Accounting for a demerger

In a demerger the distributing company gives a subsidiary or a trade to its shareholders, so it records a distribution in kind: it debits retained earnings and credits the investment or net assets given away, normally at their book value. Section 845 of the Companies Act 2006 makes the legal amount of the distribution equal to that book value, provided the company has profits available. The shareholders record what they receive, and a corporate shareholder must work out whether its gain is realised.

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This page covers the accounting entries. The corporation tax and capital gains reliefs, clearances and conditions are explained in demergers: statutory and liquidation demergers.

What forms can a demerger take?

HMRC’s Company Taxation Manual at CTM17280 describes two statutory routes. In a direct demerger under section 1076 of the Corporation Tax Act 2010, the parent distributes its shares in a 75% subsidiary straight to its own ordinary shareholders, who become direct owners of the subsidiary. In an indirect or three cornered demerger under section 1077, the distributing company transfers a trade, or shares in a 75% subsidiary, to another company, usually a new one, which issues its shares to the distributing company’s shareholders. CTM17310 describes a third route through liquidation, where the shares in new companies are distributed to shareholders in the course of a winding up.

Each route produces different entries, so the first job is to identify which company gives what to whom.

What does the distributing company record in a direct demerger?

Paragraph 22.17 of FRS 102 requires an entity to reduce equity for the amount of distributions to its owners. TECH 02/17BL, the ICAEW and ICAS guidance on distributable profits, notes at paragraph 2.9H that FRS 102 contains no requirements on how to measure a distribution in kind, that UK companies have almost invariably used the book value of the asset, and that it has also been acceptable to use fair value and recognise a profit on disposal.

Using book value, the entry is:

Debit retained earnings (distribution to owners), with the carrying amount of the investment.
Credit investment in subsidiary, with the same amount.

No gain or loss arises. Paragraph 22.18 requires disclosure of the fair value of any non cash assets distributed during the period, except when those assets are ultimately controlled by the same parties both before and after the distribution. In a pro rata demerger of a family company that exemption will often apply, but it depends on who controls the company before and after.

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How much distributable profit does it need?

Section 845 applies where, at the time of the distribution, the company has profits available for distribution and could make the distribution without breaching Part 23 if its amount is fixed under the section. Where nothing is received in return, the amount of the distribution is the book value of the asset, meaning the amount at which it is stated in the relevant accounts. TECH 02/17BL paragraph 2.9D adds that the company must have a positive balance of distributable profits immediately before the transfer, even if only 1p; a nil balance is not enough.

Section 846 helps where the asset’s book value includes an unrealised profit, such as a revaluation or a merger reserve attached to the investment. That profit is treated as realised for the purpose of judging whether the distribution is lawful. Paragraphs 10.73 to 10.76 of TECH 02/17BL work through a case where an investment carried with a £450,000 merger reserve is distributed using that reserve plus £60,000 of other realised profits.

Paragraph 2.9FA warns that a transfer which passes section 845 can still be an unlawful return of capital at common law, for example if the book value has been increased by spending after the date of the relevant accounts. See dividends in specie for the company law steps that apply to any distribution of assets.

When is the distribution recorded?

TECH 02/17BL paragraph 2.10 says a distribution is made when it becomes a legally binding liability. For a final dividend in specie declared by the members, that is the date of declaration; for an interim dividend authorised by the directors, normally only when the shares are actually transferred. Paragraph 32.8 of FRS 102 prevents a dividend declared after the year end from being recognised as a liability at the year end.

What changes in an indirect demerger?

Here the distributing company transfers the trade or subsidiary to a new company and the new company issues shares to the distributing company’s shareholders. The distributing company receives nothing, so it again records a distribution in kind: debit retained earnings, credit the net assets or investment transferred at book value, subject to the same section 845 test.

The new company records the assets it receives and the shares it issues. Paragraph 22.8 of FRS 102 measures equity issued at the fair value of the resources received, except where merger relief or group reconstruction relief applies:

Merger relief under section 612 applies where the issuing company secures at least a 90% equity holding in another company under an arrangement for the allotment of its equity shares in consideration for the transfer of equity shares in that company. Where it applies, the premium does not have to go to share premium, and TECH 02/17BL paragraph 9.43 confirms that under FRS 102 the investment may be stated at the nominal value of the shares issued.
Group reconstruction relief under section 611 only applies where a wholly owned subsidiary allots shares to its holding company or to a fellow wholly owned subsidiary. A new company that issues shares directly to the distributing company’s shareholders does not meet that condition.

Where the new company receives a trade rather than shares, section 612 cannot apply because it requires equity shares in another company as the consideration, and any premium goes to share premium under section 610(1). The detail is in merger relief and group reconstruction relief.

What happens in the consolidated accounts?

If the distributing company prepares group accounts, it loses control of the demerged subsidiary on the demerger date. Paragraph 9.18A of FRS 102 calculates the gain or loss on loss of control as the difference between the proceeds, or the event that resulted in loss of control, and the carrying amount of the subsidiary’s net assets including related goodwill. Cumulative exchange differences on a foreign subsidiary are transferred directly to retained earnings. If the group measures the distribution at that carrying amount, no gain arises and the whole amount is shown as a distribution in the statement of changes in equity; measuring it at fair value would instead produce a gain. See disposal of a subsidiary in group accounts.

What do the shareholders record?

Individual shareholders do not prepare accounts. For tax, CTM17250 explains that an exempt distribution is not income for the shareholder and will normally not give rise to a capital gains disposal.

A corporate shareholder needs a policy, because FRS 102 does not deal specifically with receiving a distribution in kind. Under paragraphs 10.4 and 10.5 it looks to similar requirements. Two approaches can be argued from those principles: recognise the new shares at fair value with a corresponding credit to income, or, where the value of the existing holding has fallen by the value distributed, allocate part of the original cost to the new shares. Either way, TECH 02/17BL paragraph 9.33 treats a dividend in kind from a subsidiary as an unrealised profit unless the asset received is qualifying consideration, and paragraph 27.7 requires the holding in the distributing company to be checked for impairment.

How does a direct demerger look with numbers?

Illustration only. Holdco Ltd owns Retail Ltd and Property Ltd. Its investment in Property Ltd is carried at cost of £200,000; its realised retained earnings are £350,000. The members declare a dividend in specie of the Property Ltd shares.

Holdco posts: debit retained earnings £200,000, credit investment in Property Ltd £200,000.
Section 845 fixes the distribution at £200,000; Holdco had £350,000 of distributable profits, so the distribution is covered and £150,000 remains.
Property Ltd is worth £900,000. Holdco discloses that fair value under paragraph 22.18 unless the same parties control Property Ltd before and after.

What mistakes come up?

Recording the transfer at fair value and treating the resulting profit as realised without checking section 846 and the guidance.
Starting with a nil or negative reserve, which section 845 does not allow.
Assuming group reconstruction relief is available to a new company that issues shares to individual shareholders.
Forgetting the fair value disclosure in paragraph 22.18.
Treating shares received by a corporate shareholder as a realised profit when they are not readily convertible to cash.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.