Top 10 tax considerations when selling a business

Top 10 tax considerations when selling a business

Tax considerations can be vital in a business sale. The ability to structure a sale on a tax-efficient basis is central to maximising shareholder value. A review of the position in advance of marketing a business for sale may identify opportunities which can be capitalised on or risks which can be dealt with.

We outline our top 10 issues below but would always recommend professional advice on a timely basis, tailored to individual circumstances, and specialist tax support through the transaction process.

1. It’s all about ER

Over recent years, the ability to sell shares in a company with the benefit of a 10% tax rate has been a major attraction for vendors. Entrepreneurs’ relief (ER) has provided the means to achieve this. However, there are a number of hard-edged requirements which, if not met, result in a loss of relief (as shown by the increasing number of tax tribunal cases).

A successful claim for ER requires conditions to be met over a period of two years prior to the sale. Where shares are sold, the company must be a ‘trading company’, the shareholder must have a sufficient shareholding and must have been an officer or employee throughout the period of two years prior to the sale.

Plan in advance; if there’s a problem meeting any of the conditions and changes are needed, there will generally need to be a further period of two years before ER is available on a sale.

Avoid late changes without taking tax advice – the conditions for relief must be met right up to the sale. A shareholder resigning their directorship or employment shortly before a sale, for example, would lose entitlement to relief.

2. Securing capital gains tax treatment

Where ER is not available, a disposal at the current capital gains tax (CGT) rate of 20% is still quite attractive. However, there are risks to the availability of CGT treatment (with or without ER) which may result in sales proceeds being taxed on a much less favorable basis. It’s important to be aware of these and to make sure the risks are mitigated.

3. Income tax risk #1 – employment-related securities

Most shares held by owner-managers will be employment-related securities (ERS). The ERS regime can subject part of the proceeds from a sale of shares to income tax at rates of up to 45% and to employee’s and employer’s NIC.

For example, where arrangements are made to provide an employee-shareholder with a share of the sale proceeds in excess of what would be expected, based on the shares they hold, the excess is likely to be subject to such charges.

4. Income tax risk #2 – buy-outs

Where shares are sold as part of a management buy-out or similar transaction HMRC have the ability to reclassify shareholder capital gains as income and subject the proceeds to income tax at dividend rates in some cases.

The rules won’t be invoked where the transaction is carried out for bona fide commercial reasons (e.g. business succession). There is an advance clearance procedure which can provide certainty that HMRC won’t invoke these provisions.

5. Changes may be afoot…!

The cost of ER to the Exchequer has come under increasing scrutiny and most political parties are proposing to review, reform or repeal ER. We don’t know what the outcome will be or how quickly any changes may come. The possible withdrawal of ER is something to consider in cases where there’s opportunity to accelerate a sales process.

Likewise, the relatively favorable rate of CGT of 20% may also come under review, raising the possibility of a significant increase in rates of taxation of business disposals, going forward.

6. Shares or assets?

Whether a sale is structured as a sale of shares or a sale of the company’s assets may be driven by the negotiating dynamic between vendor and purchaser, but, in any case, it’s important to appreciate the differences in tax outcomes.  

A sale of business and assets will frequently result in tax being paid at company level on gains realised from the sale of chargeable assets such as property and goodwill. The shareholder will then be subject to tax (ideally CGT with the benefit of ER) on a subsequent winding-up of the company and extraction of the proceeds of sale. Tax at both company and shareholder levels may increase overall tax costs significantly.

7. It’s a wind-up!

Following a sale of trade and assets, a solvent liquidation process may be needed to extract the proceeds of sale. Distributions to shareholders ordinarily attract CGT treatment but HMRC have the ability to invoke tax provisions to tax them as income where the shareholder becomes involved in a similar business activity within the following two years.

While intended to combat tax-motivated ‘phoenixing’, the rules can apply quite widely and care is therefore needed to make sure the intended tax treatment isn’t put at risk.

8. Pre-sale demerger

Vendors should consider what a potential purchaser will wish to acquire. Will a purchaser of a trading business wish to acquire the trade properties? In some cases they will not. It’s unlikely they would want to acquire non-core investment assets. Finding a means of enabling the purchaser to acquire only the activities they want introduces complexity and tax inefficiency to a sales process.

If these issues are identified well in advance, a tax-efficient demerger of those assets could be undertaken to address these matters.

9. Looking after non-shareholders

The commitment of key staff will be central to ensuring the success of a sales process. Without forward-planning, the ability to reward these individuals will likely be limited to bonuses taxable as employment income.

Consider establishing more tax-efficient incentives in advance. An Enterprise Management Incentive (EMI) share option scheme might provide a more compelling and tax-efficient solution for all parties.

A successfully implemented scheme would allow for appreciation in value from the date of grant to be free of PAYE or NIC, option-holder gains to be subject to CGT and ER and a corporation tax deduction for the company.

10. Inheritance tax

In selling their business, many owner-managers move from a position in which most of their wealth (in the form of their shares) is protected from inheritance tax (IHT) through business property relief to one in which their wealth (the cash proceeds of sale) is fully exposed to IHT at a rate of 40% on death.

Consideration should be given to addressing this pre- and post-sale, for example, through Business Property Relief (BPR) qualifying investments, gifts, the use of trusts, family investment companies or life insurance. These are complex areas requiring careful tailoring to individual circumstances, but the savings that could be achieved are often very large.

Dominic Carter, Director, Tax Advisory Group