20/10/2008

Type of entity and assets to be sold

The first aspect to consider is the form of business entity, and exactly what is to be sold. The form of business entity would usually be considered at the date of start up, and the essential distinction is between a UK company, offshore company or trading personally or via a partnership.

Using a company has advantages in that not only does it provide for a measure of protection against the traders personal assets (house, investments etc) but it can also reduce the ongoing tax liabilities on the business profits, where some of the business profits are reinvested in the business.

As many businesses will not look to extract significant sums for a number of years, using a company could reduce the tax rate to 22%, from 40%. In addition, there could be a saving in national insurance, as the company would not be subject to NIC on profits arising, but a sole trader or partner would.

However on disposal, unless you can structure a disposal as a disposal of the shares, there could be a nasty CGT shock.

When using a company you have two options for the disposal. You could sell the shares or alternatively the company could sell the assets. If you traded personally you would simply sell the assets/trade directly.

Generally speaking for most UK residents a disposal personally will be much more attractive than a company disposal due to Entrepreneurs Relief. A disposal of business assets (which included shares in your personal trading companies as well as an interest in a business) can qualify for an exemption of 4/9% of the gain after one year. This is a massive tax benefit and usually a company disposal could not compete.

The net effect of Entrepreneurs Relief as you probably know is that it can reduce the effective tax rate to 10% on gains of up to £1,000,000 (that's per person though).

If the company did sell the assets not only would it not be entitled to claim Entrepreneurs relief, but you'd then also need to consider extracting the cash from company. Fine if you are an expat as you can just take a dividend free of UK income tax, but if you're UK resident you will be subject to a further 25% income tax charge for all amounts in excess of the basic rate tax band.

Therefore if you do own a company the best option is usually to sell the shares in the company. The gain will then arise on you, and you can look at claiming taper relief.

This though depends on whether the purchaser wants to buy the shares. A problem particularly with property type businesses is that a purchaser may well see the company's assets as a short term resale opportunity. Therefore if they acquire the shares they will be 'inheriting' the previous tax liability, as any gain since the company originally acquired the property(s) will come into charge when the property's are sold. In this case, although the purchaser may well agree to a share purchase, you'll therefore usually find that a discount is made for the company's tax liability up to the date of the share disposal. This will eliminate any tax benefits to you of the share disposal route.

This should really be considered at the original start up, as if in this case the business was owned personally the tax savings could be substantial due to the enhanced reliefs.

Therefore choosing the type of entity would not usually be undertaken prior to a disposal unless you are carrying on a business as a sole trader and and want to arrange for a disposal of shares in a company, rather than a direct disposal of assets.

The main reason for this would be if you run a UK business but are also looking to emigrate from the UK personally. In this case there are some big advantages to transferring the business to a company before you leave the UK.

The reason for this is that although as a non UK resident you are exempt from UK CGT on gains, this does not apply to gains arising from a UK branch or agency trade (ie where there is a permanent establishment). Therefore if you are carrying out a trade from the UK even if you leave the UK you could find yourself subject to UK CGT.

A simple way around this is to incorporate the business before you leave the UK. There are some tax reliefs that allow a trading business to transfer all of its assets to a company without a tax charge. You could then leave the UK and sell the shares in the company free of UK CGT as a non UK resident.

I mentioned above that an overseas company could be used as one of the types of entities. In most cases UK resident domiciliaries would achieve no tax benefit by using an offshore company. If you were planning to leave the UK or if you had overseas partners/directors the position would be completely different but unless these applies for MOST such UK residents they would find obtaining tax benefits difficult.

Other assets

A big problem with a company is that if you want to sell the shares in the company (which as we've seen above will minimise tax for many UK residents) you can't pick and choose which parts of the business are to be sold. If you own the business personally or the company is selling the assets you could select which assets are to be sold and which ones retained. When you sell the shares these relate to shares in the whole company, and therefore the whole of the business/assets, and therefore ensuring that the company contains the parts of the business and other assets that you want to sell is very important.

This is often a problem with a company that has been used to undertake two trades or where an investment property is held in a trading company. You would then need to extract the trade that you wished to retain/property. A simple transfer of a trade or the property out of the company should be avoided as this would not only be a taxable chargeable gain but unless full consideration was payable to the company for the transfer an income tax charge could arise on the shareholders.

There are basically two ways to achieve the transfer of assets out of the company tax efficiently.

Hive Up

This would work by the shareholder using the share for share exchange provisions to form a new holding company and the property could be transferred out of the company free of tax.

Example

Giles owned all of the shares in Giles UK Ltd which owned a commercial property and a trading business. He could form a new company (Giles Investments) which would acquire the shares in Giles UK Ltd from Giles in return for an issue of shares by Giles Investments to Giles.

The position would then be that Giles would own the shares in Giles Investments.

The property could then be transferred free of any immediate tax charge to Giles Investments.

This would be good as Giles UK Ltd would then hold just the trading business and would be a much more attractive option for a trade purchaser.

Demerger

We've looked at these in a different article but essentially they can be used to split a company either where there are two trades being carried on, or where there is a trade and an investment business.

Broadly there are two methods of carrying out a demerger. The first utilises a specific legislation introduced for this purpose and the second used the insolvency legislation. Under either case you could use these provisions to transfer assets or trades out of the company to ensure that you are selling only the assets you want to sell (and the assets that the purchaser wants to buy.

Excess cash and pre sale dividend

If the company has a large cash balance, and if Entrepreneurs Relief is not due a tax efficient option is often to extract cash from the company as a dividend.

The effective tax rate on this will be likely to be 25%, but the CGT rate if the shares had been owned would be in the region of 40%. In this case it would then make sense to extract the cash before the disposal by way of a dividend.

Clearly if you'd qualify for Entrepreneurs Relief on the shares this would be less attractive. Having said that Entrepreneurs Relief is only given to trading companies. The Revenue will refuse to treat a company with substantial non trading assets as a trading company, and therefore if there was a large cash balance in the company, this could in itself prevent business asset status. It would then be important to consider whether the extraction of cash as a dividend could revive business asset status a couple of years before a disposal to maximise relief.

Previous liabilities

One of big problems with a share disposal is that from the purchasers perspective it is the most 'risky'. They won't just be acquiring a bundle of assets and liabilities like they would under an asset deal. As the company has a separate legal entity they'll also be taking on any company liabilities.

Therefore from the purchases perspective the risk is that they'll be sued for something that happened before they even owned the shares. In order to protect the purchaser the disposal contract and will be every comprehensive and include a raft of warranties and indemnities for you to sign to try and protect the purchaser as much as possible.

If this doesn't sound appealing you could look to a hive down to meet your and the purchasers requirements.

A hive down is essentially a cross between an asset purchase and a share deal.

The seller company would transfer its trade and assets to a new company, and this new company is then acquired by the purchaser. It's of benefit to purchasers as it allows a share purchase but also allows them to acquire a company holding those assets and the part of the business which the seller wants to dispose of, and which the purchaser wishes to acquire. This means that it allows the purchaser to acquire a 'clean' company which does not come with any bad history and with no risk of any skeletons jumping out of the closet.

There are some special tax reliefs which can be available using the hive down route to ensure that the transfer can be made free of tax however the main tax advantage to the purchaser would be the ability to transfer any losses to the new company.

What you'll be looking to achieve is to put together a package that fits in with both you and your purchasers requirements. This could therefore include removing any surplus assets, using a newco to arrange a share disposal or arranging a hive down to provide a clean company.

This could even include a straightforward asset disposal by the company for example if:

• You were non UK resident and could extract cash from the company free of tax
• The company had large capital losses to offset any gains
• The company would be reinvesting proceeds in other business assets and could make a rollover relief claim (this would not be available if you personally made the reinvestment, but the gain arose to the company).