Demerger by spin-off – over a year of experience and key takeaways

When is a demerger by spin-off an effective restructuring tool?

During the lifecycle of a company, circumstances often necessitate corporate restructuring, which may involve changes to the capital structure, organizational framework, or operational activities to align the business with evolving market conditions and enhance overall efficiency. A demerger by spin-off is particularly advantageous in situations where a company aims to:

• optimize its corporate structure, for instance, by segregating operational and investment activities,
• prepare for the divestiture of a business segment, by isolating specific assets or business units,
• facilitate succession planning, such as transferring part of the business to the next generation,
• mitigate legal risks, for example, by isolating activities with different risk profiles,
• ensure regulatory compliance, particularly where a demerger facilitates adherence to industry-specific regulations.

Our experience indicates that this restructuring method is effective for both large corporations and mid-sized enterprises, particularly in highly regulated sectors (e.g., financial services, energy) and fast-growing technology companies.

What challenges do companies encounter during its implementation?

Despite the flexibility of this mechanism, companies may face several legal and operational challenges, including:

• complexity of the process – the necessity to prepare a comprehensive demerger plan and ensure compliance with the applicable legal framework,
• tax implications – an in-depth legal and tax assessment is required to prevent adverse tax consequences, such as the risk of the demerger being classified as a transaction designed for tax avoidance under anti-abuse provisions,
• regulatory constraints – entities operating in regulated industries must determine whether prior approval from supervisory authorities is required,
• employment law considerations – employees assigned to the spun-off business must be properly transferred to the newly incorporated entity in accordance with applicable labor law provisions.

How does a demerger by spin-off affect existing permits and licenses?

A demerger by spin-off is governed by the principle of universal succession, meaning that the newly established entity assumes the rights and obligations associated with the spun-off business. However, this does not guarantee the automatic transfer of all permits and licenses, as specific industry regulations may impose additional approval or re-issuance requirements. The impact of a demerger by spin-off on permits and licenses is particularly significant in regulated industries (e.g., financial services, pharmaceuticals, energy). The treatment of such authorizations depends on their legal nature:

• certain licenses and permits may transfer automatically if they are linked to the business activity rather than the legal entity itself,
• in other cases, obtaining new regulatory approvals or administrative decisions may be required, which may prolong the restructuring process,
• a prior legal and regulatory assessment is crucial to avoid scenarios where the newly formed entity is unable to operate due to the absence of necessary authorizations.

What tax benefits may be associated with this form of corporate restructuring?

A demerger by spin-off may provide various tax advantages, but careful structuring is required to ensure compliance with tax laws and avoid challenges from tax authorities. Key tax considerations include:

• tax neutrality – if the demerger qualifies as a tax-neutral reorganization, it does not trigger immediate taxation of corporate income,
• optimization of tax costs – a properly structured demerger can allow for a more efficient allocation of assets and liabilities, improving the tax position of the entities involved,
• eligibility for tax exemptions and reliefs – depending on the industry and corporate structure, the transaction may benefit from preferential tax treatments, such as those applicable to businesses operating in special economic zones,
• risk of recharacterization under the GAAR clause – if the tax authorities determine that the demerger primarily serves tax optimization purposes without a legitimate business rationale, they may challenge its tax neutrality and impose additional tax liabilities.

To ensure compliance and mitigate risks, it is common practice to seek advance tax rulings from the tax authorities before proceeding with the demerger.

Failure to obtain such rulings may expose the transaction to tax reassessment, whereby the authorities may determine that the demerger triggers corporate income tax obligations for both the demerging company and the newly created entity.

With proper legal and tax structuring, a demerger by spin-off can serve as an effective and tax-neutral corporate restructuring strategy.

Summary

A demerger by spin-off is a powerful corporate restructuring tool, but its success depends on careful strategic planning. After a year of its application in practice, it has proven effective in various business scenarios, yet its efficiency is contingent upon:

• proper process structuring,
• understanding the impact on contracts, regulatory licenses, and industry compliance,
• ensuring alignment with tax and legal requirements.

With proper preparation, companies can leverage this mechanism to enhance operational efficiency, mitigate risks, and achieve long-term business success.