Every architect will retire eventually, and many will pass on their business to their sons or daughters. However, in many cases, there are no reliable or willing heirs. In these situations, the business owner will usually sell up to a third party. However, unless the sale is executed correctly, the business owner could face a large, and mostly unnecessary, capital gains tax bill. So here's a few ways around it.
For architectural companies in which the business owner holds shares, there is a degree of tension between buyers and sellers when negotiating the sale of a company. Many buyers wish to pursue 'asset deals' where they buy the business directly from the company, rather than buying shares in the company. On the other hand, almost all sellers prefer to sell shares in the company. These preferences are largely driven by tax considerations.
For the seller, the key driver is the desire for a sale that is liable for capital gains tax at only 10 per cent. This is achieved with Business Asset Taper Relief (BATR). However, where the business is contained within a company, this rate can only be achieved by selling shares.
The buyer may wish to undertake an asset deal in order not to avoid the historic attributes of the company. In addition, if the buyer is a company, it can deduct any 'goodwill' paid on the acquisition of the business against its future corporate tax liabilities.
'Goodwill' is the difference between the value of the company's net assets as stated in its accounts, and the price to be paid by the buyer for the business. In most situations, this difference is very large, and hence the goodwill is a very large amount, and hence a tax deduction for the goodwill is a very valuable relief for the buyer.
An asset sale is potentially disastrous from the seller's perspective because it will be taxable in the seller's company and be liable for corporation tax at 30 per cent. In addition, the sale proceeds will be received by the company, not the seller directly, and a minimum of 10 per cent of further tax will be payable when stripping the sale proceeds out of the company into the seller's hands. Sellers are strongly advised to resist an asset sale, and instead insist on a share sale.
The main condition for the 10 per cent capital gains tax rate offered by BATR in a share sale is that the owner has held shares in a 'trading company' for at least two years. A trading company is defined as 'a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities'.
Problems frequently arise where trading companies hold large cash balances. In these situations, the Revenue may deny the 10 per cent capital gains tax rate, and may instead tax the share sale at capital gains tax rates of between 24 and 40 per cent.
The Inland Revenue's interpretation is that 'substantial' means more than 20 per cent by reference to various criteria including assets, income and directors' time. Therefore, if the value of non-trading assets, which could include excess cash, is a substantial part of the total assets held then this could affect the trading status of the company, and the availability of BATR.
However, there is little consistency in how local Tax Inspectors are applying this guidance. Some actually argue that holding cash is an activity in itself, and therefore they deny relief where trading companies retain large cash balances in excess of 20 per cent of total assets.
The 20 per cent limit, however, only relates to excess cash.
Arguing that additional cash is needed as working capital to meet outstanding and ongoing fluctuating liabilities can justify all or some of the cash retained. The cash may also be earmarked for specific expansion of the trade or the acquisition of a new business.
And where the company does have surplus cash, the cash should be removed from the company prior to the sale. There are a number of different ways of achieving this, each with their own associated tax issues, such as dividends and bonus payments.
Finally, as a matter of housekeeping, it is important that owner/managers should undertake a regular and constant review of their company's activities, in order to ensure that where possible any non-trade assets, including excess cash, are kept within the 20 per cent limit. In this way the company will be ready for sale when the time comes.
If the shares in the business are sold on or after 6 April, then the owner's capital gains tax bill is payable on 31 January in two years' time. However, if the shares in the business are sold before 6 April, then the owner's capital gains tax bill is payable on 31 January in only one year's time.
If you want to avoid tax altogether when selling your business, as owner, you must:
? leave the UK before the beginning of the tax year of the sale of their business; and - sell or rent out any UK residential property that you own before the beginning of the tax year of the sale of their business; and - establish residence in a suitable offshore jurisdiction that does not levy capital gains tax, such as the Channel Islands, the Isle of Man, and various Caribbean Islands; and - remain outside of the UK for five full tax years, with only short trips permitted back to the UK during that time.
Because these are usually costly options available only to rock stars, maybe you should resign yourself to paying 10 per cent capital gains tax on the sale of your business.
Andrew Shilling is a Chartered Accountant and a Chartered Tax Adviser at Chiltern. Contact: shillinga@chilternplc. com