TQOTW: Stamp Duty & Capital Reduction Demerger
The two shareholders of a Limited company client would like to go their separate ways and split the business. The group is not considered a trading group and there are insufficient distributable reserves at present to distribute a portion of the business. Both shareholders are keen to avoid a liquidation. Therefore, we are considering undertaking a capital reduction demerger, but are aware of changes to Stamp Duty relief by Finance Act 2020. Please could you explain the impact of these changes?

A capital reduction demerger often involves imposing a holding company via a share for share exchange to create sufficient share capital reserves to reduce on demerging. Relief from Stamp Duty on a share for share exchange is given by s77 Finance Act 1986 (FA 1986) where certain conditions are met, notably where the shareholdings before and after provide a ‘mirror image’ and there are no ‘disqualifying arrangements’.

‘Disqualifying arrangements’ are defined by s77A FA 1986 as arrangements where “it is reasonable to assume that the purpose, or one of the purposes, of the arrangements is to secure that–

(a) a particular person obtains control of the acquiring company, or

(b) particular persons together obtain control of that company”

Prior to the 22nd July 2020 this would have caused a duplication of charge to Stamp Duty on a capital reduction demerger if the shareholder retaining their interest in the imposed holding company obtains control (i.e. They do not have control prior to the demerger).

For example, say Company A Limited is held 50/50 by two shareholders – Mrs C and Mr D. As a preliminary transaction to a capital reduction demerger, a holding company (Company B Limited) is imposed via a share for share exchange.

Following the exchange, Company B Limited is held 50/50 by Mrs C and Mr D and Company A Limited is wholly owned by Company B Limited. After various intergroup transfers and a reorganisation of Company B Limited’s share capital (notably creating separate classes), the share capital held by Mr D is cancelled and the shares in Company A Limited are transferred to Newco Limited owned 100% by Mr D. Newco Limited subsequently issues shares to Mr D as consideration. Newco Limited pays Stamp Duty at 0.5% on the market value (‘MV’) of the shares in Company A Limited it has received.  Mrs C now owns 100% of Company B Limited and therefore obtains control.

As Mrs C has obtained control of Company B Limited and it is reasonable to assume that this was one of the purposes of the arrangements (the arrangements include the share for share exchange imposing Company B Limited), this would be a disqualifying event under s77A Finance Act 1986. Therefore, on imposing Company B Limited as the holding company, s77 FA 1986 relief would not be due, meaning Stamp Duty is payable on the share for share exchange at 0.5% of the MV of Company A Limited by Company B Limited.

Therefore, as the reconstruction would not have qualified for reconstruction relief under s75 FA 1986, the Stamp Duty would be payable on the share for share exchange (payable by Company B Limited) AND on the acquisition of Company A Limited by the Newco (payable by the Newco).

However, for instruments executed on or after 22nd July 2020, s77A FA 1986 does not apply where the person obtaining control holds at least 25% of the target company (the company whose shares are being acquired on exchange, in this case Company A Limited) throughout the three years prior to the exchange.

Looking back at the example above, the analysis of s77 FA 1986 relief changes as follows:

Exchange takes place on 31st May 2020 Exchange takes place on 31st May 2021
Mrs C acquired 25% or more on 1st January 2018 No relief under s77 as obtaining control is a ‘disqualifying event’ under s77A. Relief under s77 available as held at least 25% throughout the relevant period of 3 years.
Mrs C acquired 25% or more on 1st January 2019 No relief under s77 as obtaining control is a ‘disqualifying event’ under s77A. As 25% not held throughout the relevant period of 3 years, s77A applies to block relief under s77.

 

An explanation of these changes as they relate to a capital reduction demerger, together with four examples, can be seen in HMRC manuals from STSM042520 onwards.

Please note that the Finance Act 2020 Stamp Duty relief changes do not alter the CGT reliefs available on a share for share exchange (via s135 TCGA 1992) or on a scheme of reconstruction (s136 and s139 TCGA 1992).

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