Impending changes 6 April 2008
Tax and Business Sales
We really are in a state of flux at present. Not only do entrepreneurs have to cope with changes to the capital gains regime, but a widespread reform of domicile and remittance is taking place.
So far as the rules on residence and domicile are concerned, there have been a series of partial U-turns to alleviate some of the adverse and unintended changes.
From the perspective of the capital gains changes, the introduction of a limited relief in the form of Entrepreneurs’ Relief will help to alleviate some of the concerns that have arisen from the increase in the effective rate of capital gains tax from 10% to 18%, effective 6 April 2008 . This relief will be of assistance to shareholders who are employees or officers and have a significant stake of 5% or more of the ordinary share capital or voting power in a trading company. The conditions for the application of entrepreneurial relief (trading status, 5% interest and officer or employee status) have been met for at least one year. This of course does not help employee shareholders, holding minority (sub 5%) interests. Particularly this could include employee participants of Company share schemes.
A “Lifetime Limit” of £1,000,000 will operate up to which capital gains tax will be charged at an effective rate of 10%. Thereafter gains will be charged at 18%. This represents an £80,000 saving against the taxes that would otherwise fall due at an 18% rate.
The following illustrations assume that the Vendors retain no continuing interest in the shares:-
Sales that have taken place
Under certain transitional provisions, those Vendors that have already sold, and accepted loan notes constituted as qualifying corporate bonds, may be entitled to Entrepreneurial Relief on the redemption or sale of those loan notes on or after 6 April 2008, where the conditions for the relief would have been satisfied at the time of the earlier sale (assuming the conditions for relief would have been satisfied if the sale had taken place on or after 6 April 2008).
For those that have already sold and been issued with non qualifying corporate bonds, they may simply approach the issuer of the loan notes and ask whether early redemption is possible before 6 April 2008, so that they benefit from taper relief. If this is not possible (perhaps where the loan notes have not been held for at least 6 months) other means of crystallising the in built gains can be used.
For those about to sell before 6 April 2008
For those Owner Managers that are about to sell before 6 April 2008, there are a number of options (assuming a wholly cash deal is not available) :-
Accept loans notes constituted as qualifying corporate bonds in the Acquirer. As already outlined the later redemption or sale of those loan notes on or after 6 April 2008 will qualify for Entrepreneurial Relief assuming all other conditions are met.
If only foreign currency denominated loan notes are available (perhaps where the Acquirer is a non resident company) consider accepting loan notes in a Company other than the Acquirer.
The value of the loan notes is then taxable up front as if an immediate disposal had taken place though significant commercial risks, and funding issues may arise.
For earn outs matters become even more complicated. In the past and on many occasions the earn outs would be satisfied by the issue of loan notes. This would allow the tax liabilities on those earn outs to be deferred. The gains would crystallise only when the loan notes are redeemed or otherwise sold. The new rules would tend to indicate that the gains arising on the redemption or sale of the loan notes issued in satisfaction of a earn outs will not be eligible for Entrepreneurial Relief. Therefore Vendors who are offered earn outs should consider accepting a cash alternative in satisfaction of the earn out (the value of this right is treated as an immediate disposal at the time of sale), make an election under S.138A(2A) to crystallise a disposal, or consider accepting an earn out in a Company other than the acquiring vehicle (again treated as an immediate disposal). Both funding the tax liabilities and the commercial issues already outlined, have to be considered.
For those who will sell on or after 6 April 2008
Once more Vendors should (assuming a wholly cash deal is not available):-
Accept loans notes constituted as sterling denominated qualifying corporate bonds in the Acquirer. As already outlined the later redemption or sale of those loan notes on or after 6 April 2008 will qualify for Entrepreneurial Relief assuming all other conditions are met.
When issued with loan notes constituted as non qualifying corporate bonds, they will be able to make an election to disapply the rollover treatment that would otherwise apply. This would then allow them to bank Entrepreneurial Relief, though the same funding issues already outlined arise.
Earn outs – the same considerations apply as outlined above
