If you have worked hard all your life to build a business, it is entirely reasonable to want to ensure that you and your family keep your hard-earned gains when you eventually sell. Fortunately, with some pre-planning it is possible to minimise the amount of tax you pay on the gain by taking advantage of existing – and entirely legal – tax reliefs.
Tax relief on sale
When business owners sell their business, the key tax objective from their personal point of view is often to ensure that capital gains tax (CGT) entrepreneurs' relief (ER) is available. ER reduces the CGT rate payable by the business owner from 20% to 10% on gains made over the value of the business when they originally set it up or acquired it. This is subject to a lifetime cap of £1million gains per individual so the maximum tax saving is £100,000
Broadly, ER applies to a sale of shares or securities of a trading company (or the holding company of a trading group) if, for two years ending with the date of the disposal, the individual selling:
- has been an officer or employee of the company with at least 5% of the ordinary share capital and voting rights; and
- is entitled to at least 5% of:
- the proceeds on a disposal of the whole of the ordinary share capital, or
- the distributable profits and the assets on a winding up.
Where the business owner is a sole trader or a partner in a trading partnership, ER can similarly apply to a sale where the business has been owned for two years ending with the date of disposal. As the qualifying conditions need to be met throughout two years before sale, advice should be sought at an early stage.
A very tax efficient method to dispose of an interest in a company is by a sale of a control holding to an employee ownership trust. The sale is funded by the company itself and is completely CGT-free. These sales are given favoured status in an attempt by the government to encourage employee partnership (the ‘John Lewis’ model). In the right circumstances a disposal by this means is clearly very attractive from a tax point of view.
Protecting tax relief on a gift or death
Inheritance tax (IHT) is payable, subject to certain allowances, exemptions and reliefs, on the value of an individual's estate on death at 40% and on lifetime gifts to a trust at 20%.
Business property relief (BPR) can mean that an interest in a trading business owned for two years before death or a gift, attracts no IHT at all. When they sell it, the owner could be swapping their business, which benefits from 100% BPR, for the cash proceeds of its sale which will be subject to IHT in their estate.
Alternatively, the owner could gift part of the business to their family, or other beneficiaries, before sale. Providing the original owner survives for seven years from the date of transfer there would be no IHT due as a result of the gift. If the original owner wanted to retain control of the gifted assets (for instance if they were concerned about asset protection in the event of divorce or bankruptcy - or just their beneficiaries going on a spending spree!) they could instead transfer them to a trust.
A gift of the business interest (before the sale becomes binding) has the added advantage that more than the current IHT threshold (£325,000) can be transferred without incurring the immediate 20% IHT liability which applies on a gift of non-BPR qualifying assets to a trust.
Using both tax reliefs
On a gift made before sale to benefit from BPR, the gains to the market value of the part of the business transferred are chargeable to CGT on the original owner with the benefit of ER. The amount chargeable on the new owner on the later sale is only any additional gain made between the dates of the gift and sale.
The danger is that the original owner has the CGT charge on the gift, albeit at the ER rate, whether the sale happens or not. If the sale falls through, there would be no proceeds of the part retained to pay the CGT due on the part transferred. The gain on the gift could then be `held over' so there is no CGT due at that point but on a later sale, the whole gain will be chargeable to CGT payable by the individuals or trustees who are then the owners. It may though be difficult for them to claim ER.
For ER to be available for individuals who receive the gift, they must meet the qualifying conditions for at least two years unless they already qualify in their own right through an existing interest they have in the business.
For trustees to benefit, broadly a beneficiary who is entitled to the income from the trust must meet the usual qualifying rules.
Securing relief from inheritance tax after sale
Even after the sale, it may not be too late to carry out some IHT planning, taking advantage of BPR. It is still possible to benefit from BPR on a gift after the sale, or on death, by purchasing new assets which qualify for BPR - the relief may then be immediately available without having to wait for the usual two-year qualifying time period. The replacement assets can be, for instance, a portfolio of qualifying alternative investment market (AIM) stocks rather than a direct interest in a business carried out by the owner.
The new assets would immediately qualify for BPR providing the original assets sold and the new assets had been held in total for at least two years out of the last five before death or a gift. This could enable more value than the IHT threshold to be transferred to a trust.
Alternatively the seller might use the proceeds to set up a family investment company (FIC) so making a gift to a similar protective structure as a trust but without the immediate IHT charge. The taxation treatment and features of a trust and FIC are different and advice on each should be taken.