News in cross-border business conversions – demerger by separation

Demergers as a form of business conversion quite common in the Czech context and a useful tool to manage risks and tax aspects of transactions, have finally been harmonised on the EU level. The amendment to the respective directive introduces new rules for cross-border relocations and demergers, including a cross-border conversion so-far unknown in the Czech Republic: demerger by separation. The implementation deadline is 31 January 2023.

Currently, Czech legislation (and practice) recognises two types of demergers (or ‘divisions’ in EU terminology):

  • demerger by split-up, whereby all the demerging corporation’s assets and liabilities pass on to at least two successor corporations, while the demerging corporation is dissolved
  • demerger by spin-off, whereby the demerging corporation is not dissolved, retains a part of its assets and liabilities, and a part of its assets and liabilities passes on to at least one successor corporation.

Czech legislation further classifies demergers depending on whether new corporations are formed (split-up/spin-off by formation of a new company), the assets and liabilities are merged by acquisition with an existing company (split-up/spin-off by acquisition), or a combination of these occurs. The Czech law regulating conversions of business companies and cooperatives also regulates the procedure to be followed in cross-border demergers.

The abovementioned amendment lays down the harmonised rules of cross-border demergers for all EU member states, for both split-up (‘full division’) and spin-off (‘partial division’), but only for demergers associated with the formation of new companies. So far, the EU regulation does not cover the split-ups/spin-offs by acquisition, due to the complexity of the process. However, the regulation contains a third demerger variant: demerger (‘division’) by separation.

While not yet regulated by Czech law, demerger by separation is a cross-border business conversion that allows for the formation of a new company by ‘separation’: a part of the demerging corporation’s assets and liabilities pass on to one or more successor companies. Unlike the already known forms of demerger, here, the demerging company (not the shareholders/members of the demerging company) gains the shares/interests in the newly formed successor company and thus becomes the sole shareholder/member of the company formed by separation. Under existing legislation, the shareholders/members of the demerging company become the shareholders/members of the newly formed company.

Demerger by separation thus simulates a situation where a corporation founds a subsidiary in which it contributes a part of its assets and liabilities or a part of a business establishment, but with all the advantages of a business transformation, for instance tax implications, legal succession to concluded contracts, etc.

The new regulation may give entrepreneurs a useful tool to facilitate cross-border restructuring and make it less costly. We expect that the new law will also allow demergers by separation as pure intra-state conversions.

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