Off-payroll working has recently attracted headlines in a number of high profile tribunal decisions.

The most notably of these is Christa Ackroyd, the BBC – “Look North” presenter who was recently found to be operating inside IR 35 and ordered to pay over £400,000 in tax and National Insurance Contributions (NICs).

Further headlines followed when other BBC talent similarly found themselves on the payroll. With this background, it might reasonably be supposed that the Government’s consultation issued on 18^th May, “Off-payroll working in the private sector”, is a further development of these apparently connected stories – it is of course, although curiously, the Ackroyd case and the BBC’s decision are unconnected.

Off-payroll working simply describes those workers who are not on the PAYE payroll. This is typically because they are engaged through their own personal service company (PSC). The nature of the relationship between the worker provided by the PSC and the engaging client may be identical to that of an employee engaged under a contract of employment, yet the resulting tax may be markedly different. This has long been recognised as unfair and IR 35 (more formally ‘the intermediaries’ legislation’) has been in place since 2000 to address this.

IR 35 does this in two ways. It first requires the PSC (effectively the worker) to determine whether, ignoring the PSC, the nature of the relationship between the worker and the engager is that of an employment. This is the “employment status” test. Christa Ackroyd argued (whether she was aware of it or not) that her relationship with the BBC was not one of employment, such that IR 35 did not apply to her PSC: the tribunal disagreed.

Where an “employment like” relationship is found between the worker and the engager, the second requirement of the IR 35 legislation is that the PSC should operate PAYE and collect employment income and NICs (including employers’ NICs).

Notwithstanding their success with the Ackroyd decision, it is the employment status test that HMRC have a problem with. The language of the Consultation Document can barely conceal HMRC’s frustrations with the current arrangements, under which the worker providing services though the PSC is responsible for determining employment status, thus “providing the means, opportunity and incentive for the wrong amount of tax to be paid”. The loss of revenue is assessed at around £1.2 billion.

Although the Consultation Document offers “options” to address this non-compliance, it is clear from the solutions immediately discounted as “out of scope”, and the barely sketched alternatives to the existing IR 35 rules, that HMRC’s “lead option” is virtually certain to be adopted. This will see responsibility for determining employment status move from the worker to the client, together with the obligation to operate PAYE, where an employment-like relationship is found.

This is already the position with regard to public sector engagers as a result of changes introduced with effect from April 2017 and it was this that dictated the BBC’s decision rather than Ackroyd. It seems inconceivable that a different conclusion will result from the present consultation in the private sector.

Little foresight is required in anticipating the changes that need to be addressed. The timing of the consultation, which closes on August 10^th, hints at the possibility, if not likelihood, of the changes coming into effect from April 2019. Engagers therefore need to start identifying off-payroll workers now, review and adopt procedures for determining their employment status and review their engagement processes.

New systems, internal guidance and contracts will involve HR, finance, legal and payroll departments in implementing these changes.

These systems will need to be robust and properly documented as failure to deduct tax in circumstances where an employment like relationship is found, and where insufficient care has been taken, will see the engager liable for the resulting tax costs.

Read more:
Off-payroll working in the private sector: consultation to bring change to IR 35

The recent volatility in the value of bitcoin goes some way to explaining the cryptocurrency’s explosion into the public consciousness.

50 Cent helped further propelled the currency’s popularity recently when he found himself a multimillionaire, having accepted (but then apparently immediately forgotten) various payments made in the form of bitcoin.

Whilst, investors are acquiring bitcoin as an investment or short term speculation and this, as many commentators have warned, is driving a “bubble”. But as 50 Cent evidences, the currency can be used as payment for goods and services. Bitcoins may also be acquired by those providing “mining” services, or bought and sold by those providing exchange facilities.

Increasingly, the currency can be used to acquire other cryptocurrencies by way of Initial Coin Offerings.

So with millions of bitcoins in circulation, and public interest remaining high, how are HMRC taxing these various interactions?

The guidance provided by HMRC has, to date, been limited to a “Brief” issued in March 2014. This asserted HMRC’s view that no specific change in tax law was required and that existing tax rules were sufficient to cover transactions in bitcoin, although it was noted that “given the evolutionary nature of these cryptocurrencies”, further guidance would be provided as appropriate.

It seems likely that the recent market volatility may require HMRC to provide greater clarity here. Until that point however, HMRC’s view on whether any profit or gain is chargeable to income tax (IT) or corporation tax (CT), or whether a loss is allowable, is considered on a case by case basis. The specific facts and activities of the parties involved will be reviewed and, crucially, whether the activities are of a trading or investment nature.

For many individuals, as the current bubble shows, bitcoins are acquired as an investment or short term speculation. In the nature of bubbles, some individuals will realise substantial gains, others substantial losses – and unsurprisingly their preferred tax treatment will be dictated by that outcome.

Those with substantial gains may seek to argue (based upon some, perhaps now regrettable, comments made by HMRC in their Brief) that transactions in bitcoin may be so highly speculative that neither a taxable gain or loss results, given the transactions are analogous to gambling.

Gambling winnings are not deemed taxable, although this is not as generous as it might first appear, as HMRC is primarily concerned with the fact that gambling losses should not be allowed.

This argument is considered by many as unlikely to succeed, particularly for those realising gains from more recent bitcoin acquisitions, although HMRC may be more easily persuaded that transactions are gambling where losses have resulted!

Those who have lost value may argue that their transactions in bitcoin are in the nature of a trading activity, for which a more generous use of loss reliefs is available. Save in very exceptional circumstances, this is another argument likely to fail as the evidential hurdle of “trading” is very high.

What is clearer is HMRC’s stance on gains achieved from investment transactions (including short term speculation) – they are subject to capital gains tax (CGT). An individual annual exemption of £11,300 is available, with the rate of CGT on gains in excess of the annual allowance being 10 per cent for a basic rate taxpayer, and 20 per cent for those higher and additional rate tax payers.

As with shares of the same class, the holder of bitcoins will have a single pooled asset for CGT purposes, which will increase or decrease with each acquisition, part disposal or disposal.

Generally any gain realised on an investment in bitcoin will be payable upon conversion to sterling or other fiat currency. Here, the gain will be calculated in reference to the sterling value received.

However, an exchange into other digital currencies (perhaps in subscription of an Initial Coin Offering), or the use of bitcoin in acquisition of goods and services, represents a barter transaction. This results in a disposal for CGT purposes of the bitcoin, determined by the sterling value of the digital currency received, or goods or services acquired.

The taxation treatment of companies holding bitcoins as investments is technically uncertain. It is dependent upon whether bitcoins should be treated as intangible assets, currency, or a chargeable asset.

Notwithstanding the correct subset of the corporation tax rules into which bitcoin fall, the general rule is that gains are taxed on realisation, currently at a CT rate of 19 per cent,  where the gain is reflected though the profit and loss account in accordance with GAAP. For corporate investors, the accounting treatment will be crucial.

But what about those businesses that accept payment in bitcoin for goods and services? The normal rules of revenue recognition are likely to apply with the bitcoin value recognised at the current sterling exchange rate, and translated into the functional currency (generally sterling) at the year end. On this basis, companies and unincorporated businesses are potentially subject to CT or IT, as appropriate, on the unrealised movement in their bitcoin holdings held in working capital.

Many businesses accepting bitcoin will therefore use a payment service provider to immediately convert to sterling, paying for the service in order to mitigate exposure to “exchange rate” movements.   Those mining or making a market in bitcoins are likely to be found to be trading, although the treatment here will be fact specific.

The recent volatility in bitcoin has shifted the emphasis away from bitcoin as a payment system and toward it as a speculative investment. This is likely to inform HMRC’s approach, certainly to those individuals investing in bitcoin as the next reporting season for 2017/18 draws near.

It is important that investors decide how to report their bitcoin transaction, with CGT treatment being the default position.

For businesses, both incorporated and unincorporated, the treatment of bitcoin transactions will, similarly, depend upon whether they arise from trading or investment transactions with the accounting treatment likely to prove determinative as to the timing of any IT or CT charge.

Read more:
Bitcoin volatility: necessary to focus HMRC’s mind?

The recent volatility in the value of bitcoin goes some way to explaining the cryptocurrency’s explosion into the public consciousness.

50 Cent helped further propelled the currency’s popularity recently when he found himself a multimillionaire, having accepted (but then apparently immediately forgotten) various payments made in the form of bitcoin.

Clearly, investors are acquiring bitcoin as an investment or short term speculation and this, as many commentators have warned, is driving a “bubble”. But as 50 Cent evidences, the currency can be used as payment for goods and services.

Bitcoins may also be acquired by those providing “mining” services, or bought and sold by those providing exchange facilities. Increasingly, the currency can be used to acquire other cryptocurrencies by way of Initial Coin Offerings. So with millions of bitcoins in circulation, and public interest remaining high, how are HMRC taxing these various interactions?

The guidance provided by HMRC has, to date, been limited to a “Brief” issued in March 2014. This asserted HMRC’s view that no specific change in tax law was required and that existing tax rules were sufficient to cover transactions in bitcoin, although it was noted that “given the evolutionary nature of these cryptocurrencies”, further guidance would be provided as appropriate.

It seems likely that the recent market volatility may require HMRC to provide greater clarity here. Until that point however, HMRC’s view on whether any profit or gain is chargeable to income tax (IT) or corporation tax (CT), or whether a loss is allowable, is considered on a case by case basis.

The specific facts and activities of the parties involved will be reviewed and, crucially, whether the
activities are of a trading or investment nature.

For many individuals, as the current bubble shows, bitcoins are acquired as an investment or short term speculation. In the nature of bubbles, some individuals will realise substantial gains, others substantial losses – and unsurprisingly their preferred tax treatment will be dictated by that outcome.

Those with substantial gains may seek to argue (based upon some, perhaps now regrettable, comments made by HMRC in their Brief) that transactions in bitcoin may be so highly speculative that neither a taxable gain or loss results, given the transactions are analogous to gambling.

Gambling winnings are not deemed taxable, although this is not as generous as it might first appear, as HMRC is primarily concerned with the fact that gambling losses should not be allowed. This argument is considered by many as unlikely to succeed, particularly for those realising gains from more recent bitcoin acquisitions, although HMRC may be more easily persuaded that transactions are gambling where losses have resulted!

Those who have lost value may argue that their transactions in bitcoin are in the nature of a trading
activity, for which a more generous use of loss reliefs is available. Save in very exceptional
circumstances, this is another argument likely to fail as the evidential hurdle of “trading” is very high.

What is clearer is HMRC’s stance on gains achieved from investment transactions (including short
term speculation) – they are subject to capital gains tax (CGT). An individual annual exemption of
£11,300 is available, with the rate of CGT on gains in excess of the annual allowance being 10 per cent for a basic rate taxpayer, and 20 per cent for those higher and additional rate tax payers.

As with shares of the same class, the holder of bitcoins will have a single pooled asset for CGT purposes, which will increase or decrease with each acquisition, part disposal or disposal.

Generally any gain realised on an investment in bitcoin will be payable upon conversion to sterling or other fiat currency. Here, the gain will be calculated in reference to the sterling value received. However, an exchange into other digital currencies (perhaps in subscription of an Initial Coin Offering), or the use of bitcoin in acquisition of goods and services, represents a barter transaction.

This results in a disposal for CGT purposes of the bitcoin, determined by the sterling value of the digital currency received, or goods or services acquired.

The taxation treatment of companies holding bitcoins as investments is technically uncertain. It is dependent upon whether bitcoins should be treated as intangible assets, currency, or a chargeable asset.

Notwithstanding the correct subset of the corporation tax rules into which bitcoin fall, the general rule is that gains are taxed on realisation, currently at a CT rate of 19 per cent, where the gain is reflected though the profit and loss account in accordance with GAAP. For corporate investors, the accounting treatment will be crucial.

But what about those businesses that accept payment in bitcoin for goods and services? The normal rules of revenue recognition are likely to apply with the bitcoin value recognised at the current sterling exchange rate, and translated into the functional currency (generally sterling) at the year end.

On this basis, companies and unincorporated businesses are potentially subject to CT or IT, as appropriate, on the unrealised movement in their bitcoin holdings held in working capital.

Many businesses accepting bitcoin will therefore use a payment service provider to immediately convert to sterling, paying for the service in order to mitigate exposure to “exchange rate” movements. Those mining or making a market in bitcoins are likely to be found to be trading, although the treatment here will be fact specific.

The recent volatility in bitcoin has shifted the emphasis away from bitcoin as a payment system and toward it as a speculative investment.

This is likely to inform HMRC’s approach, certainly to those individuals investing in bitcoin as the next reporting season for 2017/18 draws near. It is important that investors decide how to report their bitcoin transaction, with CGT treatment being the default position.

For businesses, both incorporated and unincorporated, the treatment of bitcoin transactions will, similarly, depend upon whether they arise from trading or investment transactions with the accounting treatment likely to prove determinative as to the timing of any IT or CT charge.

Read more:
Bitcoin volatility: necessary to focus HMRC’s mind?

The relief is generally well known, at least in terms of its essentials; it simply describes a favoured 10 per cent rate of capital gains tax which applies to gains realised on the sale of a business, whether as a sale of shares in a trading company or the sale of goodwill in an unincorporated business, typically a partnership.

The relief is well named: it seeks to incentivise entrepreneurial individuals, typically, but not limited to, the founders as it extends to all those having a minimum ownership stake (whether as shareholder or partner) who are actively involved in the business.

The relief is relatively simple.  Where the business is unincorporated (a sole trader, or more often, a partnership) it is sufficient that the individual has held his or her interest for a period of 12 months to the time of the sale.  Where the business is incorporated the individual must hold 5 per cent of the ordinary share capital and voting rights and be an employee or director, again for a period of at least 12 months to the time of the share sale.  The essential elements are therefore straight forward: a minimum ownership requirement coupled, in the case of a company, with a directorship or employment (neither of which need to be full-time roles) satisfied over a 12 month period to the date of sale.

Perhaps as a result of this simplicity the relief has proved successful.  It has increased in cost some 6 times since its introduction in 2008/09. This may be attributed to its simplicity although part of this additional cost must be attributed to the extension of the relief: not least its extension to shares acquired pursuant to options under the Enterprise Management Incentive Scheme (a tax favoured employee share option scheme targeting key hires and employees).  Here the relief is available simply by virtue of the fact that the shares were originally acquired pursuant to the rules of the EMI scheme.

However, part of this additional cost, which had reached £2.9billion by 2013/14 is attributed by HMRC to abusive behavior by certain taxpayers.  It is not surprising therefore that limiting the scope of the relief has been firmly on HMRC’s agenda in recent years.  Whether judged abusive or innovative certain of the “remedial” changes were to be expected.  The ability to incorporate a business into the owners’ own company by way of a sale of the goodwill for a cash consideration and at an effective tax cost of 10 per cent was always likely to be stopped and, given the objective of the relief, perhaps reasonably so, in the absence of any sale of the business to a third party . Similarly, HMRC have recently taken steps to target phoenix companies in order to deny entrepreneur’s relief on gains realised on a liquidation where the trade recommences in a new company in the same ownership.

The restriction on entrepreneur’s relief with respect to joint ventures was perhaps neither: that is anticipated or reasonable. Happily the changes introduced in 2015 have now to some degree been reversed in the current 2016 Finance Bill.  These are relatively technical changes (save for those affected!) but nevertheless indicate the increased level of HMRC scrutiny with respect to the relief.

Perhaps more surprising are the areas which HMRC, currently at least, have not addressed.  The ability to access the relief by directors and employees who do not undertake a full-time role is at odds with similar reliefs under both the income tax and capital gains tax codes. The absence of a full-time employment or directorship requirement for those accessing entrepreneur’s relief (other than under the EMI extension) offers the ability to introduce a spouse in an employment role disproportionate to the shareholding interest provided.  While it is always open to HMRC to contend the employment or directorship lacks true economic substance it is surprising that the legislation has not been amended to put the matter beyond doubt.

Entrepreneur’s relief is only available for shares in a trading company where the activity undertaken does not consist “to a substantial extent” of non-trading activities.  What is “significant” is ultimately a matter for the Courts to decide, although HMRC has provided guidance and broadly regards 20 per cent of any relevant metric (for example, profits, assets, management time) as relevant in determining whether an activity is significant.  The position of so called “surplus cash” creates a potential issue here.  Is the holding of accumulated profits in the form of cash a non-trading activity: and if it is, does it represent a significant activity having regard to the various metrics that might be considered?  Certainly in terms of management time and contribution to profit (given current low rates of interest) it is unlikely to be significant although the surplus cash may represent a significant asset on the balance sheet.  HMRC are clearly concerned over the ability to accumulate profits and ultimately extract these profits on a sale or liquidation with the benefit of a 10 per cent tax charge.  Given HMRC’s uncertain ability, based on the current state of the law, to police such planning for money box companies it seems probable that this is a further area for which legislative change might be anticipated.

Entrepreneur’s relief was simple and remains valuable. Some of that simplicity has been eroded as a result of remedial legislation to curb abuse of the rules; some as a result of ill thought through change now substantially reversed: however much of that simplicity is under threat as it is proving just too expensive—and further change may be anticipated.

Neil Simpson, Tax Partner, haysmacintyre

Read more:
Entrepreneur’s relief: further changes likely in order to curb cost

Previous articles in this series have focused on measures to create and “lock-in” the value of a business in the course of the sale process: through incentivising the team, pre-transaction due diligence and planning, tax aware structuring of the deal and negotiation of the “earn-out”.

In this article consideration now turns to protecting the value realised on the eventual sale.

The immediate protection sought is to minimise the tax charged on the consideration received (or receivable, where, as will generally be the case, there is an earn-out).

The importance of accessing the favoured 10 per cent entrepreneur’s relief rate of capital gains tax is key to the planning here.

As highlighted in earlier articles, entrepreneur’s relief should be available for those employee/director shareholders holding 5 per cent or more of the company at the time of the sale (and throughout the previous year) or those exiting with any interest in shares derived from the exercise of EMI Options.

The earn-out consideration may, with appropriate planning, be brought into the calculation of the gain for entrepreneur’s relief purposes (see: locking-in value: structuring the earn-out) rather than falling to be taxed at the full capital gains tax rate of 28 per cent or, more disappointing still, as employment income charged at the individual’s marginal rate of income tax and NIC.

Entrepreneur’s relief is proving unexpectedly expensive to the exchequer and this has resulted in a number or recent restrictions to the base of the relief. This trend is likely to continue and the effect of these changes must be reviewed regularly.

It is possible to defer the gain realised on a sale of a business by way of an appropriate reinvestment of the proceeds realised. This may be a feature of the deal itself, where the consideration is to be satisfied in part by way of shares issued in the acquirer.

For serial entrepreneurs it may arise from the reinvestment of the proceeds into shares in a new venture (or perhaps an existing venture). Certain tax favoured investments, such as those under the enterprise investment scheme (EIS) may also offer the opportunity to defer the gain.

The ability to defer the gain may be seen, at first blush at least, to be very attractive, particularly where the view that tax deferred is taxed saved is adopted.

Unfortunately tax deferred is simply tax deferred. The immediate cash-flow advantage of a deferral must be considered in the light of the possible rates of tax on an eventual exit.

In many cases it will be preferable to “bank” the entrepreneur’s relief rather than run the risk of a less favoured exit and higher tax charge on the eventual sale of the shares into which the gain has been deferred.

Having mitigated as far as possible the tax costs arising from the sale it should be recognised that this, while the most immediate, is not the only threat to the value achieved and protection required.

The sale itself brings a very substantial change to the tax profile of the former shareholder.

Cash or near cash (the right to the earn-out consideration) has been exchanged for what was (but may not have been appreciated as such at the time) a tax favoured asset: shares in a trading company.

Much has been made of the favoured entrepreneur’s relief treatment of such shares: to this should be added the ability to gift such shares in a tax neutral way and their complete exclusion from the individual’s Estate for inheritance tax (IHT) purposes (this by way of “business property relief”).

In very crude terms an Estate in which the most significant asset held comprises shares in a trading company will incur no IHT on death. The same Estate immediately following the sale of such shares (strictly as soon a binding agreement to sell such shares is reached) will be subject to IHT at a rate of 40 per cent on death. The former shareholder now faces both of the “two certainties”.

Protecting the value of the Estate for IHT purposes starts with a tax efficient Will. The rules of intestacy have no regard to tax efficiency and very rarely reflect the individual’s wishes with respect to the devolution of the Estate: the execution of a will becomes more than simply good housekeeping.

Although such Will planning achieves a greater urgency following a sale (given the change in the composition of the Estate) it may well be appropriate to commence such planning earlier.

Certainly where family wealth is to be more widely shared it will be appropriate to transfer shares to family members or family trusts in advance of the sale: this having regard to the tax favoured status of the shares which allow such gifts and/or transfers to be achieved on a tax neutral basis.

A transfer of shares into trust may be achieved without immediate IHT charge while a transfer of the cash proceeds realised would potentially give an immediate IHT liability at the lifetime rate of 20 per cent. It is often forgotten that IHT is a tax on gifts as well as on assets of the Estate held on death.

To return to a refrain used throughout this series of articles: the sale of a business is a process with a time line.

The planning and preparation required for such a sale may focus on different aspects of the business and its ownership dependent upon where the business is on that time line.

However, each builds on the other and a successful outcome depends upon successfully addressing each phase in turn. Tax considerations feature at each stage and, as this article has sought to show, continue even after a successful exit.

Read more:
Protecting value: post transaction planning

As introduced earlier in this series of articles, the sale of a business is a process with a timeline.

Previous articles have considered key aspects of that process and their place in the timeline: most recently, the planning in the pre transaction phase, before the purchaser has been identified or even actively sought. What follows, of course, is the identification of the purchaser.

Intuitively, the identification of the purchaser and negotiating the terms of the Sale and Purchase Agreement (SPA) should mark the culmination and end of this process.

This is not the case. It is, however, a critical phase in the process when value can be “locked in” for the benefit of the vendors.

Negotiating one headline price at one point in time (the time of the SPA) is generally in neither party’s best interest, vendor nor purchaser. The vendor’s shareholders are concerned to achieve a price for the business that reflects their assessment of its future profitability and potential for growth.

The purchaser may be willing to pay such a price, but only when that profit and/or growth is delivered or is at least reasonably assured.

The confident expectations of the vendors need to be reconciled with the, understandably, more cautious view of the purchaser. The “earn out” is the mechanism that seeks to achieve this.

The “earn out” simply describes a mechanism under the SPA for delivering additional consideration to the vendors payable by reference to the future performance of the business.

This performance will be assessed by reference to agreed metrics included in the SPA, typically EBITDA or some other measure of profit over a defined earn out period of, usually, up to three years.

The taxation of the earn out is one of the most complex aspects of the deal. In terms of maximising post tax returns for the vendors, it is important to ensure that the earn out is taxed as further consideration for the shares sold.

The key here is making certain that the favoured 10% rate of entrepreneur’s relief applies to the earn out consideration (and not higher rates of capital gains tax or even income tax.

Negotiating a favourable earn out is a key component in structuring the deal. The other main elements concern what is to be sold (shares or assets) and how the consideration is to be satisfied.

The question of what is to be sold, whether shares in the company or the trade and assets of the company should be resolved at an early stage. It is almost invariably in the vendor’s interest to sell shares, not least in terms of maximising the after tax return.

It is equally the case that the purchaser’s interests are best served under an assets deal (securing tax relief for their purchase consideration and avoiding the risks of acquiring the company with its unknown liabilities).

Any thoughts of indulging the purchaser’s concerns over their tax efficiency and simplifying the deal (an assets deal will generally minimise the need for extensive warranties and indemnities) should be firmly rejected at the outset.

An assets deal represents a zero sum game between the vendor and the purchaser, as any tax relief achieved for the purchaser, by way of amortisation for tax purposes of the goodwill in the business acquired, gives a corresponding corporation tax liability to the vendor company on the gain realised on the disposal of that goodwill.

The purchaser will generally accept the vendor’s position here (and may be more easily reconciled to it as a result of proposed changes which will remove the benefit of tax relief for the amortisation of goodwill acquired).

As to the consideration payable under the SPA, cash is always king. Loan notes or debt should be supported by appropriate securities or bank guarantee. Equity in the acquirer may be offered and may be attractive. However, it should be recognised that this is essentially an investment decision. If the purchaser has a full listing, the investment is in the nature of a portfolio investment. Where the purchaser is unlisted (or does not have a full listing), it is in the nature of private equity investment and the risk and rewards should be viewed as such.

As with the earn out, it will be important to consider the entrepreneur’s relief position on an eventual realisation of these consideration shares and plan accordingly.

Negotiating the SPA is not the end of the sale process. It addresses key structuring issues in terms of the mix, timing and parameters of the overall consideration and the subject matter of the transaction: assets or shares.

It sets the framework for the exit achieved and, hopefully, triggers a substantial down payment in respect of the shares or assets sold.

However, the hard work of delivering the value locked in under the earn out commences. The sale process continues – even in the ownership of the purchaser!

Read more:
Locking in Value: structuring the deal

The sale of a business is a process with a timeline.

Previous articles have looked at the importance of addressing due diligence [Improving value through financial and tax due diligence] and aligning the equity interests of the stakeholders [Realising value: the importance of correctly structuring equity ownership] at the commencement of that timeline (ideally at least two years in advance of a sale).

What of pre-transaction planning? This is the planning entered into before a potential purchaser has been identified (or even actively sought) and is distinct from the planning to be entered into in the course of negotiating the deal (the subject of a forthcoming article on “locking in value” in the course of the contractual negotiations).

To give this planning phase a time frame it is broadly the 12 months prior to entering into Heads of Agreement (although such prescience is unlikely to be available save with the benefit of hindsight!).

The pre-transaction period is a time to finalise the structure of the business to be sold and prepare the vendors for that sale.

In terms of preparing the business for sale a number of potential issues may need to be addressed.

The business may have acquired assets that are not to form part of a future sale. There may be property interests which are to be retained, either directly in the ownership of the shareholders or by way of transfer into a “Prop Co” in common shareholder ownership.

For companies that have previously been “lifestyle” businesses there may be private assets (cars, yachts and other playthings) to be extracted into appropriate direct shareholder ownership.

IP rights may have been retained outside the company and may need to be restored in advance of a sale (or may be held in the business and need to be extracted).

The importance of addressing what is to be sold extends beyond simply cleaning up the balance sheet. The business may comprise different trading divisions at differing stages of development and with different potential destinies.

The ability to hive-down or demerge such activities into separate but common shareholder ownership will be an important consideration in this pre-transaction phase.

Conversely there may be businesses that for historical reasons have been carried on as separate divisions or in separate but associated ownership where these should be combined.

Any asset extraction, reorganisation or restructuring of the business should take place now comfortably in advance of Heads of Agreement. With an appropriate tract to future time “tax clearances” may be obtained to enable such restructuring to be entered into on a tax neutral (or as near as may be) basis.

Once “arrangements are in force” (tax speak for a possible sale) these clearances may no longer be available and certainly will prove more difficult or impossible to obtain.

In many cases unnecessary tax costs will be borne to facilitate restructuring that should have been dealt with well before “heads”.

Leaving aside the tax costs unnecessarily incurred, management time will be better employed in the immediate pre-sale period engaging with the potential purchaser rather than restructuring what is to be sold.

Dealing with such matters creates pressure on the management team in delivering the sale and gives an impatient purchaser a negotiating advantage at a crucial stage in the sale of the business.

Similarly, this pre transaction phase should be used by the vendor shareholders to consider, on a more holistic or strategic level, their financial and tax planning in advance of the intended sale.

The founder shareholders in particular should give some initial thought to their personal tax and wealth management. In terms of the former, the availability of entrepreneurs’ relief is a key consideration.

Entrepreneur’s relief gives a favoured 10 per cent rate of CGT and is available for shareholder’s holding at least 5 per cent of the share capital (tested by reference to an entitlement to both 5 per cent of the voting rights and 5 per cent of ordinary share capital).

In addition the shareholder must be an employee or director and all of these conditions must be satisfied throughout the 12 months to the date of the sale (coincidentally the pre transaction phase for present purposes). Satisfying these tests only at the time of sale is insufficient and too late!

While accessing entrepreneurs’ relief is likely to be the main focus in tax planning for an exit (at an acceptable tax cost at least) consideration should be given in this pre transaction phase to wider planning beyond the immediate CGT liability.

Where that planning involves passing wealth to family members, including children and grandchildren, either directly or by way of suitable family trusts then consideration should be given to making those transfers now.

Shares in a trading company are favoured for tax purposes and particularly so for inheritance tax.

The shares in a trading company will typically qualify for 100% relief from inheritance tax as business property (under the business property relief provisions).

Implementing these gifts now, particularly if a family trust is to be utilised, will give an IHT free transfer as business property as compared to gifts out of post-sale cash which potentially results in a lifetime inheritance tax charge at 20 per cent.

IHT planning should not commence at precisely the point that a tax favoured asset is exchanged for a non-favoured asset!

The pre transaction phase is one in which the essential groundwork and planning for the targeted sale is put in place: both as regards the business to be sold and the vendors’ strategic financial planning arising out of the expectation of such a sale.

It is key to a successful outcome of the eventual sale: planning overlooked now may not be recovered once the pace of events increases following first contact with a potential purchaser.

Read more:
The importance of pre transaction planning