There Are a Variety of Ways Both Individuals and Companies Could Look To Reduce or Avoid Capital Gains Tax on The Sale of a Business.
In this post we look at some of the most common ways.
Sale of Shares by An Individual
Where you have an individual selling shares in a company some of the most common ways are:
Use of Annual Allowances and Tax Rates
An individual might decide to transfer some shares to their spouse prior to the sale. This will enable the spouse to use their annual capital gains exemption against the chargeable gain on the shares. It may also enable the spouse to use the 18% tax rate if available.
The same advantage can be taken of a child’s exemption and lower tax rate provided that hold-over relief can be claimed on the transfer of the shares to the child. This will be the case generally if the company is a trading company, or holding company of a trading group, and either the shareholder owns at least 5% of the votes or the company is unlisted.
One way to escape the UK tax system altogether is to emigrate. The general rule under UK law is that UK residents can only avoid capital gains tax on a sale of shares by emigrating in one tax year, selling the shares in the next, and not returning to the UK for at least five complete tax years after their emigration. A successful emigration prior to the sale would avoid UK tax on the sale altogether.
Alternatively, it may be possible for a seller to decide to emigrate after the sale but before, say, any loan stock issued as consideration is redeemed. This could avoid the tax charge on the redemption of the loan stock but if prior to the sale the seller had an intention to emigrate he or she would have to mention this in the tax clearance made to the Revenue (discussed above) and this could result in the refusal of the clearance. Any clearance granted to an applicant who had failed to mention an intention to emigrate may well be invalid.
A final possibility is that a seller could persuade a buyer to enter into put and call options concerning the sale of the company, rather than agreeing now to sell the shares, such options only being exercisable after the seller has emigrated.
Another option could be to use a conditional contract for the sale with the condition only being satisfied in the tax year after you have left the UK. The disposal would then be free of CGT for you.
Though not exactly a scheme, there are quite a lot of tax advantages in holding onto shares rather than selling them. If one dies whilst holding shares, there is no capital gains tax charge and the base cost of the shares is uplifted in the hands of the personal representatives to their market value at the date of death. Though inheritance tax is chargeable on death, business property relief will generally wipe out any charge on, for example, all shareholdings other than those in fully listed companies (and, indeed, even some shareholdings in such companies).
Tax Planning for Companies
UK companies are rather limited in their methods of reducing a tax charge on the occasion of a company sale.
The main options are:
Substantial Shareholding Exemption
Companies selling shares benefit from an exemption from corporation tax. The exemption applies generally where corporate shareholders sell shares in trading companies in which they own at least 10% of the ordinary shares, profits and assets, but only where they have owned them for at least 12 months in the two years preceding the sale.
The selling company must have been a trading company or member of a trading group generally for the twelve months prior to the sale and must generally continue to satisfy this condition following the sale (though this last condition is not necessary in all circumstances).
Where the exemption is available, the seller has a great incentive to ensure that the sale is structured as a share sale rather than an asset sale.
Share and Loan Note Exchanges
It’s possible to avoid a disposal of the shares in the target company for capital gains tax purposes if the transaction falls within section 135 of the Taxation of Chargeable Gains Act 1992. This can be achieved provided that the shares in the target company are sold, not its assets, and that the consideration takes the form of shares or debentures in the buyer company. The deferral under section 135 can also apply where the consideration is the issue of loan stock to the buyer.
Where the seller is a UK resident company, paying out a dividend to the seller prior to the sale results in it not paying any corporation tax on the dividend, compared with paying up to 26% corporation tax if the shares had been sold. Do not presuppose, however, that dividend stripping is without tax problems simply because it is common.
* First, where the seller is a company, a dividend strip cannot be used to create or increase an allowable loss on a sale of the shares, (section 177 TCGA 1992).
* Secondly, a mass of complex legislation (including section 31 TCGA 1992) prevents the use of the technique to reduce a chargeable gain in specific circumstances.
Dividend strips also work for individuals who are basic rate taxpayers because the tax rate on dividends (effectively nil for basic rate taxpayers) is less than their capital gains tax rate (18%). For higher rate taxpayers the saving from a dividend strip will only be 3% (i.e. 28% – 25%). Those paying income tax at 50% will find that a dividend strip actually increases their tax rate (from 28% to 36%).
It is often suggested in the context of company sales that a termination payment is made to the departing directors, who will usually also be selling shareholders. The idea is usually to try to achieve a tax exemption for the first £30,000 of the termination payment (the exemption being available for non-contractual termination payments only). There is also the prospect of the target company being able to claim a tax deduction for the making of the payment.
This idea should be approached with caution. If it is the case that £30,000 has simply been taken from the purchase price and re-characterised as a termination payment, then not only might these tax advantages not arise, there may also be an argument that tax evasion has been committed. Any termination payment paid must be genuine (and even then it is arguable as to whether the target company will get its tax deduction).
Restrictive Covenant Payment
A similar idea is for the target company to make a payment to the retiring directors/sellers in return for them promising not to compete with the business of the target company. The idea here is to claim a tax deduction for the payment – such a payment is taxable as income in the hands of the recipients.
Again one should approach the suggestion with caution. Unless the agreement is genuine there is a possibility that it may be viewed as evasion if it simply involves re-characterising part of the purchase price as a restrictive covenant payment.
Need advice on selling your business? Get in touch here