You have agreed to sell your 100% shareholding in your trading company. The buyer is offering cash, qualifying corporate bonds, or a combination of both. How can you structure the consideration to maximise tax savings?
Timing
If you sell shares at a gain, this is usually taxed the year in which the sale contract is agreed. However, it can be spread over a number of years to the extent that the proceeds of sale are taken as qualifying corporate bonds (QCBs) , e.g. fixed interest loan notes. Spreading the gain can lower the overall tax burden compared with taking all the sale proceeds as cash.
Example. Jeremy (a higher rate taxpayer) 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 Jeremy’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.
If Jeremy 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 Jeremy 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 with the position had he taken all the sale price in cash. Assuming the exemption stays at its current level of £12,300 per year that would save Jeremy just under £10,000 (£12,300 x 20% x 4) in CGT.
Savings v spreading
If the right conditions are met, Jeremy’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. To the extent the gain is deferred using QCBs your client loses the right to BADR. So, instead of saving tax, taking QCBs can leave them worse off overall. However, it’s possible to secure BADR on the gains deferred through QCBs.
Pro advice. In order to take advantage of this, the company needs to be your personal company at the time the QCBs are redeemed. You could therefore negotiate to stay on as a director or employee, maintaining a 5% shareholding.
Election
The buyer may not agree to this, in which case you could opt to make an election for the whole gain to be taxed upfront as if the consideration had been paid wholly in cash. You will lose the advantage of spreading the CGT, but would secure BADR assuming the conditions are met. This could be more efficient overall, but of course may be unappetising during the ongoing cost of living crisis.
Of course, if you sell shares in your company and is 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.
By taking qualifying corporate bonds as payment for shares you can spread any capital gains tax (CGT) over several years. This allows you to use the annual CGT exemption for those years to reduce the overall tax bill. However, it might save more by electing not to defer taxation of the gain and instead claim business asset disposal relief, unless the amount deferred is relatively low.
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.