Selling your business - capital gains tax
From 6 April 2008 the Government introduced a new Capital Gains Tax (CGT) flat rate of 18%, abolishing Business Asset Taper Relief and Indexation Allowance. In addition they introduced a new relief called 'Entrepreneurs Relief' (ER).
Broadly speaking ER is available on the first £1 million of an individual's qualifying gains crystallising post 5 April 2008. It creates an effective rate of 10% CGT available to shareholders in a trading company (or the holding company of a trading group) provided that shareholder (i) holds at least 5% of the ordinary share capital in the company and (ii) has been an officer or employee of the company for at least one year prior to the disposal of their shares.
Shareholders must ensure these criteria are met and should consider tax planning to ensure ER is maximised however when selling, the availability of ER is now very much a key factor in structuring the terms of the sale, particularly in respect of deferred and earn out consideration.
Deferred Consideration
Where deferred consideration is ascertainable at
completion, historically the favoured route for shareholders would
have such deferred consideration payable by way of a non-QCB loan
note. This would defer the CGT until payment was received
under the loan note. However, in practice today on the basis
that the shareholder is unlikely to be an officer or an employee
and hold 5% of the shares prior to such a loan note being redeemed,
ER will not be available.
In such circumstances, for a shareholder to take advantage of ER they will now most likely to take a QCB loan note in respect of the deferred consideration. However, although a QCB loan note defers the CGT until the loan notes are redeemed, the tax is still payable regardless of whether or not the loan notes are redeemed (i.e you may not get paid but must still pay the tax!). Accordingly, such a shareholder should ensure the payments under the loan notes are properly secured.
It should be remembered where no ER is available it will still be beneficial for the shareholder to take a non-QCB loan note in respect of such deferred consideration.
Earn Outs
The position is even more complex in terms of earn
outs.
Where ER is available to a shareholder and there is an earn out
situation, ER will not be automatically available should the earn
out be satisfied by way of loan notes (be it a QCB or a
non-QCB).
Where the earn out is satisfied in cash, ER is available, but only on part of the earn out. This is because for tax purposes the right to receive an earn out is valued as a separate asset and it is upon the value of this separate asset that ER is available.
However the liability to CGT will crystallise in that year and accordingly be payable upfront, more often than not, prior to receiving any sums due under the earn out.
Accordingly, shareholders will need to value the earn out right and calculate whether or not that earn out right is worth paying tax upfront to take advantage of an 8% tax saving.
Where shareholders have more than one shareholding they may not wish to use up their ER and save it for later transactions.
In conclusion Susheel Gupta, a Partner at Higgs & Sons dealing with corporate tax issues, states "the Chancellor's wish to simplify the CGT regime has not happened. However, there are a number of ways to restructure corporate transactions to ensure shareholders get maximum returns whilst the commercial objectives of the deal are retained."
If you require further advice or assistance please contact the Corporate department at Higgs & Sons by calling 01384 342100.
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