Following changes to the Companies Act that came into force last week, it is no longer possible to save stamp duty on the takeover of a Main Market company by structuring the transaction as a scheme of arrangement in which the target’s existing shares are cancelled and new shares are issued to the bidder (a cancellation scheme). Takeovers can still be structured as a scheme of arrangement in which the target’s existing shares are transferred to the bidder, but stamp duty will be payable on such a transfer in the same way as on a takeover that is structured as a conventional offer – i.e. where the target’s shares are listed on the Main Market stamp duty will be payable at 0.5% of the consideration. (Stamp duty does not apply to transfers of AIM shares.)
As a result, one of the key advantages of using a scheme of arrangement on the takeover of a Main Market company has been removed. Bidders will therefore need to weigh up whether the other advantages of using a (transfer) scheme - e.g. that the bidder will be certain of acquiring 100% of the target once the scheme is approved by (broadly speaking) 75% of the target’s shareholders - outweigh the additional costs of instructing counsel, court fees etc and the other disadvantages of using a scheme. Although schemes will continue to be used, more takeovers are now likely to be structured as conventional offers.
Although the prohibition on cancellation schemes is designed to close a loophole in the stamp duty regime, it has been introduced not via changes to the stamp duty legislation but via changes to the principal section in the Companies Act 2006 that deals with reductions of capital (section 641). According to the Government, this is because of legal constraints arising from the EU Capital Duties Directive, which prohibits the taxation of new share issues.
Section 641 sets out the circumstances in which a company can reduce its share capital. Public companies can reduce their share capital only if the reduction is (i) approved by a special resolution passed at a general meeting of shareholders; and (ii) confirmed by the court at a special hearing (the court hearing). Private companies can reduce their share capital either by following the same court-sanctioned procedure as public companies or, much more commonly, by following a simpler procedure that requires a special resolution of shareholders, and a “solvency statement” made by the directors, but no court involvement. A reduction of capital does not take effect until certain documents are registered at Companies House.
To be effective, a scheme of arrangement must be approved by shareholders at a special meeting convened at the direction of the court (the court meeting) and then sanctioned by the court, and a copy of the court’s order sanctioning the scheme must be delivered to Companies House. So where a takeover is structured as a cancellation scheme, target shareholders must approve both the scheme itself (at the court meeting) and the associated reduction of capital (at a general meeting, usually held immediately afterwards) and the court must approve the scheme (typically at a first court hearing) and the reduction of capital (often at a second court hearing, usually held a couple of days later). The reduction of capital forms part of the terms of the scheme. It is very rare for the acquisition of a private company to be structured as a scheme of arrangement.
Generally, companies have great flexibility to reduce their share capital in whatever way they choose. But section 641 now stipulates that, whichever procedure is used, a company may not reduce its share capital as part of a scheme of arrangement by virtue of which a person (or its associates) is to acquire all the shares in the company, or all the shares of a particular class (other than shares which the person or its associates already hold). For public companies, this means that the court will no longer approve a reduction of capital that is part of a scheme of arrangement. For private companies using the out of court procedure, it means that – presumably - Companies House will not register a reduction of capital if it is part of a scheme of arrangement (and even if such a reduction were registered it would not be valid).
Carved out from the prohibition, however, are reductions of capital that are part of a scheme of arrangement to insert a new holding company on top of the group. This is provided that all or substantially all of the members of the company that is effecting the scheme become members of the new holding company and their proportionate shareholdings remain substantially the same. Such corporate reorganisations are sometimes carried out where, for example, the board decides that there would be tax advantages for the company and its shareholders if the parent company were to be incorporated and controlled from overseas.
The prohibition applies to takeovers in respect of which a “firm offer” announcement (as required by the Takeover Code) is made after 4 March 2015. For companies not subject to the Takeover Code, the prohibition does not apply to any takeover where the terms of the takeover were agreed between the parties before that date.
Schemes vs conventional offers
Over the last 10 years or so, the majority of larger recommended bids have been structured as cancellation schemes, often because the savings in stamp duty significantly outweigh the costs and other potential disadvantages of using a scheme. We expect many bids still to be structured as (transfer) schemes mainly because of the advantage noted above that, once the scheme is approved by (broadly speaking) 75% of those target shareholders who attend and vote at the court meeting and sanctioned by the court, it becomes effective and the bidder becomes the owner of 100% of the target’s shares. By contrast, to acquire 100% under a conventional offer the bidder must get acceptances from (broadly speaking) 90% of the target’s shareholders. However, this advantage, and the other advantages of a scheme, will now sometimes be outweighed by the higher costs and other potential disadvantages of a scheme.
Availability of rollover relief on certain share for share offers
Where target shareholders are offered shares in the bidder as consideration, they will usually want to obtain capital gains tax rollover relief on the shares element of the consideration. This will prevent a “dry” tax charge crystallising on the disposal of their target shares to the extent that they have not received cash with which to pay the tax. If the bid vehicle is a subsidiary of the acquiring group, but the consideration shares are to be issued by the parent company (as would be usual), previously rollover relief would have been available under section 136 of the Taxation of Chargeable Gains Act 1992 if the takeover was structured as a cancellation scheme. The ban on cancellation schemes will therefore mean that, where the consideration includes shares issued by the parent of the bid vehicle, rollover relief will be available only if the conditions in section 135 TCGA can be met. In some cases this may create practical difficulties. For further information see the note published in February 2015 by the Corporate Law Sub-Committee of the Law Society.
The changes to section 641 of the Companies Act 2006 were introduced by The Companies Act 2006 (Amendment of Part 17) Regulations 2015, which came into force on 4 March 2015.