Considering selling a business? Dan Hartland and Charlotte Senior consider sensible tax strategies for entrepreneurs planning for exit in an uncertain tax environment.
For entrepreneurs considering a sale in the short to medium term, the pandemic has resulted in significant uncertainty as to future tax policy. The challenge the government faces in balancing the books means that shareholders are particularly concerned about potential increases in capital gains tax rates and the curtailment of shareholder reliefs.
CGT in the spotlight
A key tax that has been under the spotlight is capital gains tax. This is seen as historically low, at a main rate of 20%, but the Office of Tax Simplification has suggested this should be more closely aligned to income tax rates. With the highest rate of income tax currently 45%, at the extreme this would represent a 25% tax increase which, for most entrepreneurs, would often equate to 25% of any future sales proceeds.
Clearly, the timing of any increase and the nature of any tax changes are uncertain but key dates where tax changes may happen include the Budget and the start of a new tax year.
How can I manage CGT risk?
There are two clear strategies in managing the risk of an increase in capital gains tax. The first is to accelerate the point at which the gain arises and the second is to remove or reduce your exposure to capital gains tax altogether.
Either approach needs to be considered in light of your individual circumstances and your objectives post-exit.
Accelerating an exit event
Third-party sale: If you're considering a third-party sale in the near future, for example to trade or private equity, there may be merit in accelerating that process with a view to completion before the key dates when a change might happen. This may not be viable and will depend on the circumstances of the business.
MBOs/family succession: An exit may not always mean a sale to a third party and you may therefore have more control over timing. Examples include:
Structuring a management buy-out (MBO) - where key future leaders of the business invest or take debt to acquire the company from the existing shareholders
A transition of the business to the next generation of family members while achieving a capital exit for the current generation
Employee Ownership Trust (EOT): This is a slightly different approach to passing ownership to existing employees. Unlike the MBO, this internal sale involves all employees participating but through a trust rather than having direct ownership. To incentivise employee-owned companies, shareholders can typically realise gains on sale of shares to an EOT with no capital gains tax liabilities arising. This generous statutory tax relief along with an increasing trend for employee ownership means an EOT is becoming an increasingly popular route to exit a business.
Removing or reducing exposure to CGT changes
Statutory reliefs/exemptions: If there is uncertainty about the timing of a future sale, there are a number of structural options to remove or reduce your exposure to CGT. These are typically driven by your wider commercial and personal objectives, and are based on statutory reliefs and exemptions.
Given the uncertainties that we face in future tax rates, it is more important than ever that entrepreneurs take advice as to their options. Considering what a business exit will mean financially net of tax will help entrepreneurs preparing for sale to properly plan for the next stage of their journey.
To discuss these issues further, please get in touch with your regional contact.