When it’s time to sell a business, or when a business owner starts planning their eventual exit strategy, tax is one of the most important things to consider. The tax implications of selling a business can vary depending on which exit route you choose, and it’s essential for sellers to understand the tax aspects when comparing different exit options.
The following is taken from a recent seminar organised by Shorts with NatWest and Freeths.
The full segment looking at the tax implications of each exit can be watched below.
Tax when exiting via a Trade Sale
If you plan to sell your shares to a Trade Buyer (i.e., a Trade Sale), you will generally pay Capital Gains Tax (CGT) at a main rate of 20% on any gains made from the sale.
As an example, if you buy shares for £100 and sell them for £500, your gain is £400, and you will pay 20% of that as CGT.
It is possible for some of the proceeds to be taxed as income, and there are nuances around deferred consideration, earn-out consideration and consideration in the form of shares. We strongly advise that sellers seek advice to help them understand the tax implications of the consideration to be received.
The Buyer will generally finance the deal, although some free cash in the Company may be used as partial funding via an upstream loan.
Business Asset Disposal Relief (BADR)
Formerly known as Entrepreneurs’ Relief, Business Asset Disposal Relief is for a reduced rate of CGT on the sale of shares in a trading business. This relief gives you a CGT rate of 10% on the first £1m gain and is worth up to £100k per shareholder.
To qualify for BADR, you need to hold shares in a trading company, must own at least 5% of the share capital, and you must be an employee or officeholder (e.g., a Director or company secretary). You must also have met these conditions for 24 months to qualify for the 10% tax.
Tax when exiting via Management Buyout (MBO)
A Management Buyout (MBO) has many similarities with a Trade Sale: you are still selling shares as a shareholder and will pay CGT at 20% (subject to reliefs and allowances). The same Business Asset Disposal Relief may also apply providing the same conditions are met.
The funding of an MBO, however, differs to that of a Trade sale. Profits in the trading business (existing and future) will often be used to finance the deal. This works well when the profits in the trading company are distributed as tax-free dividends to the purchasing company (“NewCo”). The benefit for the management team is not having to withdraw money to pay out the deferred consideration to the seller (i.e. without the need to pay tax on).
|“NewCo” is the company set up by the management team which plans to proceed with the MBO. The NewCo is an otherwise empty company, owned by the management team and containing their combined contributions and any external funding.
A seller may wish to keep some shares in NewCo. If you sell into a NewCo via an MBO, you may roll over any gains you make on those shares, and effectively defer any tax on that aspect. In effect, you should only pay tax on the consideration received in cash or loans. It should be noted, however, that you will not be able to control the NewCo without the risk of Income Tax arising on the proceeds.
The NewCo pays Stamp Duty on the deal, and this is therefore not a cost to the seller(s).
You can learn more about how a Management Buyout works in our dedicated Management Buyout guide.
Tax when exiting via an Employee Ownership Trust (EOT)
If you sell your shares to an Employee Ownership Trust and meet all the required conditions, it will be a tax-free sale. This has gained a lot of attention in the last few years. However, tax alone is not the principal benefit of an EOT sale. You can learn more about the wide-ranging benefits of an EOT in our detailed guide.
Tax benefits of an EOT also extend to employees, who can receive tax-free bonuses of up to £3,600 a year.
In order for the sale to be tax-free, the following conditions must be met:
- The company must be a trading company
- The EOT must acquire a controlling interest in the company (>50%)
- All employees must benefit equally from the EOT
- Only the first sale of shares to an EOT qualifies for the 0% tax. If you sold 51% today and 20% next year, the 20% would not qualify for 0% tax.
- Shareholders with a 5% stake in the business cannot make up more than 40% of employees. This is known as the 2/5th participation fraction.
Like with a Management Buyout, the EOT would have to pay stamp duty on the value of the trading company. This is a cost to the EOT, not the seller.
Recap the full seminar
Planning the best route to exit your business can begin many years before the event. There are many ways to exit, each with their own set of benefits and pitfalls.
On 7th July 2022, Shorts teamed up with Freeths and NatWest for an exclusive seminar, which outlined the pros and cons of each method of sale, looking at the funding, legal and tax implications of each.
You can now watch the full seminar, which you can access below.
As a Tax Partner, I advise clients on all aspects of UK tax, ranging from business taxes, transactions and private client matters, helping to achieve the objectives and aspirations of businesses and their owners.View my articles