STSM042550 | Section 77A – Capital Reduction Demergers – Example Demerger and Stamp Duty Implications – Example Three

Targetco was formed five years ago and is owned by members of the Rose Family (50% collectively) and Daisy Family (50% collectively).

The ownership of Targetco is split as follows:

Rose Family (50%):

1. Zak Rose – who holds 25% of the issued shares

2. Zoe Rose – who holds 15% of the issued shares

3. Zahra Rose – who holds 10% of the issued shares

Daisy Family (50%):

1. Wallace Daisy – who holds 20% of the issued shares

2. Wendy Daisy – who holds 20% of the issued shares

3. Wilf Daisy – who holds 10% of the issued shares

The Rose and Daisy families decided to go their separate ways and wish to split the business up between them. They do this by carrying out a capital reduction demerger:

• Step One – A new holding company is inserted

A new holding company (Acquire Co) acquires 100% of the issued share capital of Targetco, through a share for share exchange. The consideration given by Acquire Co is the issue of new shares in proportion to the six shareholders of Targetco (25/15/10- 20/20/10).

• Step Two – Targetco distributes assets to Acquire Co

Targetco declares a dividend in specie to Acquire Co of 50% the trade and assets relating to the business.

• Step Three – Acquire Co reorganizes its share capital

Acquire Co reclassifies its ordinary shares into “R ordinary” and “D ordinary” shares. The R shares (held by the Rose family members) give rights to 50% of the business and assets and the D shares (held by the Daisy family members) give rights to the remaining 50%.

• Step Four – Acquire Co carries out a capital reduction

Acquire Co reduces its share capital. This allows it to make a distribution in specie of its 100% shareholding in Targetco to a new company (Newco). Newco issues shares of equivalent value to the Daisy family members as consideration. The D shares in Acquireco are cancelled.

• Final Structure

• Targetco is owned by Newco, which in turn is owned by the Daisy family members;

• Acquire Co is owned by the Rose family members (Zak 50%, Zoe 30%, Zahra 20%).

Stamp Taxes on Shares Implications

Relief under s.77 FA1986 would not be available on Step One, as at the time the instrument was executed to effect it, there were arrangements in place for “particular persons together” (the Rose family members) to gain control of the acquiring company.

This is because s.77A applies to deny relief as at the time of the share for share exchange (Step One) there are arrangements for “particular persons together” (the Rose family members) to obtain control of the acquiring company (at Step Four).

However, this analysis may be affected by the changes to s.77A FA1986 made by FA2020 (see STSM042460).

This is because they mean that a person who has held at least 25% of the issued share capital in the target company during the “relevant period” is excluded when determining whether a disqualifying arrangement is in existence

Here, Zak Rose held 25% of the issued share capital in Targetco throughout the “relevant period” and therefore is excluded from the tests at s.77A(2)(a) and s.77A(2)(b).

Due to this, there will only be a disqualifying arrangement if Zoe and Zahra Rose (who collectively hold 50% of the shares in Acquire Co) are “particular persons together” who have obtained control of Acquire Co. As on a simple shareholding basis they would not have control (given that Zak Rose also holds 50% of Acquire Co shares) this would need to be considered based on the particular circumstances.

Relief under s.75 FA1986 would also not available on Step Four, as the shareholding does not mirror (see STSM042370).