Background and Summary The classification of shares received in the course of a demerger
15.The Act addresses an aspect of the trust law classification of investment receipts from companies as income or capital: the classification of dividends received by trustee shareholders which are distributions made in the course of a corporate demerger.
16.Such demergers can be of two kinds: direct and indirect. In each case Company A transfers part of its business to a new subsidiary company, Company B, and then declares a dividend to its shareholders. In a direct demerger the dividend is satisfied by Company A distributing the share capital of Company B to its own shareholders. In an indirect demerger the shares in Company B are transferred to a separate holding company, Company C. In consideration for this transfer, Company C satisfies Company A’s dividend by issuing its own shares to the shareholders of Company A.
17.Pursuant to a decision of the House of Lords,(1) shares distributed in the course of a direct demerger have to be classified as income. The result of this is that following a company reorganisation by way of a direct demerger, the trust fund’s former capital asset – the original shareholding in Company A – will be effectively split between capital and income to the extent that the value is now represented by shares in Company B. The Company B shares passing to the income beneficiary could represent a substantial percentage of the original shareholding in Company A – far in excess of normal expectations for an income return.
18.However, exceptionally, it was later decided in the High Court that shares distributed in the course of an indirect demerger should be classified as capital.(2) Therefore, in such a case the shares in Company C retain the classification of the original Company A shareholding; the income beneficiary does not receive a portion of that asset merely by virtue of the corporate reorganisation.
19.The Act provides that the shares distributed in defined direct and indirect demergers will for the future in both cases be treated as capital for the purposes of the trust. This reform affects both private and charitable trusts, whenever created.
20.The new classification of such receipts may, in some circumstances, prejudice the income beneficiary. The Act provides a power to compensate the income beneficiary by way of a payment from trust capital in these circumstances.