In the midst of battling with everyday realities such as this pandemic, some of the wider implications are not immediately apparent. This is the case for many entrepreneurs – whether they are looking to exit or not, writes Rosie Todd.
The delayed Budget – pushed to the delightfully uncertain “next year” – may well, if rumours are to be believed, bring significant tax rises. One of the main speculations is a potential increase in capital gains tax rates to match income tax, with the recent Office of Tax Simplification’s report on CGT adding fuel to this particular fire. If this were to happen, what should entrepreneurs be considering now?
Whilst tax should never be the main driver, staring down the barrel of a potential 25% tax hike does focus the mind. For many business owners, the possible increased tax hit on selling their business has prompted a review of whether it is time to sell.
The trouble is, for most, 2020 has been a difficult year and many businesses have not enjoyed economic growth. Price negotiations are therefore tricky and, even if you can find a buyer, you may not get all of the cash out on day one.
If you are in the lucky position of being able to negotiate a good price, what tax considerations should you be thinking about pre-exit?
If you hold shares in a trading business, these may qualify for an inheritance tax relief known as business property relief which, if it applies, would give a one-off opportunity to pass value into a trust.
Usually, transfers into trusts trigger an upfront IHT charge at 20% (to the extent that the value exceeds your nil rate band – currently £325,000). However, if the shares qualify for BPR, you can transfer the shares to trust without incurring the upfront IHT.
Buyers may also seek to de-risk their assessment of a business’s value by tying proceeds to the future performance of the business.
Importantly, a trust isn’t all one-way traffic from a tax perspective. The trust is a taxable entity and will pay tax (including on the later sale of the shares transferred to it), but provided you survive for seven years, it does allow significant value to be taken out of your estate for IHT purposes whilst still retaining control.
And if there’s no buyer?
If no buyer is available, the usual round of strategies to trigger a disposal rear their head, as when taper relief was removed back in 2008. Some of these may “work” but care is needed; the tax landscape has developed greatly since 2008 and what was sensible planning back then may well fall foul of the General Anti-Abuse Rule or other anti-avoidance measures now.
You also need to be alert to the risk that the Government could bring in anti-forestalling measures, as was the case with the recent Entrepreneurs’ Relief changes, which may defeat attempts to create a disposal artificially prior to any rate change. As ever, it is crucial to get advice before embarking on any planning.
COVID-19, deal structuring and receiving proceeds
Deal pricing and structure is something for commercial negotiation between the parties; there is no definitive rule. However, as mentioned above, most businesses have seen some disruption to their cash flow this year.
Furthermore, even with a vaccine on the horizon, an uncertain economic and trading outlook may encourage some buyers to seek to fund an acquisition using alternatives to cash, and/or make payments in instalments to preserve cash flow.
Buyers may also seek to de-risk their assessment of a business’s value by tying proceeds to the future performance of the business, perhaps requiring you to retain some operational role in the business. These types of structural aspects are not new to M&A (particularly in private equity transactions), but have been increasingly used in recent months.
The timing and method of delivery of proceeds has tax implications, some of which can be surprising for individual sellers. It is important to bear these in mind when you are negotiating the deal structure, and to seek specialist advice tailored to your personal circumstances.
Payment of proceeds in instalments can give rise to “dry” tax charges for CGT purposes, where the due date for payment of CGT falls ahead of the cash receipt. For some taxpayers, this may be preferable in order to access current CGT rates and reliefs, such as Business Asset Disposal Relief, formerly known as Entrepreneurs’ Relief.
The key consideration is usually practical, including how to actually fund tax liabilities, and whether a payment arrangement with HMRC is possible.
Receiving securities in the buyer – shares or loan notes – as an alternative to cash can open up the possibility of deferring CGT liability until a later disposal of those securities, also known as a “rollover”.
Rollover prevents dry tax, and locks-in investment in the buyer’s group, but it may mean losing the availability of BADR, and taking some risk on future changes to CGT by the time of disposal. Rollovers also require careful planning, particularly if the buyer’s group structure is complicated. Another consideration is timing: it is common for sellers to seek HMRC clearance for a rollover, but this can take a month or so to return. It is therefore worth considering this early in a transaction timetable.
Accounting for future profits
Earn-outs, where proceeds are tied to future performance of the business, give rise to particular tax considerations, alongside more obvious commercial factors.
If a seller continues employment with the group after the sale, a key concern is usually whether earn-out proceeds may be characterised as employment income and subject to PAYE deductions for income tax and national insurance. Depending on the terms and timings of the earn-out, the CGT analysis may require separate valuation of the “right to receive” future cash, or, where paid in securities, the possibility of deferring tax as a rollover. If you have any BADR allowance left – which was reduced to £1m lifetime gains this tax year – impact on your eligibility will need to be considered.
Selling your business may be the most significant financial event in your life. In all cases, it is worth considering your expected tax position early on in sale negotiations to understand the impacts and explore all your available options.
This article was first published in SME, see here.
Rosie Todd