What measures should be taken to best prepare for a corporate reorganisation?
Planning the reorganisation prior to its commencement is key. Where the optimisation of the capital structure (including funding and tax) is a significant driver for a reorganisation, accounting and tax leads will typically design an outline of the reorganisation with its objectives in mind, sometimes setting out proposed steps for achieving those results. Where the steps are specified, legal advisers will need to analyse the proposed steps to establish their feasibility from a legal perspective. Where detailed steps are not specified, legal advisers will need to assess and advise on the available options. In either case, tax and legal advisers typically need to work together to create a plan that implements the group’s reorganisation objectives.
Although corporate reorganisations are primarily intra-group transactions, they must nonetheless be considered and planned carefully, as a number of internal and external stakeholders are likely to be interested in their objectives and implementation. Communication with key stakeholders is therefore important and should be considered early in the planning stage. Employees in particular may be very sensitive to the implications of a reorganisation and worry about their job security. Auditors will need to review and assess the transactions undertaken and the way they have been accounted for during the course of their annual audit, and tax authorities may do the same from a tax perspective. Prospective buyers will normally undertake due diligence where a pre-sale corporate reorganisation has been undertaken and will want comfort that the transactions were properly undertaken, that the correct assets and liabilities are held in the target group, and that the reorganisation has not resulted in the target group inadvertently incurring liabilities. Commercially, customers and suppliers may be concerned about their trading partners’ financial stability and reliability, and contracts or assets may not be capable of transfer without a consent or waiver from contractual counterparties, particularly where prohibitions on assignment or subcontracting do not contain a carve-out for intra-group transactions. Lenders (particularly those holding security over affected companies or assets) may need to be consulted and their approval sought under the terms of finance or security documents. In these circumstances, the lenders will need to be satisfied that their risk exposure or security position is not adversely impacted by a proposed reorganisation.
In order to plan with all the above in mind, a preparatory due diligence or information gathering exercise is helpful in ensuring the re-organisation is structured and implemented optimally. The number of issues to consider means that larger reorganisations require extensive coordination and project management.Employment issues
What are the main issues relating to employees and employment contracts to consider in a corporate reorganisation?
The impact of a reorganisation on employees depends on how it is structured. If a reorganisation is effected through transfers of shares and employees remain with their existing employers, the reorganisation should have a limited impact on those individuals, and their terms and conditions of employment. However, if a reorganisation will result in employees transferring between group companies, this is likely to constitute an employee transfer under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). TUPE requires a prescribed informational process (and, in certain circumstances, a consultation process) to be carried out with employee representatives prior to the transfer, and generally restricts changes to employee terms and conditions, and redundancies in connection with the transfer.
Aside from any TUPE transfer, another possible outcome of a reorganisation might be employee redundancies. If so, a pre-redundancy consultation process would need to be undertaken with, or on behalf of, the relevant employees in accordance with UK law and redundancy payments would be payable (either on a statutory minimum or company-specific enhanced basis). If 20 or more employees are being made redundant, a consultation period of a minimum of 30 days will apply prior to the redundancies being implemented.
What are the main issues relating to pensions and other benefits to consider in a corporate reorganisation?
The key issue to consider is whether the group operates, has operated, or is a participant in a DB Plan, and whether the reorganisation is being undertaken in connection with an M&A transaction. In any case, the impact of the reorganisation on the DB Plan should be assessed and, where necessary, addressed. If a company that participates in a group pension plan is to be sold to a third-party purchaser (with the pension plan staying behind with the retained seller group), in practice, the departing company will need to cease participation in the pension plan. If so, its pension liabilities can be apportioned on a contingent basis to one or more group companies that will continue to participate in the pension plan. The UK Pensions Regulator (the Regulator) and the pension plan trustees are likely to play an important role in this process. Appropriate legal, financial and actuarial advice may need to be obtained by the group before implementing a reorganisation, particularly where a DB Plan is involved.
No formal consent is needed from the Regulator in relation to re-organisations. However, if the Regulator considers that a reorganisation is materially detrimental to a DB Plan, it has statutory ‘moral hazard’ powers, which it can seek to exercise against the group (and any other connected parties, wherever located in the world) to require additional funding or other financial support to be put in place to support the DB Plan. This can be up to the level of the DB Plan’s buyout deficit (ie, the cost of securing liabilities in full with an insurance company). The Regulator has been increasingly interventionist in its approach in recent times, particularly in relation to M&A transactions, so reorganisations undertaken in contemplation of M&A transactions may come under increased scrutiny and should be planned with the M&A process in mind. The Regulator operates a voluntary ‘clearance’ process, which allows groups to seek confirmation that the Regulator will not exercise its moral hazard powers in connection with a reorganisation.
The consent of the trustees of the DB Plan is likely to be required if the reorganisation will result in any group company ceasing to participate in the DB Plan (for example, if that company is being substituted for another group company as a participating DB Plan employer). The trustees’ consent should generally not be required for any reorganisation steps as such. However, the trustees will need to be informed of any material corporate activity within one month of this taking place and, if they are concerned about the impact of the reorganisation on a DB Plan, they may seek to exercise any powers available to them (such as to demand additional employer contributions to the DB Plan) or involve the Regulator.
In relation to other employee benefits (including defined contribution pension arrangements), the impact of the reorganisation is unlikely to have a material impact from a legal perspective, although it may still need to be addressed. For example, if employees are transferring under TUPE from one group company to another, the receiving employer will need to ensure it has suitable benefit arrangements in place for provide the transferring employees. The impact of the reorganisation on any share incentive arrangements will also need to be evaluated (eg, whether the reorganisation will result in the accelerated vesting of any employee share options).Financial assistance
Is financial assistance prohibited or restricted in your jurisdiction?
The historic prohibition on the giving of financial assistance by a company in connection with the acquisition of its shares by a third party was repealed in respect of private companies on 1 October 2008. Therefore, the current position under English law is that private companies that are not part of group involving a public company may give financial assistance to fund a third party’s acquisition of its or its parent company’s shares.
The position is different in relation to public companies, which are prohibited from giving financial assistance for the purpose of the acquisition of their shares or shares in a parent company. This prohibition also prevents private company subsidiaries from financially assisting such acquisition of shares in a public company that is its parent company. The term ‘financial assistance’ is broadly defined and can include (without limitation) cash payments, gifts, loans, transfers above or below fair market value, asset transfers, incurring liabilities, releasing debts and providing security.
Where a reorganisation involves the acquisition of shares in a public company or its parent, it is essential to ensure that the parties involved comply with the relevant provisions of the CA 2006. A breach of the financial assistance prohibition may result in fines, and directors may face fines or prison terms of up to two years, or both. In 2017, four former executives at a major listed UK bank were charged with criminal offences in relation to the giving of unlawful financial assistance during the financial crisis in 2008.Common problems
What are the most commonly overlooked issues or frequently asked questions in a corporate reorganisation?
One common area of difficulty is in relation to ‘capital contributions’ (ie, contributions to the capital of a company without the issuance of shares). Capital contributions are common in some jurisdictions, but are a source of uncertainty and confusion in England owing to a lack of statutory framework (the CA 2006 makes no reference to capital contributions) and conflicting guidance regarding their treatment from tax and accounting authorities, and in case law.
HM Revenue & Customs’ (HMRC’s) guidance manual states that capital contributions are ‘occasionally’ made and proposes that they should be treated as either ‘distributable reserves . . . as a gift or a donation’ or, where such payment may be repayable in any circumstances, as a loan. The Privy Council case of Kellar v Williams states that ‘if the shareholders of a company agree to increase its capital without a formal allocation of shares, that capital will become, like share premium, part of the owner’s equity, and there is nothing in the company law of . . . England to render their argument ineffective’, indicating that a capital contribution should go to a non-distributable reserve. Finally, the guidance in the technical release on realised and distributable profits issued by the Institute of Chartered Accountants in England and Wales in April 2017 states that a capital contribution will be treated as a realised profit (thereby increasing distributable reserves) where it is received in the form of ‘qualifying consideration’. The question of whether consideration is qualifying is not always straightforward, as the definition of ‘qualifying consideration’ includes cash, assets readily convertible into cash, the release, settlement or assumption of liabilities by a third party and various other forms of consideration that are essentially ‘cash-like’ by nature, but these may need to be set off against any liabilities contributed.
As a result of the uncertainty surrounding capital contributions, tax, accounting and legal advice should always be sought where capital contributions are proposed, and the terms on which a capital contribution is given and received should be clearly documented and recorded.
Other common issues include, in relation to employment and pensions, the need to consider the powers of the UK Pensions Regulator and pension plan trustees in any reorganisation involving a DB Plan and the application of TUPE. The internal flow of services and licences, and the changes that arise as a result of a reorganisation, are also commonly overlooked. Developments in recent years in relation to data protection also need to be considered to ensure changes in the flows of personal data resulting from the reorganisation are compliant and accurately reflected in policies and consents.
Accounting and taxAccounting and valuation
How will the corporate reorganisation be treated from an accounting perspective? How are target assets and businesses valued?
The accounting treatment will depend on the precise steps carried out as part of the reorganisation. As seen above in relation to capital contributions, the accounting treatment may not be straightforward, so it is important to obtain accounting advice before undertaking a re-organisation to ensure the desired accounting outcomes are achieved. In addition, where distributions are contemplated, it may be necessary or desirable to obtain assistance from accountants in verifying both whether the relevant companies have sufficient distributable profits, and whether distributions received from subsidiaries may be treated as realised profits (and whether an impairment in the book value of the subsidiary making the distribution should be made as a result of the distribution).Tax issues
What tax issues need to be considered? What are the tax implications of carrying out a corporate reorganisation?
Specific tax advice should always be obtained in good time during the planning phase of the reorganisation, and the documents implementing a reorganisation should be reviewed from a tax perspective to ensure the desired tax treatment is achieved. This is important because reorganisations can impact taxation at both the corporate group level (in terms of the reorganisation steps and also in terms of the tax profile of the group going forwards) and shareholder level. Depending on where the relevant group companies and shareholders are based, consideration may need to be given to non-UK as well as UK tax systems.
In principle, some of the key aims of any tax structuring will be to avoid the incurrence of any ‘dry’ tax charges caused by the reorganisation (ie, the triggering of a tax charge where the liable entity has not received any corresponding income or gain that would enable it to pay the tax charge), and also to minimise or eliminate any transfer taxes or stamp duty that may be incurred as a result of the reorganisation steps. These aims can often be achieved through relying on various reorganisation exemptions provided for in tax legislation, but care is typically required to ensure that such exemptions are available. It is, therefore, important for tax advisers to work closely with the legal advisers drafting the documentation for implementing the reorganisation steps and review its terms to ensure the desired tax treatment is achieved.
It is usually permissible for companies forming a group for capital gains purposes to transfer assets on a tax-neutral basis. The intention of this is to treat companies in the same group as one taxable entity. It should be noted that when an intra-group transfer is on a no-gain, no-loss capital gains basis, there may be a de-grouping charge if one of the companies in the group exits within six years of the transfer.
While usually not mandatory, consideration should be given to whether any tax authority filings or clearances are desirable in connection with a proposed reorganisation, particularly where the application of exemptions or relief is essential to avoid a dry tax charge.
In addition, in July 2013 the Organisation for Economic Co-operation and Development (OECD) published an Action Plan on ‘Base Erosion and Profit Shifting’ (BEPS). Its 15 ‘actions’ are aimed at providing an international framework to address and combat international tax avoidance. Over recent years OECD and G20 countries have introduced a number of tax measures aimed at implementing the BEPS project. For example, in response to Action 4, the UK introduced new rules with effect from 1 April 2017 that limit the amount of interest that may be deductible for corporation tax purposes for large UK groups. There is now a greater focus on BEPS when structuring new transactions, and it is likely that larger corporate groups will continue to review their internal funding structures and react accordingly in light of recent and future developments.