Watch out for massive tax increases on selling your business in 2010
1/05/2009
If you own a trading company that you're considering selling you should be aware of how the planned tax changes from 6 April 2010 could impact on your tax bill. Structure of the disposal There are two basic methods of structuring a sale of your company. Firstly as a share sale, or secondly as an asset deal. In the first you just sell the shares, whereas in an asset deal the company sells the assets to the purchaser. In most cases a share sale would be preferred if you're the seller as it will usually lead to the lowest tax charge. However, many purchasers prefer to acquire the assets, and you may therefore have to go down the asset route. If you do, the tax changes in 2010 could prove very costly. How an asset deal works In an asset deal your company sells the business to the purchaser. Therefore there would be a capital gain in your company which would be subject to corporation tax. In the current year this would be taxed at 21% if the total profits & gain is less than £300K. There's an effective rate of 29.75% for profits/gains above £300K but below £1.5M. In addition the profits left in the company belong to the company. If you want to extract them, you'll have to take the cash out of the company. Remember that the company will have incurred a corporation tax charge, so you'll only be able to extract the after-tax amounts. There are a number of ways that you could achieve this but the dividend option is probably the most popular as it offers a relatively low rate of income tax while also being pretty straightforward. Extracting cash from the company as dividends means that there is an effective income tax charge of 25% on the amount of the dividends for higher rate taxpayers in 2009/2010. As always with dividend payments, this is not tax deductible in the company's hands. When you consider that the company will have already suffered tax on the payment this really pushes the overall effective tax rate up significantly. Example Pete has received an offer for the trade and assets of his company, Pete Ltd. Let's assume the disposal proceeds are £1 million and the gain arising is £400,000. The company will pay corporation tax of: 300,000 @ 21%= £63,000
100,000 @ 29.75%= £29,750
Total corporation tax= £92,750 The remaining after-tax proceeds of £907,250 can then be extracted as a dividend. Let's assume Pete is a higher rate taxpayer, meaning that he'll be taxed at 25% on the dividend. This would equate to an income tax charge of £226,813 and the net amount James would receive would be £680,437. By comparison, if Pete could have structured the deal as a share sale, he may have obtained a 10% rate of tax, enabling him to have disposal proceeds of £960,000 - a massive £279,563 more in his pocket. To compensate the buyer for the disadvantages of a shares acquisition, he could afford to drop the proceeds by a significant sum (eg, £100,000) and still be in pocket. The double charge to tax can therefore be a big problem for business sellers who obviously want to maximise their after-tax profits. This represents the position in the current 2009/2010 tax year. How will this change after 5 April 2010? There are a number of changes to the tax rates and allowances that are planned to apply as from April 2010 and April 2011. The key impact for company owners will be the change to the rate of tax for large dividend receipts. As from 6 April 2010 anyone earning over £150,000 per tax year will pay income tax at an effective tax rate of 36.1% on dividend receipts. In addition the rate of corporation tax for small companies is supposed to increase to 22%. When you take these two changes into account the tax charge for anyone looking to extract profits from a company could significantly increase. For instance, if we look at the example above but assume the disposal and extraction of the proceeds occurred in tax year 2010/2011 the position would be: The company would pay corporation tax of: 300,000 @ 22%= £66,000
100,000 @ 29.50%= £29,500
Total corporation tax= £95,500 The remaining after-tax proceeds of £904,500 can then be extracted as a dividend. If we assume Pete has other income that pushes him above £150,000 anyway he would be taxed at an effective 36.1% on the dividend. This would equate to an income tax charge of £326,525 and the net amount Pete would receive would be £577,975. This is a substantial reduction in the actual amount that he receives. In this case it's almost a massive £102,500 less cash than if the disposal and extraction had taken place in 2009. It's also around £382,000 than if he'd gone for a share sale! So if you are planning a disposal of your company you should wherever possible go for the share sale. It would usually be in unusual case that an asset deal would be the best option (eg if there was a high base cost for the assets, if there were capital losses etc). If you do have to go for an asset deal look to extract any proceeds prior to 6 April 2010. Alternatively you could: Extract below the £150K super tax band annually so that your effective rate would be 25%
Extract below the higher rate tax band annually (ie less than around £43K if no other income) to avoid any income tax
Become non UK resident and extract free of UK income tax
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