The immediate protection sought is to minimise the tax charged on the consideration received (or receivable, where, as will generally be the case, there is an earn-out). The importance of accessing the favoured 10 per cent entrepreneur’s relief rate of capital gains tax is key to the planning here. As highlighted in earlier articles, entrepreneur’s relief should be available for those employee/director shareholders holding 5 per cent or more of the company at the time of the sale (and throughout the previous year) or those exiting with any interest in shares derived from the exercise of EMI Options.
The earn-out consideration may, with appropriate planning, be brought into the calculation of the gain for entrepreneur’s relief purposes (see: locking-in value: structuring the earn-out) rather than falling to be taxed at the full capital gains tax rate of 28 per cent or, more disappointing still, as employment income charged at the individual’s marginal rate of income tax and NIC. Entrepreneur’s relief is proving unexpectedly expensive to the exchequer and this has resulted in a number or recent restrictions to the base of the relief. This trend is likely to continue and the effect of these changes must be reviewed regularly.
It is possible to defer the gain realised on a sale of a business by way of an appropriate reinvestment of the proceeds realised. This may be a feature of the deal itself, where the consideration is to be satisfied in part by way of shares issued in the acquirer. For serial entrepreneurs it may arise from the reinvestment of the proceeds into shares in a new venture (or perhaps an existing venture). Certain tax favoured investments, such as those under the enterprise investment scheme (EIS) may also offer the opportunity to defer the gain.
The ability to defer the gain may be seen, at first blush at least, to be very attractive, particularly where the view that tax deferred is taxed saved is adopted. Unfortunately tax deferred is simply tax deferred. The immediate cash-flow advantage of a deferral must be considered in the light of the possible rates of tax on an eventual exit. In many cases it will be preferable to “bank” the entrepreneur’s relief rather than run the risk of a less favoured exit and higher tax charge on the eventual sale of the shares into which the gain has been deferred.
Having mitigated as far as possible the tax costs arising from the sale it should be recognised that this, while the most immediate, is not the only threat to the value achieved and protection required. The sale itself brings a very substantial change to the tax profile of the former shareholder. Cash or near cash (the right to the earn-out consideration) has been exchanged for what was (but may not have been appreciated as such at the time) a tax favoured asset: shares in a trading company.
Much has been made of the favoured entrepreneur’s relief treatment of such shares: to this should be added the ability to gift such shares in a tax neutral way and their complete exclusion from the individual’s Estate for inheritance tax (IHT) purposes (this by way of “business property relief”). In very crude terms an Estate in which the most significant asset held comprises shares in a trading company will incur no IHT on death. The same Estate immediately following the sale of such shares (strictly as soon a binding agreement to sell such shares is reached) will be subject to IHT at a rate of 40 per cent on death. The former shareholder now faces both of the “two certainties”.
Protecting the value of the Estate for IHT purposes starts with a tax efficient Will. The rules of intestacy have no regard to tax efficiency and very rarely reflect the individual’s wishes with respect to the devolution of the Estate: the execution of a will becomes more than simply good housekeeping.
Although such Will planning achieves a greater urgency following a sale (given the change in the composition of the Estate) it may well be appropriate to commence such planning earlier. Certainly where family wealth is to be more widely shared it will be appropriate to transfer shares to family members or family trusts in advance of the sale: this having regard to the tax favoured status of the shares which allow such gifts and/or transfers to be achieved on a tax neutral basis. A transfer of shares into trust may be achieved without immediate IHT charge while a transfer of the cash proceeds realised would potentially give an immediate IHT liability at the lifetime rate of 20 per cent. It is often forgotten that IHT is a tax on gifts as well as on assets of the Estate held on death.
To return to a refrain used throughout this series of articles: the sale of a business is a process with a time line. The planning and preparation required for such a sale may focus on different aspects of the business and its ownership dependent upon where the business is on that time line. However, each builds on the other and a successful outcome depends upon successfully addressing each phase in turn. Tax considerations feature at each stage and, as this article has sought to show, continue even after a successful exit.
By Neil Simpson, Tax Partner at haysmacintyre