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Every business owner will eventually want to sell up. They may want to retire and pass on their business to their sons or daughters; others may have to sell for personal or health reasons.
Whatever the motivation, unless a sale is executed correctly the seller could face a large, and mostly unnecessary, tax bill. So what can be done to minimise the bill?
Most businesses are contained within companies in which the business owner holds shares. However, there is a degree of tension between buyers and sellers in negotiating the sale of a company. Many buyers wish to pursue ‘asset deals’, where they buy the business directly from the company, rather than buying shares in the company. On the other hand, almost all sellers prefer to sell shares in the company. These preferences are largely driven by tax considerations.
Realising your assets
For the seller, the key tax driver is the desire to achieve a sale that is taxed at only 10% by utilising the generous Business Asset Taper Relief (BATR). Where the business is contained within a company, this 10% tax rate can only be achieved by selling shares.
The buyer may, however, wish to undertake an asset deal because the buyer will then acquire none of the historic attributes of the company, tax or otherwise. In addition, if the buyer is a company, it will have the ability to deduct any goodwill paid on the acquisition of the business against its future corporate tax liabilities.
However, an asset sale is potentially disastrous for the seller. This is because an asset sale will be liable for corporation tax at 30%. In addition, the sale proceeds will be received by the company, not the seller, and a minimum of 10% of further tax will be payable when stripping the sale proceeds out of the company into the seller’s hands.
All told, the seller could face a tax bill of at least 40% of the sale proceeds by agreeing to an asset sale, whereas a share sale should result in a tax bill of only 10% of the sale proceeds.
The seller should therefore strongly resist an asset sale, and instead insist on a share sale.
The small print
The 10% tax rate offered by BATR in a share sale has a number of conditions attached. The main condition is that the owner has held share in a ‘trading company’ for at least two years.
The definition of a ‘trading company’, and the Inland Revenue’s approach in applying this definition, is where problems frequently arise, especially where trading companies hold large cash balances. In these situations, the Revenue may deny the 10% rate, and instead tax the share sale at rates between 24% and 40%.
The tax rules define a trading company as “a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities”.
The Inland Revenue’s interpretation is that ‘substantial’ means more than 20% by reference to various criteria including assets, income and directors’ time. Therefore, if the value of non-trading assets, which could include excess cash, is substantial (more than 20%) of total assets held, then this could affect the trading status of the company and therefore the availability of BATR.
However there is little consistency in how local tax inspectors apply this published guidance. Some argue that the holding of cash is an activity in itself, and therefore deny relief where trading companies retain large cash balances in excess of 20% of total assets. This argument is debatable, though.
Know your limits
Faced with this dilemma, what can managers do to protect their position? First, it should be remembered that the 20% limit relates only to excess cash. Arguing that additional cash is needed as working capital to meet outstanding and ongoing fluctuating liabilities can justify all or some of the cash retained. The cash may also be earmarked for specific expansion of the trade or the acquisition of a new business.
In addition, owner managers should undertake a regular and constant review of the company’s activities, to ensure that where possible any non-trade assets, including excess cash, are kept within the 20% limit.
It’s all in the timing
The timing of any sale is also important in establishing when the resulting tax liability is payable. The critical date is the beginning of the tax year, April 6.
If the shares are sold on or after April 6 then the owner’s capital gains tax bill is payable on January 31 in two years’ time. However, if the shares are sold before April 6, then the owner’s capital gains tax bill is payable on January 31 in a year’s time. The moral here is that selling in March is a bad idea because the tax becomes due a year sooner.
Selling a business is fraught with tax complications and tax pitfalls, and is likely to be scrutinised in detail by the Inland Revenue. However, provided the seller obtains professional tax advice and negotiates in a tax-informed manner with the buyer, it should be possible to obtain a tax rate of only 10% of the sale proceeds.
Andrew Shilling is a chartered accountant and a chartered tax advisor and the head of M&A Tax Services at tax consulting firm Chiltern
Whatever the motivation, unless a sale is executed correctly the seller could face a large, and mostly unnecessary, tax bill. So what can be done to minimise the bill?
Most businesses are contained within companies in which the business owner holds shares. However, there is a degree of tension between buyers and sellers in negotiating the sale of a company. Many buyers wish to pursue ‘asset deals’, where they buy the business directly from the company, rather than buying shares in the company. On the other hand, almost all sellers prefer to sell shares in the company. These preferences are largely driven by tax considerations.
Realising your assets
For the seller, the key tax driver is the desire to achieve a sale that is taxed at only 10% by utilising the generous Business Asset Taper Relief (BATR). Where the business is contained within a company, this 10% tax rate can only be achieved by selling shares.
The buyer may, however, wish to undertake an asset deal because the buyer will then acquire none of the historic attributes of the company, tax or otherwise. In addition, if the buyer is a company, it will have the ability to deduct any goodwill paid on the acquisition of the business against its future corporate tax liabilities.
However, an asset sale is potentially disastrous for the seller. This is because an asset sale will be liable for corporation tax at 30%. In addition, the sale proceeds will be received by the company, not the seller, and a minimum of 10% of further tax will be payable when stripping the sale proceeds out of the company into the seller’s hands.
All told, the seller could face a tax bill of at least 40% of the sale proceeds by agreeing to an asset sale, whereas a share sale should result in a tax bill of only 10% of the sale proceeds.
The seller should therefore strongly resist an asset sale, and instead insist on a share sale.
The small print
The 10% tax rate offered by BATR in a share sale has a number of conditions attached. The main condition is that the owner has held share in a ‘trading company’ for at least two years.
The definition of a ‘trading company’, and the Inland Revenue’s approach in applying this definition, is where problems frequently arise, especially where trading companies hold large cash balances. In these situations, the Revenue may deny the 10% rate, and instead tax the share sale at rates between 24% and 40%.
The tax rules define a trading company as “a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities”.
The Inland Revenue’s interpretation is that ‘substantial’ means more than 20% by reference to various criteria including assets, income and directors’ time. Therefore, if the value of non-trading assets, which could include excess cash, is substantial (more than 20%) of total assets held, then this could affect the trading status of the company and therefore the availability of BATR.
However there is little consistency in how local tax inspectors apply this published guidance. Some argue that the holding of cash is an activity in itself, and therefore deny relief where trading companies retain large cash balances in excess of 20% of total assets. This argument is debatable, though.
Know your limits
Faced with this dilemma, what can managers do to protect their position? First, it should be remembered that the 20% limit relates only to excess cash. Arguing that additional cash is needed as working capital to meet outstanding and ongoing fluctuating liabilities can justify all or some of the cash retained. The cash may also be earmarked for specific expansion of the trade or the acquisition of a new business.
In addition, owner managers should undertake a regular and constant review of the company’s activities, to ensure that where possible any non-trade assets, including excess cash, are kept within the 20% limit.
It’s all in the timing
The timing of any sale is also important in establishing when the resulting tax liability is payable. The critical date is the beginning of the tax year, April 6.
If the shares are sold on or after April 6 then the owner’s capital gains tax bill is payable on January 31 in two years’ time. However, if the shares are sold before April 6, then the owner’s capital gains tax bill is payable on January 31 in a year’s time. The moral here is that selling in March is a bad idea because the tax becomes due a year sooner.
Selling a business is fraught with tax complications and tax pitfalls, and is likely to be scrutinised in detail by the Inland Revenue. However, provided the seller obtains professional tax advice and negotiates in a tax-informed manner with the buyer, it should be possible to obtain a tax rate of only 10% of the sale proceeds.
Andrew Shilling is a chartered accountant and a chartered tax advisor and the head of M&A Tax Services at tax consulting firm Chiltern
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