The company purchasing your business is paying you partly in cash and partly with securities, specifically loan notes. You’re allowed to cash them in after a year. For tax efficiency, is it more advantageous to do this all at once or over several years?
Capital gain
If you sell shares in your company for more than you paid for them, the difference is a taxable capital gain. Usually, this is taxed for the year in which the sale contract is agreed. However, it can be spread over a number of years to the extent that proceeds of the sale are taken as qualifying corporate bonds (QCBs), e.g. fixed interest loan notes. Spreading the gain can lower your tax bill compared with taking all the sale proceeds as cash.
Example. Simon owns all the shares in Acom Ltd, a company he formed several years ago. He agrees to sell his shares to another company resulting in a capital gain of £500,000. The buyer is prepared to pay for 40% of Simon’s shares in cash and 60% with fixed interest loan notes issued by the buyer’s company.
The gain is automatically attributed between the cash and the loan notes in the same proportion. The gain relating to the loan notes is only taxed for the year(s) which are redeemed. So, if Simon redeemed, say, 20% of the loan notes in each of the next five years this would release £75,000 of capital gain (£500,000 x 60% x 25%) per year. If Simon had no other gains in those years he could use his annual capital gains tax (CGT) exemption for each to reduce the amount liable to CGT. Thus, he gets four extra annual exemptions compared to the position had he taken all the sale price in cash.
BADR saves more tax
If the right conditions are met Simon’s share sale can qualify for business asset disposal relief (BADR) which reduces the usual CGT rate (up to 20%) on gains up to £1 million to 10%. But there’s a catch.
Trap. To the extent the gain is deferred using QCBs you lose the right to BADR. So, instead of saving tax taking QCBs can leave you worse off. However, it’s possible to have your cake and eat it, that is obtain BADR on the gains deferred through QCBs.
Tip. BADR can be claimed on gains resulting from redeeming QCBs if this happens at a time when you own or control 5% or more of the company’s (or another group company’s) ordinary share capital and you’re an employee or director. Negotiate to keep a 5% stake in your company and a role as an employee or director.
Tip. If the Tip above isn’t possible, you can elect for the gain not to be deferred for the part relating to QCBs. This means you’ll pay the CGT on the whole gain as if you had been paid wholly in cash, i.e. there’s no deferral but at least you’ll get BADR on the gain, assuming the qualifying conditions are met.
Which is the best option?
If you sell shares in your company and are paid wholly or partly in QCBs , whether it will be advantageous to use the CGT deferral or elect for it not to apply depends on the amount of the gain and how much of it relates to the QCBs. For example, if the total deferred gain were £60,000 spread over five years, it would probably be tax efficient not to make an election and so forego BADR on it.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.