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Markel Tax

01 Jun 2020

Tax considerations before you sell your business

The current Covid-19 pandemic is having a major economic impact on a number of businesses across all sectors of the economy. Unfortunately, some businesses will be showing signs of distress and business owners may decide now is the time to sell their businesses or discrete parts of their businesses. This article focuses on sellers where the business is operated within a company and the key considerations to be addressed before proceeding with a sale of the whole or part of the business or the shares in the company.

Share sale

As a seller, where the intention is to exit the business completely, it is often more beneficial and straightforward to sell the shares in a company, as this allows for the proceeds of sale to be paid directly to the seller. More importantly, a number of valuable reliefs may be available on the sale of shares, such as:

  • Business asset disposal relief (formally entrepreneurs’ relief) a capital gains tax (CGT) relief that reduces the rate of CGT to 10% on disposals of qualifying business assets, subject to a lifetime limit of £1 million.

To qualify the seller must, throughout a two year period to disposal, have held at least:

  • 5% of the ordinary share capital

  • 5% of voting rights, and be beneficially entitled to either

    • 5% of the profits available for distribution to equity holders and 5% of assets on a winding up, or

    • 5% of proceeds on the disposal of all of the ordinary share capital of the company

Additionally, the company must have been a trading company or the holding company of a trading group.

  • Enterprise Investment Scheme re-investment relief may allow the capital gain, or a portion thereof, to be deferred where the proceeds from the sale of the shares are reinvested in qualifying EIS shares.

  • In the case of the disposal of a company from a group of companies, substantial shareholding exemption (SSE) may apply to the sale of shares, providing a complete exemption from corporation tax of any gain.

Broadly this relief is available where, throughout a continuous period of 12 months during the six years prior to disposal, the selling company:

  • held at least 10% of the ordinary share capital of the company being sold,  

  • has been beneficially entitled to at least 10% of the profits available for distribution to equity holders, and

  • has been beneficially entitled to at least 10% of the assets available for distribution to equity holders on a winding up.

Additionally, the company being sold must have been a trading company or the holding company of a trading group or sub-group from the start of the period above to the date of disposal.

There are some potential drawbacks both from a tax perspective and commercially, which a seller has to consider in respect of a share sale.

Where the sale of a company from an existing group is proposed, the potential for a de-grouping charge has to be considered, which can arise where the company leaving the group acquired an asset from another member of the group at no gain no loss in the six years prior to leaving the group. In certain instances, the de-grouping charge can attach itself to the sale of the shares and the availability of SSE may then avoid the de-grouping charge, but this would be reviewed as part of the due diligence process on sale.

Similarly, stamp duty land tax group relief can be clawed back where the company has previously claimed this on intra-group transfers and leaves the group within three years.

The purchasers will carry out a due diligence of the company to ascertain the extent of any potential exposures and tax risks and the seller will be obliged to make disclosures and enter into warranties and indemnities with the purchasers. The purchasers will be buying the company and taking responsibility for all historic tax issues and risks as well as inherent gains on assets held. As a result, it is often the case that sellers will be offered less consideration for their shares and certain disclosed issues may lead to further price chipping. Many distressed businesses may have losses and the purchasers may want to be certain that these losses can still be used going forward, but the recent tightening of the anti-avoidance rules on acquiring loss making companies may make this less attractive.

For VAT purposes, a disposal of the business under the share sale route would mean that the entity disposing of the shares is making an exempt supply. Although output tax would not be charged when making an exempt supply, it could have implications for VAT recovery on costs attributable to the disposal. Early consideration should be given to the VAT recovery position when this might be material.

Trade and asset sale

It is often the case that a purchaser does not want the risks of acquiring a company and simply wants to acquire the trade and assets instead. The seller may also wish to retain certain assets within the company and so will agree to the disposal of a specific trade and its assets; the tax implications of the transaction will depend on the specific assets being sold.

A purchaser will typically offer a price to acquire the trade and assets of the business as a whole, however, for tax purposes this needs to be split between the various types of assets being acquired and can offer some tax planning opportunities.

The acquisition of the trade will trigger a cessation in the books of the seller’s company and bring an end to the accounting period so the impact of this should be considered on trading profits and losses. Part of the proceeds may be in respect of qualifying assets on which capital allowances have been claimed so the impact of a balancing adjustment also has to be taken into account. Allocating a larger part of the consideration to plant which, although may create a balancing charge, could be covered by trading losses. Similarly, the sale of intangible assets may create a trading credit which could be covered by available trading losses.

Trading losses will generally be lost by the seller on sale but there may be some entitlement to claim terminal loss relief. Capital losses will remain behind in the seller’s company and since these can only  be offset against chargeable gains arising on the disposal of any capital assets it may be beneficial to allocate a greater portion of the consideration to capital assets to set against the capital losses. For example, property values may have fallen during the Covid-19 period resulting in a capital loss, and triggering a capital gain on disposal of the assets of the trade could offset this loss.

Sellers should be mindful that the profits on the disposal of the assets are subject to corporation tax and the extraction of post-tax proceeds from the company will give rise to a tax charge on the seller. The cash can be extracted in a number of ways, either over time in the form of salary, dividends, benefits and other means of income or as a capital sum in the form of a liquidation or informal winding up.

If the capital extraction method is preferred, then a liquidation is likely to be chosen route of cash extraction. However, specific anti-avoidance rules need to be considered. The process of liquidation requires the appointment of a liquidator and therefore additional professional fees for the benefit of obtaining capital treatment in respect of the assets distributed. It may also be possible to obtain  business asset disposal relief giving a 10% CGT rate on the resulting capital disposal where the company is liquidated within three years of the date the company ceased to trade. The targeted anti-avoidance rules could apply if the seller were to carry on a similar trade or activity within two years of the liquidation and the liquidation of the company was itself considered to be tax driven. If the rules apply, then the distribution would be liable to income tax.

There are VAT implications of trade and asset sales, and the issues are usually complex. A prime question is whether the sale qualifies for VAT relief under the transfer of a going concern (TOGC) provisions. If it does qualify, the sale of the business is a VAT free transaction. However, determining whether it qualifies is not straightforward, as there are a number of inexact conditions and significant case law to consider. For example, relief partly depends upon the purchaser being compliant both at the point of purchase and subsequently, and the purchaser’s failure to meet any one of the relevant conditions will result in the TOGC relief not being applicable and a VAT liability falling on the vendor. Steps are required to ensure the purchaser’s compliance and the vendor’s VAT risk should be managed carefully, usually within the agreement for sale.

A review will be needed where a business includes property, as this can be excluded from the TOGC relief under certain circumstances, leading to additional VAT liability for the seller and increased SDLT for the purchaser. The impact of disposal on the vendor’s VAT position under its capital goods scheme calculations must also be taken into account where the business includes a qualifying item such as a property. 
There are further complications when partially exempt businesses and VAT groups are involved. For example, VAT recovery on costs relating to the disposal will not be straightforward if the business is not a fully taxable businesses. 

These VAT risks are tricky to manage for sellers of assets. The benefits of TOGC are significant and vendors who are pressed by purchasers to apply TOGC rules should proceed with advice. 

Forms of proceeds

It is common, particularly in these difficult times, for an element of the consideration received to be in some form of deferred consideration. The amount of deferred consideration could be contingent on future targets being met, often referred to as an earn-out.

For tax purposes, the basic principle is that the date of disposal for CGT purposes is the date that an unconditional contract is entered into and this date establishes the point at which the gain should be calculated. The timing of receipts of proceeds is, for the most part, irrelevant in determining the disposal date.

The treatment of deferred consideration falls into two categories, referred to as deferred ascertainable and deferred unascertainable consideration, the difference being that if the amount to be received at a later date is fixed or known at the date of disposal, then it is considered ascertainable. Alternatively, if the amount to be received in the future is determined by some future event, then it is considered unascertainable.

In the case of ascertainable consideration, the entire amount to be received in the future is included in the CGT calculation at the date of disposal, and therefore the liability due on the whole amount. If the amount actually received in the future differs, there is a subsequent adjustment to this calculation. Individual sellers can elect to pay some of the CGT by instalments where the date the amount to be received is more than 18 months after the date of disposal.

Given the current economic climate, sellers may want certain safeguards included within the sale and purchase agreement in the event of part of the consideration not being paid. They may insist on a formal loan note which pays interest. The loan note may allow the seller to hold over the payment of the CGT liability until it is redeemed but there may be a loss of business asset disposal relief (BADR) in such circumstances, although elections can be made to trigger the disposal safeguarding the BADR position but this will mean that the tax is payable up front. There may be risks where the loan note is in the form of a qualifying corporate bond where the gain crystallises but is held-over and only becomes payable on redemption of the loan note. The seller will, therefore, be liable to pay the tax even if the consideration is not paid which may be a bigger risk where a distressed business is acquired.

For unascertainable consideration, the right to receive future consideration is valued at the date of disposal and this value is included in the initial CGT calculation. The seller is treated as acquiring an asset, referred to as a ‘chose in action’ being the right to receive future consideration, at the value recognised in the CGT calculation. When the future consideration is received the seller is deemed to have disposed of the chose in action for the amount actually received. Where this results in a loss, the individual seller may elect to carry the loss back against the original gain. If, however, a gain is realised by the individual seller on the chose in action, the gain is subject to CGT and BADR is not available on this subsequent gain.

The seller may be offered shares as part of the consideration so the implications of this such as future entitlement to BADR need to be considered. Generally, a share for share sale would not trigger a chargeable gain on that part of the consideration but again an election can be made to safeguard existing entitlement to BADR.

For corporate entities selling their trade and assets for an element of deferred consideration, the position largely follows that for individuals. The consideration taken into account in the disposal of the assets will be calculated as above, dependant on whether the deferred consideration is ascertainable or unascertainable, and will be split between the various types of assets. Unlike for individuals, BADR will not be available on the disposal of assets and in the case of earn-outs, companies may not make an election to carry back allowable losses arising on a chose in action to any chargeable gains arising on the disposal of the trade and assets.

Tax points for VAT purposes should also be considered when deferred or contingent consideration is involved, as this will affect whether VAT is payable before consideration is received or whether VAT is not due until the amount payable is known. 

Summary

The above considerations are a few of many that a prudent seller and their advisers should factor in before proceeding with a sale. As a reminder of some of the key things to consider:

  • Negotiate a sale of shares of the company or the trade and assets bearing in mind entitlement to valuable reliefs such as BADR and SSE and likely offers from the purchaser.

  • Are there any assets you wish to maintain within the company?

  • What is the likely consideration? Will any of the consideration be deferred and if so how will the future amount be determined?

  • On an asset sale how can the consideration be split tax efficiently from the seller’s perspective?

  • After the trade and assets of the company are sold, how should the proceeds be extracted? Could the funds be recycled into some other venture? Be mindful of the anti-avoidance rules on a liquidation.

  • What are the VAT implications of the sale and how will VAT risk be managed?

Selling a business will be a major transaction for many clients and they will want comfort that all aspects of the sale are covered to avoid unexpected tax and VAT liabilities, particularly in more complex and larger transactions. The team at Markel Tax have many years of experience advising on the sale and purchase of businesses so feel free to contact us.

For further information and advice on purchasing or selling a business contact Martin Mann martin.mann@markel.com or Mark Baycroft mark.baycroft@markel.com , or for VAT support Kevin Hall kevin.hall@markel.com or call our TaxDesk on 0333 920 5708.

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Tagged Property tax & SDLT Value added tax (VAT) services Capital allowances Property tax & SDLT Value added tax (VAT) services Capital allowances COVID-19
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