By Michael Graham, Head of Tax at Sanders Chartered Accountants and Jeremy Aron, Client Legal Director at TLD
With the recent budget bringing changes to Capital Gains Tax (CGT), it’s a good time to explore the tax implications for owners and shareholders when exiting a business. We’ll look briefly at the recent budgetary changes and discuss how to maximise some of the available tax reliefs that are on offer to entrepreneurs looking to exit.
We’ll also give you some valuable insights on the vendor due diligence process, how to structure deals efficiently, and the impact of timing on tax.
What are the changes in the 30th October budget?
Capital Gains Tax
The Labour Government’s first budget included changes to CGT which will directly impact anyone thinking of selling their business. The headline rates have increased from 10% and 20% to 18% and 24% respectively. There were no changes to the residential property rates.
Business Asset Disposal Relief (BADR)
In addition to increasing the above rates, there were also changes to some of the reliefs available on an exit including BADR (previously known as Entrepreneurs’ Relief) and the lesser-used Investors’ Relief.
BADR is available to directors, employees and business owners who are selling their shares in a UK trading company. It allows shareholders to have part of their gains taxed at a lower rate of CGT. The limit for relief has been retained at £1,000,000 of qualifying gains, but over the next two tax years, the rate of CGT will rise from the current 10% to 14% in April 2025 and again to18% by April 2026.
What are the conditions for BADR?
The following conditions must be met for a period of at least two years ending with the date of sale:
- The shares that are being sold must be shares in a trading company or the parent company of a trading group.
- You must be an officer or an employee of the company.
- The company must be your personal company.
There are intricacies within the definition of ‘personal company’, but the crux of this is that you must hold at least 5% of the ordinary share capital, entitling you to 5% of the voting rights, and 5% of the assets of the company on a sale or winding up.
The final condition for qualifying for BADR – that the company must be your personal company – is relaxed for Enterprise Management Incentive (EMI) holders who can benefit from BADR even if they are not a 5% shareholder in the company.
Share option schemes
It is important to think carefully when introducing a share incentive scheme for your staff, to determine the objectives you want the scheme to achieve and ensure it is properly implemented. Schemes to incentivise employees with equity must be administered correctly so that all shareholders achieve what is expected at exit.
Bringing experts in at the outset to advise you will mitigate the risks of unexpected surprises at sale. Where possible, we recommend the use of HMRC approved share schemes, such as EMI and Company Share Option Plans (CSOPs). These come with some valuable tax advantages and give you the opportunity to enter into discussions with HM Revenue around important details like valuation, which ultimately impacts the tax treatment of these options when employees come to exercise them.
Vendor due diligence
Speed is often of the essence in M&A transactions. Any seller will therefore be keen to avoid the distractions or concerns that may be generated by discoveries made by a buyer during its due diligence. There are therefore significant advantages for sellers in undertaking vendor due diligence before going to market, notably giving you more control in the process. Whilst vendor due diligence inevitably has a cost, it will almost always bring to light any issues that may damage the sale or reduce the value of the business and enable you to take remedial or corrective action before launching the process with potential buyers.
Structuring the deal for tax efficiencies
What are you selling?
Sellers should be looking at what tax efficiencies are available when selling. A fundamental principle is to understand the structure of your business and know exactly what it is you’re selling. Is your business structured as a limited company, a partnership or a sole trader? Are you selling a parent company with subsidiaries? Are you just selling the trade and assets rather than the shares themselves?
Discuss the differences with a tax advisor and explore how each option plays out in terms of tax outcomes.
Look at your balance sheet
When you’re approaching an exit, look at your balance sheet to see if there are any issues that need to be cleared up. If there is excess cash and you have director loan accounts that need to be repaid, you can use this excess cash to repay those in a tax efficient way.
If you don’t have loans to repay, then you may want to consider voting for a dividend prior to sale to make sure that the shareholders are extracting the value and the distributable profits that they’ve generated as the owners.
Time it right
Timing can be a critical factor when it comes to the tax treatment of a disposal. There are different ‘clocks’ that are relevant for certain reliefs such as BADR, Substantial Shareholding Exemption and Investors’ Relief.
BADR for example, requires you to have held the shares for two years prior to sale.
Ask your advisor to help you understand what reliefs you may be eligible for. If timing is a factor, consider negotiating with the purchaser to ask for a delay to allow you time to meet these conditions.
You may also want to consider pushing the sale into the next tax year to extend the payment date for tax by an additional 12 months.
Negotiate a reasonable set of warranties
There are ways to protect yourself and your tax position through the deal documents. As a seller, you will want to negotiate a sale and purchase agreement which limits your potential liability to the buyer as far as is practically possible. The importance of pragmatic and commercial legal advice cannot be over-emphasised during this process.
Be careful of tax liabilities
Very often in the context of a share sale, buyers push for tax deeds. A tax deed is basically a tax indemnity. Any tax deed should be carefully reviewed and tightly negotiated to avoid the risk of having your retirement or exit plans impacted by future claims from your buyer.
Looking for help?
If you are an owner or shareholder thinking of exiting your business and would like some expert legal or tax advice, use the contact details below to get in touch.
