Demerger, Team Move, Split: What We Mean

A law firm rarely stays the same shape forever. Sometimes the change is a combination, two firms coming together. Sometimes it is the reverse: a department or a group of partners separating off, or a team of fee-earners moving to another practice and taking their clients with them. This guide deals with the reverse case, the split, because the tax and regulatory mechanics are genuinely different from a merger even though they draw on the same underlying rules.

Three close cousins are worth naming up front. A demerger or split is where a department, or a group of equity partners, hives off to form a new firm or to join another one, often taking the goodwill and clients attached to their book of work. A lateral team move is where a group of fee-earners, usually employees or fixed-share members rather than full equity partners, moves between firms with their matters. A partner exit that takes work with it sits somewhere between the two. The labels matter less than the substance: in each case work, people and value leave one firm and arrive at another.

Whichever label fits, the analysis runs along four threads, and this guide follows them in order: how WIP and goodwill are apportioned on the way out, how each affected client must consent before files and client-account money transfer, how the departing partner's capital account is valued and settled, and how restrictive covenants and PII shape the exit. A demerger is a tax decision and a regulatory decision at the same time, and getting one right while neglecting the other is a common and expensive mistake.

The Income-Versus-Capital Line, in Reverse

The spine of the tax analysis on any split is the line between income and capital. A partnership or LLP has no shares, so when its business (or part of it) moves, that movement is treated as a transfer of business assets rather than a share sale. Two of those assets are taxed in completely different ways.

Goodwill is a capital asset. Where goodwill genuinely transfers and is paid for, the gain on it is charged to capital gains tax, not income tax, and it is reported on the capital-gains pages. WIP and debtors are trading income. Under ITTOIA 2005 ss.182 to 185, work in progress brought into account on a cessation or transfer is an income receipt, not capital, so it is taxed at income tax rates plus Class 4 NIC for the individual partners. Billed-but-unpaid debtors are likewise trading receipts.

That difference is large. Income in the hands of an individual partner can be taxed at up to around 47% (45% additional-rate income tax plus 2% Class 4 NIC on the top slice), while a capital gain on goodwill is taxed at 18% or 24% from 30 October 2024, or potentially at the Business Asset Disposal Relief rate. So the transfer documents must split any consideration or apportionment between goodwill (capital) and WIP and debtors (income), exactly as on a merger or a sale. A loose document that lumps everything together invites HMRC to treat more of the value as income.

One honest caveat applies more often than firms expect. On many team moves there is no purchase of goodwill at all. The leavers cannot simply take the old firm's goodwill, and personal goodwill in a professional firm is notoriously hard to value and transfer. In that scenario the old firm keeps its goodwill, and the real economic content of the move is the WIP, the debtors and the clients who choose to follow, not a goodwill cheque. The income side then dominates the tax picture.

Apportioning WIP and Debtors When Matters Move

When live matters transfer mid-retainer, the practical question is who owns the value built up so far. The answer is that the WIP and any billed-but-unpaid debtors accrued at the old firm belong to the old firm and are its trading income; work done after the move is the new firm's. There is a clean dividing line, and the documents should record it.

The single most useful mechanism is a WIP cut-off: the value of unbilled time and disbursements on each transferring matter at the transfer date. Agreeing that figure does three things. It fixes the old firm's income from the matter, it tells the new firm where its own time recording starts, and it gives both firms an audit trail if HMRC or the SRA later asks. Alongside the cut-off, the documents should record how pre-transfer debtors are collected and accounted for, and who issues the bills for work straddling the move.

The trap to avoid is treating a WIP transfer as if it were capital. WIP that moves with a matter is not goodwill and is not a CGT asset; it is income recognised under FRS 102 and brought into account under ITTOIA 2005 ss.182 to 185. Dressing it up as part of a capital payment for goodwill does not change its character, and an aggressive split is exactly what an enquiry looks for. For the underlying mechanics of valuing and taxing unbilled time, see our guide to selling a solicitor practice and the broader law firm partnership tax guide.

Goodwill on a Demerger

Where a demerging group genuinely acquires goodwill, the capital side comes into play. Suppose a sub-group buys out a defined book of business, a brand or a recognised client following, paying real consideration for it. That is a capital disposal for the transferring firm or partners. The gain is charged to CGT at the standard 18% rate (within the basic-rate band) or 24% rate (above it) on all chargeable assets from 30 October 2024, or at the Business Asset Disposal Relief rate where the disposal qualifies, after the £3,000 annual exempt amount (2025/26 and 2026/27).

The buyer side has its own goodwill position. A company that acquires goodwill on or after 1 April 2019 as part of a business acquisition that also includes qualifying intellectual property can claim fixed-rate relief at 6.5% a year, capped at six times the qualifying-IP expenditure. But where the new entity acquires goodwill from a related party (for example partners rolling their existing practice into their own new company), the relief is restricted, so do not assume the new firm gets goodwill amortisation on what is effectively a self-incorporation.

Be candid, though, that on a typical team move there is often no goodwill payment. The leavers cannot lawfully appropriate the firm's goodwill, personal goodwill is hard to pin down, and the clients are free to choose their solicitor in any event. So while the capital analysis matters wherever real goodwill changes hands, the headline asset on a great many splits is the WIP and the transferring clients, taxed as income, not a capital sum.

BADR and the Standard CGT Rates on a Qualifying Exit

Where a partner or member disposes of the whole or part of the business, Business Asset Disposal Relief can apply, and a genuine demerger of a slice of the partnership can be such a disposal. BADR cuts qualifying gains up to a £1m lifetime limit per individual to a reduced CGT rate. The rate is date-banded and rising: 10% to 5 April 2025; 14% for disposals from 6 April 2025 to 5 April 2026; and 18% from 6 April 2026.

The qualifying conditions must be met throughout the two-year period to disposal: there must be a trading business, and for a partnership or LLP interest the individual must be a genuine partner or member disposing of the whole or part of the business. A partner caught by the salaried member rules (treated as an employee for tax) may be regarded as not having a genuine BADR-qualifying interest, so the salaried member analysis feeds directly into the relief.

Gains above the £1m lifetime limit, or any gain that does not qualify for BADR, are taxed at the standard 18% / 24% rates (from 30 October 2024), after the £3,000 annual exempt amount. The step from 14% to 18% on 6 April 2026 is a live timing lever: for a qualifying disposal that could complete either side of that date, the four-point difference on up to £1m of gains is up to £40,000 per individual. Where a demerger is being negotiated in late 2025/26, completion timing is worth modelling carefully against the commercial and regulatory readiness of the deal.

Settling the Departing Partner's Capital Account

Money flows out as well as in on an exit, and the capital account is where it sits. Because a partner is taxed on their allocated profit share rather than their drawings, the firm has to handle three distinct things when a partner leaves.

First, finalise the leaver's profit share to the exit date. They are taxed on that allocation under ITTOIA 2005 s.850, whether or not they have drawn it in cash. Second, value and repay the capital account per the partnership or LLP agreement: broadly, capital contributed plus undrawn profits, less drawings and any amounts owed back. The agreement, not the cash drawn, governs the figure and the repayment timetable, which may be staged. Third, deal with any tax reserve held for the leaver, returning or applying it as the agreement provides.

Two wrinkles deserve attention. The basis-period reform transition can interact with a cessation: a partner leaving before the five-year spread of transition profits completes (2023/24 to 2027/28) may have the remaining balance brought into charge in the cessation year, and each partner computes overlap relief from their own records. And where the leaver borrowed to fund a capital buy-in, the qualifying-loan interest relief under ITA 2007 ss.398 to 412 stops when they cease to be a partner and the capital is repaid. Keep the capital settlement and the tax settlement clearly separate so that neither is mistaken for the other.

The regulatory side has two gates, and the first is client consent. You cannot move a client's file or their client-account money to the new firm without the client's instruction and consent. Each affected client must be told about the move and asked whether they want their matter to transfer to the new firm, remain with the old firm or go elsewhere. The client's free choice of solicitor is a regulatory principle, so the choice is genuinely theirs.

Client money then moves only on that authority, and the transfer is a regulated client-money exercise under the SRA Accounts Rules 2019. The money stays in a separate client account (Rule 3); every transfer must relate to the delivery of regulated services and must not use the client account as a banking facility (Rule 3.3); the account is reconciled at least every five weeks, signed off by the COFA or a manager (Rule 8.3); and an accountant's report may be due where client money has been held (Rule 12, with the exemption available only where the balances did not exceed an average of £10,000 and a maximum of £250,000 in the period).

Treat the client-balance transfer as exactly that: a controlled movement of regulated money with a documented audit trail, not an internal book transfer between connected firms. The COFA on each side should be able to evidence the client's authority for every balance that moves.

SRA: Authorising the New Entity and Notifying Changes

The second regulatory gate is authorisation of the new firm. If the departing team forms a new LLP or company, that entity needs SRA authorisation as a recognised body before it can practise. If it has any non-lawyer owner or manager, it triggers ABS (licensed body) authorisation under Part 5 of the Legal Services Act 2007, with the SRA acting as the designated licensing authority. Either way the new firm needs a designated COLP and COFA in place.

The old firm has its own notifications: it must tell the SRA about its change in managers or owners and update its own COLP and COFA where the people in those roles have left. Authorisation of the new entity is effectively a completion condition for the move, because the team cannot start billing regulated legal work through an entity that is not yet authorised. The lead time on authorisation can be material, so it usually drives the overall timetable. For how the structure choices interact with authorisation, see converting a law firm to a limited company or ABS and the contrast with a corporate member of an LLP.

Restrictive Covenants and What the Leavers Can Take

Partnership, LLP and employment agreements usually contain restrictive covenants, and they shape the whole exit. The common types are non-compete (for a limited period and area), non-solicitation of clients, non-dealing with clients, and non-poaching of staff. These covenants are enforceable only so far as they protect a legitimate business interest and go no further than reasonable in scope, duration and geography. A covenant drawn too widely risks being unenforceable in full.

Covenants interact with the move in practical ways: they affect which clients the team may approach, whether and how the move can be announced, and the risk of a dispute or an injunction application. Crucially, the client's free choice of solicitor, a regulatory principle, sits alongside and can cut across a non-solicitation covenant: a client who decides on their own initiative to follow a trusted adviser is exercising a right the regulator protects.

This is legal-practice territory rather than accountancy, and the case law is fact-sensitive. Treat covenants as a flag to take specialist legal advice early, before any approach to clients or staff, rather than something to interpret from the agreement alone. Our role is to make sure the tax and capital-account consequences of whatever is agreed are handled correctly.

PII, Run-Off and Continuity of Cover

Any structural change is a moment to check professional indemnity cover. On the SRA Minimum Terms and Conditions, a firm that ceases must obtain run-off cover for six years. So if part of the firm closes as an entity in the split, that entity needs run-off; if the firm continues and only a team leaves, the continuing firm keeps its cover but should confirm no matter is left exposed during the handover.

The new firm needs its own PII on the Minimum Terms before it practises. The minimum sum insured per claim is £3m for a relevant recognised or licensed body (an LLP, company or ABS) and £2m for a sole practitioner or partnership, with no monetary limit on defence costs. The main practical risk on any transition is a matter falling into an uninsured gap between the old and new cover, so map the matters and confirm continuous cover across the move date.

Worked Examples

These sketches are illustrative only, to show how the threads connect, and are not advice on any particular firm.

Example 1: a team move with live matters and WIP. A group of fee-earners moves from Firm A to Firm B, and their clients choose to transfer. At the move date, Firm A has unbilled WIP and billed-but-unpaid debtors on those matters. The WIP and those debtors are Firm A's trading income, taxed at income tax rates plus Class 4 NIC for A's partners, recorded against a clear WIP cut-off; work after the move is Firm B's. Each client must consent to their file and any client-account balance transferring, with the money moved under the Accounts Rules and an audit trail. The point in a line: the work built up before the move is the old firm's income, and the clients still have to say yes.

Example 2: a demerger of a department. Two of six equity partners hive off the firm's commercial-property team into a new LLP, taking goodwill attributable to that book. The goodwill is a capital disposal for the leaving partners, charged to CGT, potentially at the BADR rate of 14% to 5 April 2026 on qualifying gains up to the £1m lifetime limit if it is a disposal of part of the business and the two-year conditions are met, then 18% from 6 April 2026. The WIP and debtors transferring are income. The new LLP needs SRA authorisation before it can practise, and clients consent to transfer. The point in a line: goodwill is capital and may get BADR, WIP is income, and the new firm needs authorising first.

Example 3: settling a departing partner's capital account. A partner leaves to join another practice. The firm finalises their profit share to the exit date (taxed on the allocation, not the drawings), values and repays the capital account per the LLP agreement, and notes that the qualifying-loan interest relief on their original buy-in ends when the capital comes out. It also checks the basis-period transition-profit and overlap-relief position and observes any restrictive covenant on which clients the leaver may approach. The point in a line: the capital account is settled by the agreement, and the tax follows the profit share, not the cash drawn.

A Specialist Note

A demerger or partner team move asks two questions at once. The tax question is whether you have split goodwill (capital) from WIP and debtors (income) cleanly, whether a qualifying disposal can reach the BADR rate within its date band, and whether each departing partner's capital account and profit share are settled correctly. The regulatory question is whether every client has consented to their file and money moving, whether the new entity is authorised before it bills, and whether PII covers every matter across the transition. The figures in this guide carry their 2026 dates; rates and thresholds change, so confirm the current position before you act, and take specialist legal advice on restrictive covenants. If your firm is planning a split, or managing a team move in or out, we help with the WIP and goodwill split, the capital-account settlement and the SRA client-account transfer so that nothing falls between the two sets of rules.