There comes a point in the life of every business when the owner decides to step down and sell the company.
As we saw in last month’s blog, you will want to make sure that you only pay capital gains tax at the 10% rate (the ‘entrepreneur’s relief’), when you sell a trade or trading company. But there may be further complications.
First of all, who are you selling to? You may structure a transaction differently if it is to a third party, to a management team, or to your children, or even to a mixture of any two or three of these. If a third party is willing to pay cash on day one, then you can simply walk away, worry free. But often your buyers won’t have the money to pay up-front, particularly in the case of a management buy-out or a sale to your children or other family members, so you may need some kind of structured disposal.
Typically, in these cases, the people wishing to buy the business will form a company (the ‘BidCo’). Let’s imagine the buyers are your management team:
BidCo buys your trading company for a mixture of cash, loan notes, and sometimes shares issued by BidCo. The cash element may come from the amounts subscribed for shares in BidCo by the management team, or from dividends paid by the acquired company to BidCo immediately after the acquisition. Either way, assuming you have a trading company and you otherwise qualify for entrepreneur’s relief, you will generate a 10% tax bill on the cash element, that capital gains tax being payable on January 31 after the next April 5 (so 31 January 2016 for transactions completed on or before 5 April 2015).
Generally, the CGT liability on the loan note element, or shares, only arises when the loan notes are redeemed or the shares are sold. However, it is important to ensure that redemption of the loan notes or sale of the shares in BidCo will also qualify for the 10% CGT rate. If, for example, you are only issued with loan notes and cash, the loan notes will not qualify for entrepreneur’s relief, as this relief requires you to hold at least 5% of the shares in the company. So if you are not receiving shares, you will need to make an election that says your CGT charge crystallises on the sale, not on the later redemption of the loan notes.
You must also make sure that you have the cash available to pay the January 31 tax bill. To do that the loan notes must be at least partly redeemable before that date.
This special treatment of shares and loan notes can be confirmed by a clearance from HMRC. This important process affords some degree of certainty over the tax treatment of your disposal and is best done for you by an experienced advisor.
We can also add other features to a buy-out. For example, in a case where parents were selling to their children in return for loan notes, the parents remained on the company’s board, partly to guide the children through the transition into full ownership, and partly to protect their investment until the loan notes were redeemed.
We are currently working on a phased management buy-out, with BidCo acquiring just over 25% of the company in the first instance, 25% later on, and then buying out the remainder with bank financing within about five years.
This gives just a brief overview of some of the issues that arise on structured disposals of your business, and highlights the need to speak to an experienced advisor on these matters.