ICI/Zeneca: Structure of the demerger
At the end of February, ICI formally announced that it would be asking shareholders to approve the demerger of its bio-science business to a newly formed publicly listed company, ZENECA Group PLC (ZENECA). ICI shareholders will receive one ZENECA share for each ICI share that they hold.
After a massive internal reorganisation, the ZENECA business has been operating separately since the beginning of this year. The demerger will be effected by ICI declaring a dividend to be satisfied by ZENECA issuing shares to ICI shareholders in consideration for the transfer of the bio-science business to ZENECA.
This structure - a so-called three-cornered demerger - has been used for a number of high profile demergers in recent years (Courtaulds/Courtaulds Textiles, BAT/Argos), mainly for tax reasons.
Technically a parent company could effect a demerger simply by declaring a dividend to be satisfied by the distribution of shares in the subsidiary to be demerged to its shareholders. But the parent would be treated for tax purposes as disposing of its demerged subsidiary at market value and may therefore incur a substantial liability to corporation tax on chargeable gains.
But where there is a transfer of assets between two companies (in this case ICI and ZENECA) as part of a reconstruction or amalgamation, relief from capital gains can be obtained even if companies are not part of the same capital gains group if certain conditions are fulfilled (section 139 Taxation of Chargeable Gains Act 1992). By taking advantage of this relief, ICI should be able to avoid the charge to corporation tax on capital gains that arises on the disposal of the bio-science business.
The distribution of shares by ZENECA to ICI shareholders should also be tax efficient. Before the introduction in 1980 of tax legislation to encourage demergers (now contained in sections 213-218, Income and Corporation Taxes Act 1988) dividends such as that to be paid by ICI would always have been treated as a qualifying distribution. As a result, ICI would have been liable to pay advance corporation tax on the dividend and ICI shareholders would have been treated as receiving income equal to the aggregate of the market value of the shares issued by ZENECA and the related advance corporation tax.
The legislation introduced in 1980 provides that certain types of distribution which are made to effect a demerger are to be treated as "exempt distributions" and thus avoid the above tax consequences if a number of conditions are fulfilled (section 213, Income and Corporation Taxes Act 1988).
One problem that ICI seems unlikely to be able to circumvent relates to the position of trustee shareholders. Owing to a 1930 Privy Council decision, ZENECA shares are likely to be treated as income in the hands of trustees.
Where there is a life tenant under a trust, trustees are generally under a duty imposed by the trust deed to pay income to the life tenant as it arises. If they do not, they are likely to be in breach of trust.
If shares are distributed to a life tenant, the Inland Revenue will probably attribute a nil-base cost to them. On disposal, the life tenant would therefore be liable to pay capital gains tax on the entire proceeds.
A further consequence of distributing shares to a life tenant may be an action by those entitled to trust assets after the life tenant's death (remaindermen). Trustees are under a common law duty to make investments so that the life tenant receives a "reasonable" income while preserving the capital for remaindermen. If the trust portfolio is substantially diminished by the distribution of shares to the life tenant, trustees may be in breach of this duty.
ICI has supported representations to the Lord Chancellor's department for consideration to be given to changes to the law but it is unlikely that any changes will be made before the demerger, currently expected in June. CJM
(For articles on demergers, see "The Vodafone and Chubb demergers", PLC, 1990, I(1), 7.)
The following diagram is also available in the PDF version of this article:
- A "three cornered" demerger