COMPANY MERGERS - 22.12.2020

How to structure a company merger tax efficiently

Scenario

Your client operates in the leisure and tourism sector and has been adversely affected by the current economic climate. It has had to make redundancies due to the downturn in trade, but fear that might not be enough if things continue as they are. In an effort to protect the longevity of the company, your client has agreed to merge with a competitor company which has similarly been affected, in order to produce a stronger, more robust entity.

The terms of the companymerger are that a brand-new company (Newco) will be formed into which the trade and assets of each company will be transferred. The companies will then be dissolved. Newco will be run as a joint venture on a 50:50 basis, with the shareholders of each company becoming equal shareholders in Newco. No payment for the transfer of assets will be made by either company.

Mergers

Unlike with demergers there is no statutory provision specific to a merger of two trading companies. However, Schedule 5AA Taxation of Chargeable Gains Act 1992(TCGA) (see Follow up ) defines a scheme of reconstruction as meaning “a scheme of merger, division or other restructuring” . Therefore, a merger would appear to involve a scheme of reconstruction, but what is one and how will it help your client with its merger?

Qualifying reconstruction

There are a number of conditions which must be met for a transaction to qualify as a scheme of reconstruction.

Issue of ordinary share capital. There must be an issue of ordinary share capital by at least one transferee company to shareholders of the transferor company.

Equal entitlement to new shares. The share issue by the transferee company must be pro rata to the shareholdings of the relevant classes of share in the transferor company.

Pro advice. Both of these conditions must be met, along with either of the following two further conditions.

Continuity of business. The business carried on by the transferor company must subsequently be carried on by one or more successor companies.

Compromise or arrangement with members. There must be a scheme or arrangement under Part 26 Companies Act 2006 - this will not be relevant in your client’s circumstances.

The businesses of your client and its competitor will continue in Newco following the companymerger , so as long as Newco issues ordinary shares to the shareholders of each company in proportion to their existing shareholdings, the merger will meet conditions 1, 2 and 3, and so will be a qualifying scheme of reconstruction.

Company CGT relief

Companies pay corporation tax on their chargeable gains, rather than capital gains tax (CGT), so at first glance the term “company CGT relief” may seem out of place. However, because the CGT legislation governs the majority of how those gains are calculated, what we are really talking about is relief from the transaction triggering a chargeable gain under the CGT legislation. Ordinarily, the transfer of chargeable assets out of a company would trigger chargeable gains on the disposal. However, s.139 TCGA provides relief where there is a reconstruction involving the transfer of a business.

Pro advice. Where s.139 applies, the transfer of assets to Newco will be on a no gain, no loss basis, such that your client will not be chargeable to corporation tax on the disposal and Newco will acquire the assets at your client’s original cost, plus any indexation (up to December 2017).

For s.139 to apply, the following conditions must be met:

• there must be a qualifying scheme of reconstruction involving the transfer of the whole or part of a company’s business to another company
• the companies must be UK tax resident, or within the charge to UK corporation tax on chargeable gains; and
• the transferor company must not receive any consideration for the transfer, other than taking over the liabilities of the business.

Pro advice. The no gain, no loss treatment is only for chargeable assets, e.g. land and buildings; it does not apply for other assets such as stock or plant and machinery. The usual rules on the cessation of trade will apply to those assets, with market value disposal amounts needed.

Pro advice. If there are land and buildings being transferred as part of the merger, providing the businesses are both trading, acquisition relief for stamp duty land tax (SDLT) should be possible which would reduce the charge to 0.5%.

The shareholders’ CGT position

When it comes to the shareholders of your client, they will be making a disposal of their shares when the company is dissolved following the companymerger . As we have already seen, the merger will be a scheme of reconstruction and therefore the relief in s.136 TCGA can apply to treat the disposal as part of a reorganisation of share capital.

Pro advice. Satisfying the conditions of s.136 will mean the reorganisation of share capital rules apply, such that the shareholders of your client will not be treated as having disposed of their shares. Instead, the shares issued to them in Newco will be treated as having been acquired at the same time and for the same price as the original shares in your client. To put it another way, the new shares “stand in the shoes” of the original ones.

In order for s.136 relief to apply, the following conditions must be met:

• there must be an arrangement between a company and its shareholders
• the arrangement must be entered into for the purposes of a scheme of reconstruction
• another company must issue shares to the shareholders of the first company pro rata to their shareholdings in that company
• the shares in the first company are retained by the shareholders, are cancelled or otherwise extinguished.

Distribution risk

In the absence of a specific relief in the case of a merger, HMRC may try to argue that the transfer of assets for shares is a distribution in specie, and therefore chargeable to income tax. One option to protect against this is to formally liquidate the original company as part of the merger, as protection will then be provided by s.1030 Corporation Tax Act 2010 . However, this might make the transaction prohibitively expensive, depending on your client’s circumstances.

Alternative

A better option might be to have Newco act as the parent of both companies. The trade and assets of each company can then be hived up into Newco, and group relief claimed for corporation tax, SDLT, and for the cessation of trade rules regarding stock and capital allowances. The companies can then be informally dissolved afterwards.

Newco can be placed as the parent company via a share-for-share exchange with your client, and then again with the competitor company. However, it is likely that a stamp duty charge will be triggered on at least one of the exchanges, as the shareholdings in Newco will not match those of either original company as required.

Pro advice. It might be possible to avoid this by using a capital reduction as discussed in the Practice Points included with Yr. 6, Iss. 4 (see Follow up ).

Follow up   https://www.tips-and-advice.co.uk , Download Zone, yr.07, iss.08