Maximising the Wealth of Your Business: Tax Planning

Business Asset Disposal (BADR) relief is one of the key considerations for business owners when they begin to think about selling their business. Previously known as Entrepreneurs’ Relief, BADR allows you to pay tax at 10% on the first £1m of gains on qualifying assets, rather than Capital Gains Tax in full. This is, of course, subject to strict criteria, so it’s important to make sure that you satisfy it in full before relying on it. 

To qualify when selling your business, the following criteria must apply for at least two years up to the date you sell your business:

• You must be a sole trader or business partner or own at least 5% of the share capital and voting right of a company and be an employee or director;
• The Business must be a trading business.

Some sellers express concerns about whether having a lot of cash in the business could disqualify your eligibility for BADR. It’s unlikely that this would be the case – HMRC have publicised that it is rare for cash alone to cause this. However, having a lot of other, more active investments could impact your eligibility for BADR. With this in mind, it can sometimes be worthwhile for businesses to undergo some restructuring before the selling process begins.

It’s important to note that if you have previously transferred shares to your spouse, you will lose BADR on their shares, unless they qualify in their own right. If they do not qualify, you might want to consider transferring the shares back to yourself.

If you are a director, and hoping to claim BADR from your sale, then it’s crucial that you do not resign before the date of the sale, otherwise you will lose out on the relief!

If the business you are selling is shares in a company owned by another limited company, then you may instead qualify for Substantial Shareholdings Exemption (SSE). This exempts company sellers from paying Capital Gains Tax or Corporation Tax on the disposal of shares. SSE applies when you sell shares owned by your company to a third party, and there aren’t too many conditions to satisfy. To qualify, you must fulfil the following criteria:

• Your company only needs to have at least a 10% shareholding in the company that you’re selling
• The company that you are selling must be a trading company
• Your company must have held the shares in the company for at least 12 months

Forms of consideration refers to how you will be compensated by the buyer for the sale of your business. It’s important that this is decided in the negotiation stage of the business deal, as it is difficult to change the structure after that point. Cash proceeds are the most common element of sale, but you can also receive other forms of consideration such as shares, loan notes and earn outs.

Cash is taxed in full at the date of completion, even if the buyer defers it. This means that even if the business pays half at the time of the sale, and half in the next tax year, the full amount will be taxed when the first payment is received. If the second payment is not received, then you can reclaim the tax already paid on that half.

If you receive shares as part of the proceeds in business sale, then the monetary value is deferred and taxed when the shares are later sold. However, there is an option to tax the share value upfront and make the most of reliefs available at the date of completion (e.g., BADR or losses).

Loan notes are a more formal way of structuring a deferred cash payment. Under this form of consideration, you would receive a loan note instrument outlining the payment schedule, which can be secured or unsecured. Similarly to shares, you can choose whether to be taxed upfront or upon receipt of the full proceeds. We recommend that you receive clearance from HMRC in advance. This means that you will be aware of how the loan note will be taxed, to avoid confusion (e.g., you expect it to be treated as capital, but it is taxed as a dividend).

Earn-outs are also complex, as your future proceeds are dependent on a predetermined financial metric of the business, for example sales or profitability. Again, there are different ways in which earn-outs can be taxed, so it’s important to undergo tax clearance and take advice before agreeing with the buyer. 

Over the years, HMRC have introduced a number of anti-avoidance legislation measures that you should be aware of when carrying out the tax planning for your business. This is to prevent individuals being able to manipulate situations to turn income into capital gains.

Transactions in securities rules (TIS) are in place to ensure that a company cannot take advantage of more attractive tax rates for capital gains, and avoid paying income tax. To avoid breach of TIS rules, we would recommend seeking clearance from HMRC beforehand, if your transaction is going to be anything other than straightforward. 

Employment-related securities rules (ERS) are in place to ensure that money received by someone who is an employee or director of the business is taxed as employment income, and not capital gains. You cannot get clearance for this, but can seek advice in advance about how you will be taxed on the sale of your business. If you are aware that your gains will be taxed as employment income, then you can plan appropriately and include it in the transaction.

Earn-outs have already been mentioned as a form of consideration, and it’s important to be aware of their tax treatment. If it appears to HMRC that the payment is related to your performance as an employee of the business, then money you receive in payment will be taxed as employment income.

When a business is being struck off, there is a limit of £25,000 from the overall value of the business that can be taxed as capital, and anything above must be taxed as income. This should be a key consideration in the tax planning process if your transaction involves striking off part of the business or restructuring of a group. 

It’s important to be aware of the targeted anti-avoidance rule, or Phoenix TAAR, as it’s affectionately known. This is in place to prevent a business’ operations being wound up to undergo liquidation only to then restart under a new guise – as a phoenix rises out of the ashes. When a seller does this, HMRC can tax the proceeds as dividend income rather than  as capital gains .

HMRC operates a general anti-abuse rule, which applies to anything that they consider as contrived or artificial in order to gain an unfair tax advantage. To avoid breaking this, or any of HMRC’s anti-avoidance legislation, please do not hesitate to seek advice from our Tax team at Fiander Tovell.

Before you enter into the transaction process, it may be necessary for your business to go through some slight restructuring, particularly if you want to extract some assets to retain following the sale. The sooner you do this, the better, so that the various tax reliefs can legitimately be used. It’s typically business premises that are extracted, such as investment property or trading premises. However, you can also extract non-core business activities or divisions that you wish to retain post-sale. 

If you do opt for corporate restructuring of your business ahead of the sale, there are various ways to do so. The key for each is to plan well ahead:

• Management buyout (MBO) is where existing shareholders are bought out by a group led by individuals who are already in the business’ current management team. 
• A demerger allows your business’ operations to be divided into multiple components, to operate separately, be sold, or undergo liquidation.
• Purchase of own shares is where a company buys its own shares back from shareholders which can be used as a way of restructuring the distribution of shares from the existing percentages.
• Sellers may choose to incorporate their business, if they believe that it would be more attractive to buyers as a limited company.
• Debt restructuring might be the right route if your business has outstanding debt that may make it less attractive to buyers. This is where a creditor allows you to change the terms of a loan repayment to make it more manageable.
• Share options allow your employees to buy into the company and receive a share of the sale proceeds on exit.

Going into the negotiation of your business sale, it’s likely to help if you are empathetic to your buyer’s concerns. If you do undergo some of the restructuring highlighted above within six years prior to the sale, then there could be some tax implications for the buyer. Similarly, movement of property assets may incur a stamp duty land tax charge if there is a change of ownership and assets have been moved in the group prior to this. The change of ownership can also lead to the extinction of any trading losses that you brought forward within the group, and it’s important that you consider how this may impact the buyer.

If the acquisition of your company makes the buyer a large group company, then they may be required to pay corporation tax in quarterly instalments, even if you aren’t obligated to currently. This could negatively impact their cash flow, which may influence how they choose to pay you following the sale. If you currently qualify for research and development tax credits, you may have different entitlements to the buyer, which could impact how they value your business. 

The perceived profitability of your business could be impacted by a number of factors, such as transfer pricing and tax relief on interest. An international trader could be critically influenced by transfer pricing; they may need to change the pricing that’s applied to supplies from the UK to businesses in other jurisdictions, which could, in turn, impact the profitability of your business. You may be claiming tax relief on interest that you pay but following the sale the buyer may not be eligible for relief, therefore affecting the profitability for them.

We would recommend completing your own due diligence exercise in preparation of the sale, to avoid the buyer having the opportunity to over-state any risks that may arise. Comb through your business operations, and consider your tax compliance and identify any reliefs that haven’t been claimed yet. This also offers a prime opportunity for you to rectify anything that hasn’t yet been treated or claimed before the buyer even enters the picture! You can also use the opportunity to identify any liabilities in your business’ VAT, PAYE and minimum wage tax compliance, so that any problems can be solved before the buyer enters the picture.