You’ll be retiring from the business you built up from scratch. You intend to sell your shares to current directors but they can only afford to pay for them in instalments. This means you can’t take advantage of certain tax breaks. How can you minimise the resulting tax bill?
Extracting your share of profits
Hopefully, after many years at the top of your company, it will have grown and the value of your shares along with it. Extracting this accumulated profit will usually result in a sizable tax bill. In private companies, especially family ones, the other shareholders might not be in a position to buy you out. The usual solution is for the company to buy your shares.
Transactions in securities
When a company purchases its own shares it must write to HMRC explaining the transaction to show that it isn’t an avoidance scheme. HMRC can also be asked for guidance on how any resulting gain made by the shareholder should be taxed, i.e. as a capital gain or an income distribution (like a dividend). The usual tack is to push for capital gains treatment as, assuming entrepreneurs’ relief/business asset disposal relief (since April 2020) (BADR) will apply, the rate of tax is just 10%.
Example. Bob is a director shareholder of Acom Ltd. He plans to retire as a director in 2020/21 and sell his shares to his four sons and daughters who are director shareholders. HMRC directs that the gain (£750,000) made by Bob should be taxed as capital. As he qualifies for BADR the capital gains tax (CGT) payable will be around £73,500. If HMRC had instead directed that the gain should be taxed as income Bob would have to pay tax in the region of £280,000.
Trap. It’s not well known, but where HMRC directs capital gains treatment you can’t choose the income tax option instead. But looking at the figures above, you might not want to.
Lower tax alternative
Bob would be well advised to consider his tax position carefully before asking HMRC to confirm capital treatment. He might be better off if he were to sell his shares by instalments as he won’t need all the money at once. In fact, as he’s retiring it would suit him to take it over, say, 15 years, after which he could turn to his pension savings. Working on current rates of income tax this could cut his overall tax bill on the proceeds to around £35,000 leaving him nearly £40,000 better off.
Tip 1. You can manipulate HMRC into refusing capital treatment by deliberately failing to meet the conditions it sets. In fact, selling shares by instalments is enough, but there are other steps you can take to make sure.
Tip 2. If Bob were married and his wife only has modest income, he could transfer, say, half his shares to her and Acom could purchase these too. That could reduce the period over which the shares could be sold to the company and cut the tax bill further by making use of his wife’s tax-free allowances, basic and lower rate bands of tax.
Financial planning
Whatever the reasons for getting your company to purchase your shares, don’t automatically assume that capital gains treatment will produce the least amount of tax. Work with your accountant and financial advisor to see if instalment purchases could be more tax efficient.
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.