Capital Gains Tax when selling your company
The 10 Percenters
Many who are thinking of selling their company assume that they will automatically be rewarded with a big pay off and only incur a 10% tax on the sale. However, securing this rate of Capital Gains Tax (CGT) is not guaranteed.
The 10% rate of CGT is available if what is being sold qualifies for entrepreneurs’ relief (ER). If ER is not available then the rate of CGT to be applied is likely to be 20% – so securing this valuable relief is essential for the exiting entrepreneur.
ER is available on £10 million of qualifying gains over an individual’s lifetime. It, therefore, has the potential to save £1 million worth of tax per shareholder.
So what can be done to ensure that, when you sell your shares, you will be able to claim ER on the sale? Here are five actions you can take:
1. Ensure That Your Company is a Qualifying Trading Company
If your company has invested any surplus profits into investments such as property, then HMRC could consider this to be a significant non-trading activity and deny ER. What is defined as a significant non-trading activity is not set out in law, but is set out in guidance and is very subjective. Broadly there is a 20% test – if your company’s non-trading activity falls into any of the below then you could be liable to pay CGT at 28%:
- It contributes more than 20% of turnover
- It represents more than 20% of the value of the company’s assets
- It consumes more than 20% of total expenses it incurs
- It utilises more than 20% of management time
2. Ensure That All Shareholders Qualify
In order to qualify for ER, all shareholders need to own 5% of the ordinary share capital of the company and also have at least 5% of the voting rights. They must also be officers or employees of the company. These conditions need to have been satisfied for a period of at least 12 months before the sale. Therefore they need to be considered sooner rather than later.
It is not rare to find circumstances in which a proportion of shares are owned by family members who do not work for the company, or that a significant proportion of shares are held in trust.
3. Consider Holding Trading Property Outside the Company
A potential purchaser might not be interested in taking on the property from which your company trades. This might prove problematic should the property be owned outright by the company. An alternative might be to hold the property personally and allow the company to occupy it for its trade rent free.
The result of the above is that any gain on the sale of the property can also qualify for ER and therefore the 10% rate. The property does not need to be sold to the same purchaser as the company but does need to be sold on or around the same time as the sale of the shares.
4. Be Careful When Receiving Non Cash Sale Consideration
If you receive shares in the purchasing company then those new shares will need to also satisfy the conditions to qualify for entrepreneurs’ relief. You also need to be careful if receiving loan notes. This is because loan notes are not shares and therefore do not qualify for ER.
5. Offer Staff an Equity Incentive That Will Qualify for ER
It is a great incentive to staff to allow them to participate in the upside of any increase to the value of the company. The best way of doing this is generally by way of a share option scheme.
The share scheme most often adopted is the Enterprise Management Incentive (EMI). EMI is an option scheme that is approved by HMRC and this allows employees to acquire shares without there being a charge to income tax.
For shares acquired under EMI options that were issued more than a year ago, there is no requirement to hold the shares for a period of 1 year and will qualify for ER irrespective of the size of the holding.
If you are considering a sale then you will need to assess whether you will obtain ER. The majority of companies will certainly qualify. However, it is always worth asking yourself, “What rate of tax will I pay when I sell up?”
If you would like further advice on Capital Gains Tax or Entrepreneurs Relief, please get in contact with a member of our Tax Services team on 01903 234094.