the life tenant (or any other person with an interest in possession) of a trust governed by the Law of England and Wales, or either part of Ireland, is immediately entitled to those shares, subject to the right of trustees to meet their expenses. This follows from the decision of the House of Lords in the case of Archer-Shee v Baker 11TC749. The demerged shares are therefore never settled property for Capital Gains Tax purposes, and there is no disposal for Capital Gains Tax purposes from the trustees to the life tenant. The allowable cost to the life tenant for any future disposal is the market value of the demerged shares at the date of the distribution, by reason of TCGA92/S17 (1), the disposal by the company being the corresponding disposal for the purposes of Section 17(2). See CG14550. So far as the trustees are concerned, the allowable cost of the shares in the distributing company, which they continue to hold, is unaffected by the demerger. If the trustees retain the demerged shares, then there has been a disposal by the life tenant to the trustees, and unless the life tenant has been paid the cash value of the shares, he or she is the settlor of them.
Direct demergers: trustees interests in possession: Scotland
If the demerged shares are income of a trust governed by Scottish Law, however, the position differs. The liferenter (or person with a similar interest in possession) of a trust governed by Scottish law is not immediately entitled to the demerged shares. The right of a liferenter is a personal right to compel the trustees to administer the trust in accordance with the directions of the truster (settlor in English terminology). If the trustees decide to distribute the demerged shares to the liferenter, rather than the cash equivalent, then there is for CGT purposes a disposal by them at market value.
Direct demergers: trustees interests in possession: other countries
If a trust is governed neither by the law of any part of the United Kingdom, nor by the law of the Irish Republic, then the trustees will need to consider the precise interests of the person or persons with an interest in possession. If that person is immediately entitled to the demerged shares, then the trustees and beneficiary fall to be treated in accordance as as for England/Wales/Ireland above. If on the other hand the rights of the beneficiary are like those of the taxpayer in Garland v Archer-Shee, 15TC693, then the trustees and beneficiary fall to be treated in exactly the same way as those of liferenter trusts under Scotland above. In small cases it may be assumed that the treatment adopted by the trustees is correct.
Direct demergers: trustees discretionary trusts etc
Trustees of a trust outside England/Wales/Ireland are treated in the same way as individuals. The demerged shares in the first instance belong to the trustees even if they are obliged to distribute them or their cash equivalent. If however they then, of necessity or by choice, distribute the demerged shares to one or more beneficiaries, there is a disposal of those shares at market value. The chargeable gain or allowable loss is the market value of the shares at the date of distribution, less the appropriate fraction of the original cost of the distributing company shares. If the shares are income in the hands of the beneficiary that does not affect the computation of the trustees’ chargeable gain. Where part only of the income of a trust is payable at the trustees’ decision, and the other part belongs to beneficiaries with interests in possession as it arises, it may be necessary to apportion the shares received in a demerger accordingly.
Trustees of a discretionary trust acquire 1,000 shares in a quoted company X Ltd for £5,000. In due course X Ltd distributes 500 shares in its subsidiary Y Ltd. This is an exempt demerger. The respective values of the holdings at the first date of quotation of the shares in Y Ltd are X Ltd £18,000, Y Ltd £6,000. The trustees subsequently dispose of their shares in Y Ltd to the beneficiaries when their value is £8,000. The computation is as follows.
Apportion costs between X Ltd and Y Ltd shares by reference to market value on first day of quotation. This gives for the Y Ltd shares:
|(18,000 + 6,000)|
Disposal of the whole holding
|Market value on disposal||£8,000|