When is the right time to sell your business?

After last year’s very successful international property offices (IPOs) – Royal Mail in the UK and Twitter in the US – 2014 looks like the biggest year for them since 2007. Owner-managed businesses with sale proceeds in the millions, or at most tens of millions, will find entrepreneurs’ relief and business property relief very valuable on transfers of assets.

Many individuals have fallen into traps, often where they have sought advice but not understood that changes to their circumstances could affect the validity of previously sensible decisions. In other cases, it has been a case of trading off one relief against another.

Entrepreneurs’ relief (ER) is available to reduce capital gains tax (CGT) for disposals or part disposals of a trading business. The business can be carried on individually, as a partnership or as a corporate entity. Where individuals dispose of shares in a company, they should be an officer or employee and have held at least 5 per cent of the share capital in the 12 months leading up to the sale. This is a simplification of the rules and there are exceptions, for example enterprise management incentive (EMI) schemes.

Business property relief (BPR) is available to reduce inheritance tax (IHT) for both lifetime transfers and those on death. Where ER is an all-or-nothing test, 100 per cent relief is available for businesses and business interests, and shares including AIM companies; 50 per cent relief is available on controlling holdings of quoted companies, and plant, machinery, land and buildings used by the qualifying company.

For businesses that wholly or mainly deal in securities, stocks and shares, land, or buildings, they would generally not qualify for BPR. HMRC has challenged a number of cases involving furnished holiday lets on this basis.

Assets that are not used “wholly or mainly” for the purposes of the business (practice is 50 per cent related to trade) will be deemed “excepted assets”, with no relief from IHT applicable. I have seen good, bad and ugly examples of planning, as the following case studies show.

Buy and build

Douglas had been a client for a number of years. At 60, he decided the time had come to wind down from business. His four children had highly paid professional jobs and were scattered round the globe. None of them had an interest in succeeding their father.

Over his working life, Douglas had built a private pension fund and separate commercial property portfolio outside the business of £4m. Having conducted a deep analysis of his lifetime goals, we agreed he had a need to sell the business for £2m – with a gross profit of £800,000, this didn’t seem too challenging, and a corporate financier felt £4m would be achievable, possibly more over the longer term with a ‘buy and build’ strategy.

Douglas gifted 50 per cent of the share capital of the business into a series of trusts. Despite not needing an income, it was decided that each of his children would have a life interest to piggyback and ensure qualification of ER in their own right.

He commenced the ‘buy and build’ strategy, feeling he would be bored in retirement, despite not needing the additional capital. Fortuitously, one of his principal suppliers, a high-street retailer, made an offer of £12m – well over expectations – because they wished to break into Douglas’ market. As each trust had held shares for over 12 months by this point, only 10 per cent tax was due on the sale, and no IHT on the initial transfer.

By good planning, and good fortune, Douglas ended up with more money than he felt he would realistically need in his lifetime, and only 10 per cent capital gains tax on sale. Some £6m of the sale proceeds was immediately outside his estate, and further gifts will be made over the forthcoming years both from income and capital; the latter will be potentially exempt transfers, but Douglas is in good health and plans to insure against his premature death.

Personal tax loss

And then there was Graeme, who had taken advice in 2004 from a “hot shot lawyer” (his words) and gifted a 30 per cent share of his 10 per cent stake in a trading business to discretionary trusts for his three children.

Subsequently shaken by the credit crunch, he, along with his co-directors, sold 30 per cent of his remaining 7 per cent equity stake in 2009 to venture capitalists (VCs). Graeme regrets not having sold earlier not least because his sale proceeds paid a significant amount of 28 per cent CGT. Plus, the value was depressed and the VCs negotiated punishing terms.

With the capital realised in 2009, the trustees purchased a portfolio of residential properties for both income and capital growth.

Unkeen to pay additional legal fees, Graeme was surprised that he had to complete a trust tax return and the realisation that a six-figure tax bill would be incurred in the form of a ten-year periodic charge, on the proportion of non-IHT exempt
assets, which were now significant.

The changes from business asset taper relief to ER also meant the trustees would pay 28 per cent tax on further sale of shares, rather than 10 per cent.

To compound matters, the business will probably be listed in the next year or so, and with the dilution of Graeme’s direct share holding down to only 4.9 per cent, he is likely to personally pay 28 per cent CGT on the proceeds.

So Graeme is left in a position that is more complicated, and less tax efficient than if he had taken no action.

BPR vs ER Briefly, the principal differences between the two reliefs, which will be relevant for both individuals and trustees are: Trading vs investment ER: Shares must be in a trading company. HMRC practice is to consider more than 20 per cent non-trading assets to be ‘substantial’ and invalidate ER fully. BPR: Shares must not be in a company that is ‘wholly or mainly’ an investment company. In this case, 50 per cent would be the threshold. Minimum holdings ER: Ignoring new EMI rules, an individual must have 5 per cent of voting share capital to qualify. BPR: No minimum holding requirement in respect of unquoted shares. Employment ER: To qualify, the individual must be an officer or employee of the company in which shares are held or of another company within the same group of companies. BPR: There is no requirement for an individual to be employed by the company. Trustees ER: Trustees are not automatically entitled to ER. Qualification of ER will be granted where beneficiaries have an interest in possession in the relevant company’s shares. BPR: Trustees are not excluded from qualification to BPR. Lifetime allowances ER: A £10m lifetime limit exists. BPR: No limit exists. Holding period ER: Shares must be held for 12 months, and the company must qualify throughout that period. For companies that have ceased trading, qualification is the last 12 months before cessation, or within three years after liquidation. BPR: Shares must be owned for two years. The company does not necessarily need to have qualified for two years. Partial relief ER: Relief cannot be granted partially, a company qualifies or does not qualify for ER. BPR: Partial relief may be granted where there are ‘excepted’ or 50 per cent relievable assets.

 

Alistair Cunningham is financial planning director at Wingate Financial Planning