Should you sell company assets or shares to reduce taxes on the sale of your company in 2008?

For any company owners looking to sell up there are two broad options.

Firstly they could sell their shares in the company. Alternatively they could arrange for the company to sell the business and they could then extract the proceeds from the company. Essentially the former is a 'one stage' approach, and the latter is a 'two stage' approach.

Which route you choose will have a significant impact on the amount of tax you will pay. For most company owners, selling the shares is far and away the best option in terms of reducing their taxes. If you're selling shares in your unquoted trading company you could be looking at a CGT rate of 10%. When you compare this with paying 20% or 30% in the company and then extracting the proceeds, for most people a share deal will have substantial tax advantages over an asset deal.

However, as you probably know, there are to be a number of changes to the CGT rules from 6 April 2008. In particular taper relief and indexation relief are to be withdrawn, and there is to be a flat 18% rate of CGT that will apply for anyone selling their business or shares.

This will not be good news for many business owners. As we've seen above under the current capital gains tax regime, with full business asset taper relief a business owner could benefit from a 10% rate of CGT. The increase to 18% will therefore represent a significant increase in the amount of tax they pay. Does it though make selling assets as opposed to shares more attractive?

The CGT changes mean that anyone selling shares from 6 April 2008 will face an 18% tax rate. By contrast a company would pay tax of 21% in 2008 if its profits were less than £300,000 or 28% if it paid tax at the full company rate (assuming no associated companies).

Therefore, whilst a share disposal is still the best option for most people it has definitely seen its lead narrowed, especially if the gains in the company are within the £300,000 small company tax band. This could arise for a number of reasons (eg if there were capital losses in the company). In this case you could arrange a company disposal of assets and face a 21% rate of corporation tax or sell the share personally and pay 18%.

The downside here though is that you'll still need to extract the cash proceeds from the company. For higher rate taxpayers this represents an additional 25% effective tax charge. Therefore if you do need to extract the cash within the higher rate band you'll make the share deal much more attractive.

In any case this is based purely on the tax rates. Although the share deal may result in a lower rate of tax, if the gain charged is much higher than an asset deal the overall tax payable could still be much higher. So when you're considering shares or assets you need to look at the whole picture to see which offers you the lowest effective tax rate.

Extracting cash from the company free of tax

One of the main occasions when an asset deal will be attractive is if you can extract cash free of income tax. This then narrows the gap between the two routes.

There are occasions where cash can be extracted free of UK tax such as:

• Where the shareholders become non-UK resident and extract dividends.
• Where proceeds are extracted over a number of tax years within the shareholders' basic-rate tax bands.
• Where any income tax liability is covered by a tax credit. This may arise on the subscription for EIS shares.

And in these situations serious consideration should be given to an asset deal given the similar tax rates that may apply to each option.

Look at the whole picture

As stated above just because a share deal has a lower tax rate does not mean it always results in the lowest tax charge.

The gain on the sale of the shares will differ from the gain on the assets for two important reasons:

• Firstly, the shares are totally different assets to the business owned by the company
• Secondly, the company is taxed differently on gains to individuals.

Therefore when looking at assets versus a share disposal you need to calculate the gains that would arise under each scenario.

Important differences could include:

• The CGT changes don't apply to disposals by a company and therefore a company will still entitled to indexation relief when calculating its capital gains, whereas individuals will not.

• The purchase cost of the assets held by the company could have a different base cost to the base cost of the shares. In particular if the company holds assets with a relatively high base cost and which have been owned for a significant period, it could be entitled to a significant amount of indexation relief to reduce the gain. In this case, a company disposal could lead to a much lower gain than would arise on a sale of the shares and (provided the proceeds could be extracted tax efficiently) the tax payable could also be much lower.

• A disposal of the shares will be entitled to the annual CGT exemption
• If you're non UK resident you can sell shares free of CGT, whereas a UK company will still be subject to tax on a disposal of the assets even if you're non resident
• Personal capital losses can be offset against gains on the shares but not for the company. By contrast if the company has large capital losses this could make the company option much more attractive.
• Rollover relief may be available to a company disposal to defer the gain. For shareholders selling their shares they will only be able to defer the gain by reinvesting into shares that qualify under the EIS scheme.

Overall, for most shareholders selling the shares will still be preferred if only to avoid the double charge to tax. However this is not necessarily always the case. If the cash could be extracted free of tax or if the company gain is significantly lower a company disposal may result in the lowest tax.

Update

The new Entrepreneurs Relief will make a disposal of shares even more attractive.

About the Author

He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.

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