In my previous commentary on this topic (Tax Journal, 25 September 2026), I referred to some aspects of HMRC’s current consultation on modernising the taxation of distributions, including the proposal to ‘freeze’ the level of capital treated as paid up on shares issued as part of a share exchange or a reconstruction.
That proposal could have a dramatic effect on the ability of companies and corporate groups to undertake certain demergers and divisions which involve a reduction of capital. The consultation paper acknowledges this. Its solution is possible improvements to the statutory demerger regime that is found in CTA 2010 Part 23 Chapter 5.
Under that regime, certain demergers by distribution in specie qualify as ‘exempt distributions’. Exempt distributions are not treated as income distributions for tax purposes. They also qualify for various other reliefs. For example, some direct demergers are treated as reorganisations for CGT purposes, the CGT and intangible fixed asset degrouping rules do not apply, and an exempt distribution is not a capital distribution.
Despite all these potential benefits, the statutory demerger regime is distinctly unattractive and rarely used. The main reasons are that it is littered with conditions which restrict its availability and many of the reliefs can be clawed back if a ‘chargeable payment’ is made within the five years following the demerger. It is best avoided if there is a suitable alternative.
For many years, there has been a suitable alternative: a demerger by way of a reduction of capital. The Government’s proposals will remove that alternative for many companies and corporate groups. The suggestion in the consultation paper is that a reformed statutory demerger regime will fill the gap. In its suggested form, it will not.
The Government is proposing to relax many of the conditions that currently surround the statutory demerger regime. But two important restrictions remain.
The first is a proposal to replace condition D in CTA 2010 s 1081(5) – which currently specifies, amongst other things, that a statutory demerger cannot be used to facilitate an onward sale and that there should be no change of control following a statutory demerger – with a clawback of reliefs where there is an onward sale or a change of control within five years of a demerger.
The second is that the chargeable payment regime remains.
The revised condition D will prevent the revised regime from forming the basis for many break-up transactions or divisions. Even in a simple reconstruction demerger, the condition is deeply unattractive. Who can tell if the perfect onward sale transaction will not emerge within the next 12 months, three years or five years? The five-year rule is arbitrary. And what does it achieve other than to stifle genuine corporate activity? Provided the overall effect of the demerger is neutral so that the shareholders roll their existing base cost in shares in the original companies into their shares in the entities that survive after the demerger and they pay tax on any onward disposal of shares by reference to that base cost, what is the abuse?
As for the retention of the chargeable payment rules, they are currently a significant disincentive to the use of the statutory demerger regime. They are little understood and arbitrary in their effect. They should be repealed. The true target of the chargeable payment regime – the abuse of tax attributes created by the demerger transaction – can be better addressed through a revised and reformed transactions in securities rule.
The proposal to reform the statutory demerger regime is being hampered by the architecture of the existing regime. Most demerger transactions seek to achieve the same thing – the same assets, held by the same ultimate shareholders, but with no material shifts in value between them. If, as a policy matter, it is decided that a demerger that meets certain conditions should benefit from tax-neutral treatment, why should the conditions not be broadly the same across all relevant taxes? The conditions for a revised statutory demerger regime could sensibly be based, for example, on the conditions for reconstruction treatment for tax on capital gains in TCGA 1992 Sch 5AA.
If that approach were adopted, in simple terms, the requirements might be:
the demerged entity’s ordinary shares are issued or distributed to holders of ordinary shares in the distributing company;
the share issue/distribution is pro rata to existing holdings of ordinary shares or any class of ordinary shares in the distributing company;
the demerged entity must be carrying on a business which continues after the demerger;
any business within the scope of UK corporation tax at the start of the process must remain within the scope of UK corporation tax at the end of the process.
The regime could be subject to a main purpose test, with a clearance procedure available. Simple.
Home >Articles > Modernising the taxation of distributions
Modernising the taxation of distributions
Why is breaking up so hard to do?
In my previous commentary on this topic (Tax Journal, 25 September 2026), I referred to some aspects of HMRC’s current consultation on modernising the taxation of distributions, including the proposal to ‘freeze’ the level of capital treated as paid up on shares issued as part of a share exchange or a reconstruction.
That proposal could have a dramatic effect on the ability of companies and corporate groups to undertake certain demergers and divisions which involve a reduction of capital. The consultation paper acknowledges this. Its solution is possible improvements to the statutory demerger regime that is found in CTA 2010 Part 23 Chapter 5.
Under that regime, certain demergers by distribution in specie qualify as ‘exempt distributions’. Exempt distributions are not treated as income distributions for tax purposes. They also qualify for various other reliefs. For example, some direct demergers are treated as reorganisations for CGT purposes, the CGT and intangible fixed asset degrouping rules do not apply, and an exempt distribution is not a capital distribution.
Despite all these potential benefits, the statutory demerger regime is distinctly unattractive and rarely used. The main reasons are that it is littered with conditions which restrict its availability and many of the reliefs can be clawed back if a ‘chargeable payment’ is made within the five years following the demerger. It is best avoided if there is a suitable alternative.
For many years, there has been a suitable alternative: a demerger by way of a reduction of capital. The Government’s proposals will remove that alternative for many companies and corporate groups. The suggestion in the consultation paper is that a reformed statutory demerger regime will fill the gap. In its suggested form, it will not.
The Government is proposing to relax many of the conditions that currently surround the statutory demerger regime. But two important restrictions remain.
The first is a proposal to replace condition D in CTA 2010 s 1081(5) – which currently specifies, amongst other things, that a statutory demerger cannot be used to facilitate an onward sale and that there should be no change of control following a statutory demerger – with a clawback of reliefs where there is an onward sale or a change of control within five years of a demerger.
The second is that the chargeable payment regime remains.
The revised condition D will prevent the revised regime from forming the basis for many break-up transactions or divisions. Even in a simple reconstruction demerger, the condition is deeply unattractive. Who can tell if the perfect onward sale transaction will not emerge within the next 12 months, three years or five years? The five-year rule is arbitrary. And what does it achieve other than to stifle genuine corporate activity? Provided the overall effect of the demerger is neutral so that the shareholders roll their existing base cost in shares in the original companies into their shares in the entities that survive after the demerger and they pay tax on any onward disposal of shares by reference to that base cost, what is the abuse?
As for the retention of the chargeable payment rules, they are currently a significant disincentive to the use of the statutory demerger regime. They are little understood and arbitrary in their effect. They should be repealed. The true target of the chargeable payment regime – the abuse of tax attributes created by the demerger transaction – can be better addressed through a revised and reformed transactions in securities rule.
The proposal to reform the statutory demerger regime is being hampered by the architecture of the existing regime. Most demerger transactions seek to achieve the same thing – the same assets, held by the same ultimate shareholders, but with no material shifts in value between them. If, as a policy matter, it is decided that a demerger that meets certain conditions should benefit from tax-neutral treatment, why should the conditions not be broadly the same across all relevant taxes? The conditions for a revised statutory demerger regime could sensibly be based, for example, on the conditions for reconstruction treatment for tax on capital gains in TCGA 1992 Sch 5AA.
If that approach were adopted, in simple terms, the requirements might be:
the demerged entity’s ordinary shares are issued or distributed to holders of ordinary shares in the distributing company;
the share issue/distribution is pro rata to existing holdings of ordinary shares or any class of ordinary shares in the distributing company;
the demerged entity must be carrying on a business which continues after the demerger;
any business within the scope of UK corporation tax at the start of the process must remain within the scope of UK corporation tax at the end of the process.
The regime could be subject to a main purpose test, with a clearance procedure available. Simple.
