How to mitigate tax when selling your business

The economic and political climate is making business owners nervous, and many are looking to sell. A survey conducted by Evelyn Partners of 504 business owners with a turnover of over £5mn found that 65 per cent of the respondents are currently pursuing an exit strategy, and 40 per cent intend to exit within a year. Reasons cited for selling included concerns about a potential Labour government and subsequent changes to the tax regime, difficulty in accessing long-term capital and the impact of inflation.

Laura Hayward, tax partner at Evelyn Partners, says that if there is a change in government “it’s only right to assume that tax policy will be reviewed and that might lead to tax changes”. While tax changes should not be the only consideration with such a crucial financial decision, after the hardships brought about by the Covid-19 pandemic, this further round of difficulties is prompting many to consider an exit.

 

 

Plan ahead

Tax planning strategies can take time, so it is important to plan ahead. “The most common mistake that I see is business owners coming to us and saying ‘I’ve got a deal on the table, what can I do to tax plan?'” says Hayward. But “by that stage, quite often it’s too late to do very much”.

Selling an asset such as a business can incur a large capital gains tax (CGT) liability. One of the key ways to reduce CGT on the sale of a business is to qualify for business asset disposal relief (BADR), previously known as entrepreneurs’ relief, which reduces the rate of tax you pay on the sale of qualifying business assets to only 10 per cent. By contrast, the standard CGT rate for higher and additional rate taxpayers is usually 20 per cent. 

If you are selling shares in a company, to qualify for BADR you need to have held at least 5 per cent of the shares and voting rights for the previous two years. There’s a lifetime limit of £1mn on BADR, which means that the relief is worth up to £100,000 per person. 

Ade Babatunde, financial planning director at Investec Wealth and Investment, says that you could transfer some of the shares to a spouse or a civil partner – a transaction that does not incur a CGT charge. If the transfer is done well in advance and meets all the relevant criteria it potentially doubles the available CGT allowances, basic rate bands and BADR, which can be offset against CGT incurred and achieve significant tax savings.

The “often overlooked” investors’ relief is also a valuable option, says Hayward, because it has a much higher lifetime limit of £10mn. But to qualify, you need to have owned the shares for at least three years before the sale, as well as meet other requirements. For example, it is not usually available if you or someone connected with you is an employee of the company.

Babatunde suggests that as you approach the sale, leave any profits you don’t need within the business – especially if you are a higher or additional rate taxpayer. If you pay yourself a salary from your company, the maximum income tax rate is 45 per cent; and if you extract profits in the form of dividends the additional rate of dividend tax is 39.35 per cent. Both are significantly higher than the CGT rate you would pay on the sale proceeds. Conversely, employer pension contributions are a tax-efficient way to extract profits because they are deductible as business expenses for corporation tax purposes (see How to boost your pension if you’re self-employed, IC, 6 April 2023).

 

Exit strategies

What you need to do ahead of your business sale also depends on how you exit the business. Some business owners – 20 per cent of those surveyed by Evelyn Partners – look to sell to a private equity firm. A few deals have fallen through over the past year, but transactions seem to have picked up again in the past quarter, Hayward says. Selling to private equity tends to require strict due diligence, but you have the benefit of dealing with a streamlined organisation that is used to doing deals.

Simon Martin, chartered financial planner and tax consultant at St James’s Place, says that you might want to separate the trading company from any investment assets, such as a property you hold within it, to keep things simple for future sales. For example, a buyer might want to buy the business but not the assets, or you might want to retain some of them. You could use a holding company that owns both the investment assets and the trading company and then sell the trading company to the buyer. Owning assets through a company can also be more tax efficient than owning them personally.

An increasing number of business owners plan to exit via an employee ownership trust (EOT) – 18 per cent of those surveyed by Evelyn Partners – or family succession – 16 per cent of those surveyed by Evelyn Partners. EOTs allow founders to exit their business very tax efficiently because CGT and inheritance tax do not apply, and this method can help you transfer control of the business to a group of directors you trust but who don’t have enough capital to buy you out. However, there are a number of things to consider before opting for an EOT, including that you often don’t get your money straight away but rather are paid for your shares out of future income generated by the company. 

Planning for a family succession can be complex because as well as corporate and tax considerations, family dynamics come into play. Some family members may be involved in the business, while others may just inherit the shares from a parent or another relative.

One way to try to be fair is to use special classes of shares. For example, growth shares allow holders to benefit from the future growth of a company but typically confer no rights to dividends or voting, while preference shares give holders priority when it comes to receiving dividends.

 

Sheltering the proceeds

Carefully consider your plans for the sale proceeds, trying to make the most of all your tax wrappers and allowances such as individual savings accounts (Isa) and pensions. You could also look at riskier but tax-efficient investment options such as venture capital trusts (VCTs) and enterprise investment schemes (EIS).

Offshore bonds have some tax advantages: the capital invested in them grows in a tax-free environment, you can withdraw 5 per cent of the original capital each year without suffering a tax charge and you only pay income tax when you take out the money at the end. 

Which tax-efficient wrappers and vehicles you use will depend on your financial goals. You might need the money for yourself, or plan to leave it to your children and grandchildren, for example.

Family investment companies have grown in popularity over the past few years. These can be funded in different ways, including via a loan made by the business owner, which is very tax efficient. Family members are shareholders and the directors decide how to invest the sum of cash. Family investment companies can be used to start passing on wealth to the next generation and structured to reflect the personal wishes of the business owner. 

However, these advanced financial planning strategies need to be handled carefully because of their complexities and you need to consider how they interact with each other.