Tax-efficient exit planning for owner managers

Background

The group consists of a holding company and a wholly owned trading subsidiary. Yourson works in the business, but does not own shares. Often, the first choice of exit for a business owner is a sale to a trade buyer. Here the company is sold to a third party who is unconnected to the company but who operates in the same industry. Usually, this is a competitor who will benefit from cost synergies while expanding its operations and eliminating competition.

A trade sale will produce the highest cash out value for an owner, but can be a long and stressful process.

As you have a holding company and trading subsidiary group in place, it will be important to understand which company a buyer is intending to purchase. If a buyer is happy to purchase the shares in the holding company, this will be the most straightforward as you will simply sell the shares and pay capital gains tax (CGT) on any gain, claiming business asset disposal relief (BADR) as appropriate.

If a buyer only wants to purchase the trading subsidiary, then it will first be necessary for the holding company to sell the shares of the subsidiary, which will be a tax-free sale under the substantial shareholdings exemption. You will then need to liquidate the holding company receiving the cash in return for the cancellation of the shares. CGT will then be payable on the gain arising.

Management buyout

A trade sale may not always be possible because there is no appropriate competitor looking to acquire a business at that time, or it could be because your do not want to sell to a buyer who will destroy your legacy. In such a scenario a management buyout (MBO) could be an attractive alternative.

An MBO will need a strong management team in place to sell to, and you might not get the maximum value for the business.

In a typical MBO transaction, the managers will not have the personal funds available so there will need to be an element of bank borrowing to fund the purchase as well as purchasing with deferred consideration. Banks will usually want to lend to a company rather than individual managers, so a new company is likely to be needed.

Example. The management team will incorporate a new company wholly owned by them which will purchase the shares from you. The managers will put their own cash into the company in the form of share capital and will borrow the balance of the purchase price from a bank.

To aid with cash flow there will usually be an element of deferred consideration built into the purchase price, i.e. the managers’ new company will pay a certain percentage of the purchase price over a number of years out of the future cash profits on the company.

The tax position for you will be the same as under a trade sale. You are selling shares to another company and so will pay CGT on the gain arising, it just happens that the buying company is owned by the management of the business rather than a third party.

Where part of the purchase price is payable on deferred terms, the full amount will still be subject to CGT on completion, but without any discount for the length of time the proceeds are received over or for the risk of non-payment per CG14881.

Employees

Where a trade sale is not on the cards and you want to preserve a legacy and that of the company, an alternative to an MBO is a sale to the employees of the business. The structure is different to an MBO, in that the employees don’t set up a new company but rather a trust fund is set up in which the employees are beneficiaries. Since 2014 it has been possible to sell the shares of a trading company (or the holding company of a trading group) to a special trust that has been set up for the benefit of the employees of the business - an employee ownership trust (EOT).

While a sale to an EOT might sound similar in principle to an MBO, there is one key difference for you - a tax-free sale!

There are a number of conditions that need to be met on a sale to an EOT. Where they are met it will mean the sale of your  shares will be deemed to have been sold for their original cost and so no gain arises.

The trustees of the EOT therefore take over the shares equal to your historic base cost and will suffer the capital gain on any future sale of the business by it.

While the tax treatment on a sale to an EOT is different to an MBO, the funding and sale proceeds structure will be similar as there is almost always an element of the purchase price payable by instalments.

Family

As your son works in the business, one option could simply be to gift the shares in the holding company for him to take over the family business. A gift of shares is a disposal for CGT purposes even though no cash is received, but holdover relief under s.165 Taxation of Chargeable Gains Act 1992 would be available to prevent any gains from being taxable.

The practical effect of claiming holdover relief is that your son will take over the shares at your  historical base cost, and they will pay the CGT if and when they sell the business.

Buyback

If you (or need) to receive some cash for the gift of the shares, you could receive the cash from the company by undertaking a company purchase of own shares for the desired amount.

Example. If yout wanted to receive half of the value of the company in cash, you could gift half of the shares to your son and have the company buy back the other half. You would end up with the cash you wanted and your son would own the company 100%.

The purchase by a company of its shares from a shareholder is by default treated as an income distribution, but providing certain conditions are met, the buy back will be treated as a capital receipt. Youwill therefore pay CGT on the proceeds received and claim BADR in the same way you would under a trade sale or MBO.

Liquidation

Where all other options have been explored and dismissed, the ultimate exit option could be to liquidate the company. This is not usually preferable as not only will the company and your legacy cease to exist, the proceeds received on liquidation will only be equal to the value of the net assets and therefore will be far less than a trade sale or even an MBO or EOT sale. It is therefore only really a last resort.