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TaxationWeb by Jennifer Adams

There is more than one potential 'exit route' for business owners selling the family company, explains Jennifer Adams, Capital Taxes Editor of TaxationWebIn the ideal world the sale of any business should be planned well in advance not least to ensure the maximum tax benefits available – but as we all know the business world in particular is not "ideal".

There are a number of questions to be answered before a company goes down the selling route – in particular whether the company would in fact be attractive to a potential buyer; if not, restructuring including demergers may be called for, possibly over a period of many months before the timing of the actual sale.

Shares or Assets?

There are basically two ways of selling a family company – either by selling the shares themselves or selling the assets and then liquidating the company. The sellers will invariably prefer to sell the shares; otherwise they will be liable for CGT twice, once on the sale of the assets and secondly on the distribution to the shareholders should the company subsequently be wound up. The purchaser on the other hand may prefer to take the assets as when he comes to sell he will be able to claim "rollover relief". "Roll over relief" is relevant if a taxpayer makes a gain on the disposal of a business asset, which he has used exclusively for the purposes of his trade. In this instance he can defer his liability to CGT if he reinvests the amount received on the disposal in new business assets. This is achieved by deducting the gain made on the old assets which would otherwise be chargeable from the cost of new assets; as such the gain is effectively rolled over to the new assets. He may also prefer buying assets as this is a more straightforward exercise than buying shares – and invariably what the purchaser wants the purchaser gets.

Non Residence

Residency rules may also be a consideration as gains can be avoided by sellers who are not resident or ordinarily resident in the UK when the actual contract is made. However, unless the vendor is a short-term visitor to the UK, the sale should not take place until after the end of the year of assessment in which the vendor leaves the UK. The reason for this is that under extra-statutory concession D2, an individual is not charged to CGT on gains from disposals made after the day of departure from the UK, but only if the individual was not resident and not ordinarily resident in the UK for the whole of at least four out of the seven years of assessment immediately preceding the tax year of departure. If the concession does not apply, residence and ordinary-residence status applies for whole tax years, hence the need for a new tax year to start before the individual is considered to be non-resident.

If the sale does take place whilst the seller is deemed to be resident abroad, but return to the UK is contemplated, the return must not take place until five tax years have elapsed following the year of departure. An earlier return will trigger a CGT tax charge in the year of return on the gain realised whilst he or she was abroad. This section applies where the circumstances are a mirror image of those in ESC D2 above (i.e. only if the individual was resident or ordinarily resident in the UK for at least four out of the seven tax years preceding the tax year of departure). Thus, if the section applies and the year of departure is 2004-05, the year of return must be no earlier than 2010-11. However, double tax treaties may avert a charge – Belgium, Luxembourg and New Zealand all only tax a limited range of gains and in theory becoming resident in one of those countries for one complete tax year could achieve no CGT on disposal in either country but as ever with such matters this should always be checked before finalising contracts.

Cash, Shares or Loan Notes?

In share sales where the consideration is for a set amount of cash, the CGT computation is obviously straightforward. Where cash is not exchanged the selling shareholders could receive a "paper for paper" transaction where the "old" shares are exchanged for the "new". In this situation no disposal is deemed to have been made and the shares received in exchange qualify for taper relief from the date of acquisition of the "old" shares – any CGT there is will be deferred until another chargeable event takes place for example, when the "new" shares are sold.

The CGT charge can also be deferred where the exchange is partly in the form of loan stock. The loan notes are treated as being the same asset as the shares for which they were exchanged but will typically not bear the same degree of exposure to fluctuations in value as the shares for which they are exchanged. The amount of taper relief available will depend upon whether the loan stock is a "qualifying corporate bond" (QCB). QCBs have special rules for CGT whereby any gain deferred into such a security will remain liable to CGT when the security is disposed. Taper relief runs to the date of exchange and the gain at that date is frozen until the bonds are disposed (the bonds themselves being exempt from CGT). The downside is that when the bond is finally sold the original gain is then taxed regardless of the fact that the bond itself is exempt or stands at a loss.

Therefore, generally where shares are exchanged for securities it is better to ensure that the security used is not a QCB as using other types of security will attract the continuous accrual of CGT taper relief during the period in which the new securities are held. However, where there is a long accrual of Business Taper Relief attaching to the shares to be exchanged then a QCB may be preferred as the bond will freeze existing taper relief entitlements.

Selling the Assets

The final method of disposing of a company comes in the selling of the assets of the company. However, going down this route can also lead to problems as the seller and purchaser invariably have a differing agenda. The seller will invariably want maximum tax reliefs and as such will allocate consideration to assets that have a high CGT base cost. Indexation allowance should not be forgotten but can do no more than reduce a gain on any asset to zero.

Summary

The above is only a snapshot of the CGT considerations necessary when contemplating the sale of a company but with careful expert tax planning it is possible to avoid the hidden traps, maximise reliefs and obtain some form of relief for the costs of the entire exercise.


Jennifer Adams is TaxationWeb's Capital Taxes Editor. Click here for more information on Jennifer and her contact details.

Jennifer Adams
March 2004