Louise Jeffreys, Managing Director at Gunner & Co takes a look at how advisers planning their future exit strategy can take advantage of this significant tax benefit.
Recently I’ve been writing a lot in IFA Magazine on the subject of helping advisers to prepare their businesses for sale at some point in the future. It is clearly a very hot topic as I’m pleased to report that I’ve been receiving lots of good feedback from readers as a result.
Interestingly, I saw a quote online recently saying that at any one time 50% of IFAs are looking at their exit options. That’s a lot of businesses looking to understand the process and prepare themselves well for future change.
If you read my article in the July/August edition of IFA Magazine, you will know that at Gunner & Co. we have designed a set of seminars to provide advisers with the information needed to have a planned and controlled exit. Part of that is thinking ahead; ensuring that you have a strategic plan in place at least a couple of years in advance.
One particular topic which we’ve included in those seminars is the ins and outs of entrepreneurs’ relief – and particularly the qualification criteria. I thought it would be useful to share some of that insight with readers of IFA Magazine. I must make it clear that I am not a tax expert, however below is an overview of the key things that I believe advisers need to be aware of when considering the sale of their business. There is simply no substitute for getting sound tax advice from a specialist when planning your exit strategy and I’ll be making that point loud and clear below!
What is entrepreneurs’ relief?
For those of you who are unfamiliar with it, entrepreneurs’ relief (ER) is a form of capital gains tax relief which is available when you are selling the shares of your business. It is currently structured to allow business owners to pay a 10% rate of CGT on up to £10 million of capital gains over a lifetime. When you compare that to the standard CGT rate, it equates to a tax saving of up to £1 million per individual, so £2m when including a spouse.
It is therefore a very generous tax break from HMRC, and something which business owners should take advantage of, by ensuring they meet the relevant criteria.
So how do you qualify for it?
An initial and very important qualification which has already been mentioned is that the acquirer of your business must be buying the shares of the business, not the assets.
What do I mean here? Well, if you sell the assets of your business, effectively your business is selling those assets, and so any payment is made back into the company. The company is then liable to corporation tax, and following that you have to extract those funds, either through a dividend or through winding up the company. Whichever way you choose, you have two costly layers of taxation.
Through selling the shares of your business, as an individual shareholder you will receive the consideration due for those shares, which is taxable through standard CGT at 20%, or ideally through ER, at 10%.
It is therefore important to understand at the outset how the tax treatment of different deal structures can differ widely and make a huge difference to your after-tax return. Often firms bring in specialist advice very late on in a sale process, when the commercial negotiation has been concluded and it is too late to make a difference. So my tip is to take advice early and factor this into your negotiation.
I’m selling my shares, now what?
As with many available tax reliefs, there are some important key qualification criteria. These need to be in place a minimum of 12 months before the transaction. It is therefore very important to plan for this well in advance.
That said, assuming you have planned in advance, the good news is that the criteria is not overly arduous.
In principle, in order to qualify, gains must be made on shares & securities in an individual’s ‘personal company’:
Let’s look at the criteria:
- You must hold a minimum of 5% of ‘Ordinary Share Capital’, and 5% of the voting rights within the company.
The definition of ‘Ordinary Share Capital ’ is complex. Broadly, this includes all share classes (whatever they are called) with the exception of fixed rate preference shares. It can be the case that the share capital of a particular company includes different classes of shares with very different rights. It is really critical to check the position carefully, particularly where shareholders are close to the 5% level. Also, remember that this needs to be done at least 12 months before a transaction as shareholders need to qualify throughout the 12 month period prior to a sale.
- You must be an officer or an employee in the business
This is a common area of focus for HMRC when checking ER claims. To qualify for this tax relief you must have a genuine job within the business, with a relevant employment contract and job description. Alternatively, an office holder such as a Director or Company Secretary can also qualify but again the individual needs to undertake the duties of the role.
HMRC will often check that an individual has performed the duties that they are contracted to perform so it is critical that any claim for ER is based on the factual position.
- The company must be a trading company, or the holding company of a trading company.
If non-trading assets of the business exceed 20% of the value (including the goodwill value), your ER may be at risk. So, for example, if the business holds investments exceeding that 20%, these additional investments will need to be divested at least a year before any transaction completes. This test can also be applied to turnover and management time.
Assuming you qualify on each of the above points, a further consideration relates to when you will pay that tax, if, as is typical with IFA mergers & acquisitions, you take your consideration across a series of deferred payments. For example; say up to 60% of the value of the deal is paid some months or even years after the deal completion, the taxation should be calculated on the full valuation and paid in full upfront. Deferred consideration can make things more complex from a tax perspective and can often mean either payment of tax on the full value up front or being subject to a higher tax rate on the deferred payments. Again, taking early tax advice can make a huge difference to the after tax return and ensure the deal progresses smoothly. Don’t leave it to the last minute as by this time the commercial deal will have been agreed and there is little that can be done to improve the position.
Just in the same way as the clients’ you advise, every individual’s situation is different when it comes to selling a business. Within the confines of this article, all we can do here is to give you an outline of the key criteria, but this will never take the place of specialist advice. Since this is a highly important matter, I’d strongly recommend getting advice from a specialist tax adviser.
Whilst I am not a tax expert, to discuss your options with regards to preparing your business for sale, readers are welcome to email me firstname.lastname@example.org and I will be happy to help and can refer you to tax specialists if required.