If you're a fast-growing, acquisitive group with private equity (PE) funding, you'll often find yourself collecting legal entities – particularly if you end up with multiple PE stacks, as shown in our diagram. An overly complex group structure is not only an administrative burden but can prove costly. There are additional compliance costs and management time to consider in maintaining entities that may no longer be required.
Example group structure with multiple PE stacks
The long-term benefits of restructuring outweigh the initial cost of the simplification. They usually result in lower annual compliance costs, improved efficiencies, potential removal of dividend blocking entities and a simplified group reporting structure. With fewer entities to manage, management can focus on key business issues.
Rationalising a group is not always straightforward, however, There are accounting, tax and company law requirements to consider as part of the reorganisation. The Companies Act 2006, for example, impacts all UK entities, whether they report under IFRS or FRS 102.
Group simplifications can be achieved by removing intermediate holding companies and consolidating trade carried out across multiple entities into a simplified corporate structure.
Example simplified group structure
This often involves the distributions of investments and trade and other assets to move trade and or entities around the group. To ensure these distributions are lawful, some form of debt or equity restructuring is often required to increase distributable reserves. For example, reduction of share capital or rationalisation of intercompany debt around the group.
These transactions can be complex and challenging to account for. What value should the assets be transferred at? Book value, nominal value, fair market value or somewhere in between? If part of the restructuring involves a share-for-share exchange, how should this be accounted for and at what value?
When restructuring a group, it's essential to have an accounting step plan to run alongside your tax and legal plans. We see many group reorganisations fail as distributable reserves have not been properly considered or understood, for example where only the tax and not the accounting consequences have been considered. Your retained earnings are not always equal to reserves available for distribution. It's not always possible to retrospectively resolve unlawful steps, and this is not something you want when you are in the middle of a transaction and a due diligence process.
In group reorganisations, it's common for entities, or their trade and assets, to be transferred to other entities within the group. This can be done in different ways, including via a sale or distributions "in specie" (meaning "as is", ie, carrying book value) as shown.
Example trade and asset transfer within a group
Intergroup transfers are commonly known as common control transactions. There is guidance (not mandatory) in FRS 102 as to how to account for these. IFRS 3 specifically scopes out accounting for common control transactions. IAS 8 requires management – if there's no specifically applicable standard or interpretation – to develop a policy that's reliable and relevant to the decision-making needs of users. Typically, some form of predecessor or merger accounting is used. This is similar to the FRS 102 guidance. This allows the transferred business or asset to be recognised at its previous carrying value with no need for valuations or recognition of additional goodwill or other intangibles.
As with all steps, you'll need to consider distributable reserves, particularly if this is a transfer at an undervalue.
A step that is often overlooked is the requirement for an impairment review. This can be critical if there's an intermediate holding company that no longer has the subsidiary in its ownership perimeter. For distributions to be lawful, these must also be lawful through intermediate holding companies. If the transfer results in an impairment, this can eliminate distributable reserves in the intermediate holding company making the distribution or sale at below fair market value unlawful.
Impairment considerations
Group reorganisations may involve inserting a new holding company or a capital reduction demerger in anticipation of a future disposal as shown. These are commonly undertaken via a share-for-share exchange, and there are various mandatory and optional share premium reliefs under the Companies Act 2006 (sections 611-615).
Share-for-share exchange issues
The application of these reliefs can impact future distributable reserves, carrying value of the investments in the parent company's separate financial statements and therefore any future impairment risk. Management should ensure that it understands the available reliefs and applies them in a way that provides the best future outcome from an accounting and distributions perspective.
This is an area where the Companies Act 2006 requirements can result in different accounting between FRS 102 and IFRS. The interaction with FRS 102 results in more flexibility in the value of the investment that must be recorded in the parent company financial statements. IFRS is more prescriptive and may require using net asset values.
It's common for loans and other intercompany balances to be forgiven or waived in group reorganisations. Tax advice should always be taken in these situations and the accounting – as a distribution, capital contribution or increase in the value of the investment in the subsidiary – may impact the tax analysis.
Where the parent has waived the debt, this should be accounted for as an increase in its investment in its subsidiary. While this isn't expected to result in an impairment – as the subsidiary has an equal and opposite increase in value due to reduction in its liabilities – this step is important to consider given its potential impact on distributable reserves.
The subsidiary that benefits from the waiver would account for this in accordance with the facts and circumstances of the transaction. This is likely to be a capital contribution directly to reserves.
Group reconstructions can often lead to the recognition of profits from the transfer of assets or from distributions received. The Institute of Chartered Accountants in England and Wales (ICAEW) has produced guidance (Tech 02/17) on what constitutes distributable profits. Management should consider this guidance when approving a subsequent distribution of these profits. If these aren't readily convertible to cash (qualifying consideration) then the profits made, or distribution received, won't be realised and therefore won't be available for onwards distribution.
A common way to create distributable reserves in a group reconstruction is to perform a capital reduction which enables share capital and share premium to be converted to distributable reserves. The Companies (Reduction of Share Capital) Order 2008 SI 2008/1915 sets out the process that should be followed for a reserve arising from a reduction in a company’s share capital to be treated as a realised profit as a matter of law. This statutory instrument requires that the capital reduction is supported by a statement of solvency. You should always take legal advice if this step is included in your reorganisation. It should be noted that if you are a plc (even if not publicly listed) that the rules are different and court application will be required.
A group reorganisation involves a number of steps so it's important to understand how the steps interact, how distributable reserves are impacted by each step and the level of distributable reserves required to effect a step.
We look at group reorganisations holistically to ensure it all works from an accounting, tax, and corporate simplification perspective. Our financial accounting advisory team also works with lawyers and other advisers, providing accounting step plans to support the tax and legal steps. We support our clients by providing additional bandwidth, either through secondment, or advisory projects, to assist them with navigating the challenges associated with group reorganisations.
If you're anticipating, or have recently undergone, a group reorganisation, get in touch with Jennifer Ilsley or Pinkesh Patel for further insight and guidance.
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