I’m always surprised to learn that when we meet business owners and discuss potential exit strategies with them, how many are still totally unaware of the fantastic tax planning opportunities that are available for them on the sale of their business. Unfortunately, the entrepreneurs relief which replaced business assets taper relief following the announcement in January 2008 is still not widely known. However, this tax relief provides a fantastic opportunity to substantially reduce the capital gains tax that would normally be paid on the sale of an asset when the sale involves a business or interest in a business. In our client survey, we asked how business owners discovered entrepreneurs relief and the results are shown in the graph below.
Surprisingly, the biggest source of this information was the existing accountant. However, our own experience has shown that many such accountants are not specialists in this advice area and they may not have dealt with many business sales historically, so they don’t always necessarily understand the full extent of the entrepreneurs relief. You could also argue there is the potential for a conflict of interest where the accountancy firm is reliant upon the annual company audit fees, and obviously a potential sale may put those fees at jeopardy. Therefore, it is not surprising that a significant number of the responses to our survey indicated poor knowledge of entrepreneurs relief and certainly, in many instances from our experience, this has not been taken into account until quite late in the sale process. The importance of entrepreneurs relief should not be understated, and to secure the valuable benefits, planning should be undertaken well in advance of any potential sale so that all of the appropriate criteria is met and the valuable relief is secured.
At the time of writing, in late 2016, capital gains tax applies at the rates of 20 percent for higher rate tax payers or 10 percent if the capital gain falls within and keeps the disposer in basic rate tax. However, as you would imagine, due to the potential size of most business sales, many clients who are unaware of entrepreneurs relief may incorrectly believe they have a 20 percent tax liability based on the current capital gain levels. However, entrepreneurs relief effectively reduces the capital gains tax liability down to a 10 percent level, and this can apply up to a potential gain of £10 million, which came into effect on 6th April 2011. Please note care should be taken here because different levels have applied historically, and if you have sold previous interests in a business, you may have used a part of your available allowance. I would strongly recommend you seek appropriate taxation advice.
As you can anticipate, with this new £10 million limit, a potential tax charge of only 10 percent is highly attractive. So, if somebody was fortunate to sell their business for £5 million and they met all of the criteria, the tax liability would be £500,000, leaving them with net proceeds of £4.5 million. I’m sure you are now considering how much tax you pay within the business via income tax, national insurance, and corporation tax. Many of those are charged at far higher rates than 10 percent. You can begin to see the importance of securing entrepreneurs relief, being aware of its very existence becomes crucial for business owners when they include the potential sales of the business in their overall strategy.
So how do you go about qualifying for entrepreneurs relief? Well, thankfully, the rules are relatively straightforward. However, I would always urge you to seek appropriate taxation advice for your own particular circumstances, and the guidance here can only be generic. You need to make sure that if any changes are to be undertaken, they are made in good time prior to any potential sale.
Looking at the main qualifying conditions, it is important that the asset in question is a whole or part of a business. This can include a partnership or sole trader or shares in the company that is a trading company. Obviously, one of the key factors that the business must include is some form of trade. Usually, a company will be classed as a trading company provided it does not carry on any other activities to a substantial extent. For example, any investment activities or something that should not be classed as trading. The term “substantially” is usually applied to mean around 20 percent of the overall activity. This can be relevant where a company holds substantial cash amounts which are disproportionate to their overall trading. Again, specialist advice should be sought in this area to avoid any potential issues. When the business is a sole trader or partnership, the disposer must be the sole trader or the partner. Whenever the company is a trading company, the disposer must be an officer or an employee of the company and have held at least five percent of the ordinary share capital of the company and be able to exercise at least five percent of the vote.
It is also important to know that to obtain entrepreneurs relief the individual tax payer has to meet all of the qualifying conditions above throughout a period of one year prior to the disposal. So the tax relief results in a capital gains tax charge of only 10 percent, and if you have your annual capital gains exemptions, which at the time of writing is £11,100 per person, these would also be offset before the remaining gain is then taxed at the 10% tax rate.
So being aware of entrepreneurs relief and making sure the relief is secured prior to the sale of the business is the next crucial factor we recommend business owners seek advice about. When we look at our survey and reviewed the commercial reasons why most business owners decided to sell their business, it was because they felt it was the right time to sell. They may have experienced recent downturns, such as the credit crisis in 2008. Indeed, a number of our longest serving clients had seen significant recessions and downturns right through the 1980s and the 1990s. So they may have experienced various times when the company has struggled, and after a substantial recovery, they feel it’s the right time to capitalize on the value within the business and to secure their future for themselves and their family.
We’ve also noticed that with the current low interest rates and companies tending to have rebuilt their cash balances, the potential take-over of a competitor has become a sensible way to spend this surplus cash, particularly when the companies are earning such a poor return in the company bank account.
From our survey we also noted, not surprisingly, that the bulk of sales (more than 50 percent) were trade sales and 30 percent were management buy-outs. These will usually form the bulk of potential buyers out there for your business. Obviously alternatives such as private equity companies, do exist.
In my experience, most businesses do have a potential resale value. This is where it is key to seek appropriate guidance and advice when you have a realistic price in mind so that the correct buyer for the business can be sought and you can achieve your goals.
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. It is taken from my book ‘Sell Your Business & Retire Happy’. This article contains the opinions of the author but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. You are strongly cautioned not to rely on the information you find here to inform your decisions – rather, use it as a starting point for doing your own independent research and consult your professional advisers. Proceed with caution – you remain responsible for your own actions.
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