How do you split a business when you fall out with your business partner?

22nd April 2022

If you go about setting up your business relationship in the right way, then you can avoid many of then issues that often arise in the future, if you have a falling out.

If you are trading as a partnership or Limited company it is always a good idea to set up a legally binding partnership agreement, or in the case of a Limited company, get a shareholders agreement drawn up by a solicitor.  These agreements will cover all key aspects of the business and how it is to be divided in the event of a future change in the relationship.

Dissolving a Partnership where there is a Partnership Agreement in Place

Once you have decided to end your partnership, you should check the terms under the partnership agreement. If your partnership agreement is well written, it will contain clauses detailing the triggers that may lead to the dissolution of the partnership and the procedure to be followed to terminate the partnership.

It may also set out a dispute resolution process, which, if followed, may end up resolving the dispute and saving the relationship. However, if dissolution is inevitable, the partnership agreement should set out how assets and liabilities are to be divided and how trading is to be wound up.

 

Dissolving a Partnership where there is no Partnership Agreement in Place

If there is no Partnership Agreement in place, the first thing you must do is cease trading under the current business name.

The dissolution of partnerships where there is no partnership agreement in place will be governed by the Partnership Act 1890 (the Act). Under the Act, the default position is that, without an agreement to the contrary, any one of the partners may issue notice dissolving the partnership and no minimum notice period is required.

 

Looking at the distribution of assets and liabilities on dissolution, the Act sets out the required steps to take, which can be summarised as follows:

 

  • All debts and liabilities of the partnership must be paid
  • Payment of advances made by partners to the partnership must then be repaid
  • Any capital due to the partners is paid
  • After these have been paid, anything left is divided between the partners according to percentage of profits they are due.
  • If there are only losses, then all partners must contribute towards those in accordance with their profit share percentages.

 

More worryingly is that without a partnership agreement you have to rely on the Act but there is nothing expressly written into the partnership agreement to your business partner poaching all the partnership clients and setting up in direct completion with you.

Splitting up a Limited Company

There are many reasons why directors of private limited companies decide to split one company into two or more companies. Often, they are owner-managed or family businesses that have grown such that different members are responsible for separate departments or types of business.  There may be family disagreements that mean members wish to go their separate ways, taking with them the part of the business for which they have been responsible.

A demerger may be relevant prior to selling one or more of the businesses, retaining the remainder. One area of the business may be a higher risk business and would be better suited to separate legal entities. A demerger is also a way to split and separate the liabilities relevant to businesses owned by the company as a whole.

The main aim is to undertake the changes as tax efficiently as possible for both company and shareholders, whilst at the same time ensuring that each company remains trading. It may not always be possible to implement a reconstruction without some resulting tax payment, but income tax and CGT often need not be the ones payable, and it is more likely that stamp duty will be charged. Often, with careful planning, this charge too can sometimes be avoided.

The two main methods by which a company may undertake a demerger without attracting an income tax or capital gains tax charge (although stamp duty or stamp duty land tax may be relevant) is either via an ‘exempt’ demerger or a liquidation demerger.  These both have quite strict requirements, and we can advise on what is most suitable for you if the need arises.

 

Other options for restructuring include:

Reductions in share capital

The ’reduction in capital’ route is sometimes undertaken in preference to the liquidation route because of the negative impact a liquidation can attract, as well as the cost. One method is when a new holding company is incorporated to own the shares of the split companies.

The advantage of this method of reconstruction is that there is no requirement to meet the conditions of the ‘exempt’ statutory distribution provisions, not least for companies that do not have sufficient distributable reserves but do not want to go down the ‘liquidation’ route.

 

With generally no income tax implications, the only concern will be a CGT charge for the shareholders, but this can be deferred

 

‘Share for share’ exchanges 

This may be possible where the intention is for the owners of one business to exchange their interests and receive shares in the new company as consideration. If no actual consideration is received, and values are the same such that there is no additional value transferred, the transaction is effectively just a swap of shares, and as such will not generally attract an income tax charge; nor would CGT implications generally arise if the ‘stand in shoes’ provisions in TCGA 1992, s 135 apply.

In Summary 

A demerger needs to be structured in a way that avoids tax for both shareholder and the original company. Tax exemption is not possible for non-trading companies or when the demerger has been undertaken with a view to change of ownership or possible future sale.

Transactions such as demergers and reconstructions are complex by nature. Specialist advice is essential, and it is usual for such transactions to be undertaken in legal agreements. Advance clearances can be sought whereby HMRC is asked to confirm that the tax provisions have been complied with.

 

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