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Sale of business as shares or as a trade

 

Written by Ray Coman

 

HMRC check into Child Benefit omission from Tax ReturnCompanies seeking to expand by acquisition will be faced by a dilemma about whether to make their purchase of the business only, or to purchase the company in its entirety.  The tax ramifications can be considerable and are explored in some breadth by the report below.

 

Substantial shareholder exemption

Profits on cessation of trade

Gains and losses on assets

Trading loss relief

Change in nature and conduct

Restriction on capital loss

Corporate Capital Loss Restriction

Trading loss restriction

Tax relief on purchase

Rollover relief

VAT and stamp duty considerations

Assumption of liabilities

Double tax charge where sold as assets

Business assets disposal relief where sold as shares

Non-tax considerations

Summary comparison of share purchase and trade purchase

 

Substantial shareholder exemption

 

In some cases, there will be no corporation tax arising on gains from the sale of shares owned by a company group.

 

The substantial shareholder exemption was introduced by the Finance Act 2001 to improve the attraction of doing business in the UK.  The intention was to remove a tax barrier from the transfer of business activities and thereby allow an organisation to focus on core areas.

 

The exemption applies to gains on disposal of shares provided conditions are met which are:

 

The transferor company must hold at least 10% of the company being sold.  Broadly, substantial means holding 10% of the ordinary shares and 10% of distributable profits

 

The ownership of at least 10% must have been held for a period of at least twelve months at some time in the six years prior to disposal.  This means, for instance, that if a disposal occurs on 30 November 2020, the amount owned at that date need not be as much as 10%, provided at least 10% has been held since 1 December 2014.

 

Prior to 1 April 2017, it was a requirement for the transferor company, and company invested in, to be trading, both before and after the transfer.  This meant that the transferor company had to carry on in business.  This would be impractical where a holding company sells its only subsidiary.  However, this is no longer a requirement.  The trading requirement only applies where the sale is made to a person who is connected with the transferor.

 

Where a business is acquired as a trade, the substantial shareholder exemption would not be available.

 

It could be possible to consider company reorganisations prior to sale to facilitate a disposal of part of the business in the future.  This could be achieved for instance by hive down or demerger.

 

Consider that the gain on disposal recognised by the transferor, while not giving rise to corporation tax will increase the distributable reserves of the transferor.  If the transferor company is subsequently sold or liquidated, business assets disposal relief could be available. An increase in distributable reserves could create a personal tax liability for the owners, for instance in the form of dividends payable.  In the owner managed business sector, sale of a company by a group might not provide a tax benefit over sale of company owned by the shareholder of the group.

 

The substantial shareholder exemption also prevents an allowable loss arising.  This could occur where the company invested in was acquired by the transferor rather than started up within the transferor group.

 

The Substantial shareholder exemption is automatic and does not require an election to be made. 

 

Profits on cessation of trade

 

When shares in a company are transferred, the trade does not stop, it is only the ownership that changes hands.  By contrast, on transfer of the business only, a trade ceases and this gives rise to tax implications which are set out in the table below:

 

 

 

Sale of trade

Share sale

Fixed assets/ capital allowances

 

Transfers at market value.  This would likely give rise to a balancing charge if the disposing company has claimed annual investment allowance.  However, the buyer can use annual investment allowance.

No cessation of trade, therefore office furniture, computer equipment, vehicles and other plant transfers for tax written down value

Stock

Transfers at market value.  This could give rise to a profit in the disposing company.  The profits are accelerated rather than increased, because there will be less profits on eventual disposal.

No cessation of trade, therefore stock transfers at book value.  Stock is recognised at lower of cost and net realisable value.

Chargeable accounting period

The year-end would change to year end of the acquiring company.

The year-end stays the same.

Terminal loss relief

If the disposing company suffers a loss in the year of sale, the loss can be carried back and set against profit of the preceding three years.

Not available.  The company has not ceased.

 

Where the assets is transferred between two companies that are connected, an election has to be made within two years of the date of transfer to treat the asset as being transferred for tax written down value.

 

From 1 April 2017, it is possible to include brought forward losses in a terminal loss relief claim. 

 

Gains and losses on assets

 

A company can own property, often the commercial premises from which it operates.

 

  

 

Sale of trade

Share sale

Capital gains

Assets are acquired at market value and this becomes the new base cost for future disposals.

Chargeable gains arise on land and buildings.  However, these could be sheltered by roll over relief

Since there is no uplift in value for the base cost of any assets, the acquirer could be assuming an exposure to tax on unrealised capital gains.  Land building and intangible assets are reflected in the sale price; however this should be discounted for tax liability assumed by the new owner.

If the company were part of a group, there could be a ‘de-grouping’ charge.

Trading losses

Trading losses do not transfer with trade, although brought forward losses of acquirer can be offset.

If the company ends following sale of its business, any losses brought forward in the company extinguish when it is dissolved.

Losses brought forward may be used against profits of the same trade.  However, s. 673 CTA 2010 will restrict brought forward loss relief where there is a change in the nature or the trade.

For group relief, vendor may use losses to date of arrangement to sell, and acquirer from date of purchase.

Capital loss

Capital losses do not transfer with the trade.

Pre-entry losses will not be available to the acquirer

 

Trading loss relief

 

A group of companies arises where several companies come under common ownership.  This could occur where a target company is made a subsidiary of a group following acquisition.  Losses arising after 1 April 2017 cannot be set against profits of group companies for the first five years following an acquisiton.  To the extent that group profits exceed £5 million, only 50% of the loss can be relieved intra-group.

 

Change in nature and conduct

 

A trading loss will not be available to the new owners following a change in ownership if there is a significant change in the nature or conduct of the trade.  The change cannot occur within 5 years of the transfer.  Prior to 1 April 2017 the limit was 3 years.  A change started gradually before the 5-year period transfer could also result in denial of relief.  Examples of significant change include not just business activity but also customer or geographic markets.

Loss relief would also be denied where the business activity has become negligible but is revived by the new owners.

 

Restriction on capital loss

 

Within a group of company, one company can surrender its trading losses to another.  While there is no method for relieving capital losses, a group of companies can transfer assets for such amount as give rise to neither gain or a loss for tax purposes.

 

An anti-avoidance provision exists to prevent “loss buying.”  Without the restriction, a company with unrealised gains could acquire another company with capital losses, transfer the asset with the pregnant gain into the newly acquired company and use losses brought forward to reduce taxable gains.

 

Similarly, a company with an unrealised capital gains could seek a purchaser with brought forward or unrealised losses.  This practice is known as “gain buying.”  Both loss and gain buying are prevented by TCGA92/Sch 7A and TCGA92/Sch 7AA.

 

Capital losses of a target company before it became part of a group are referred to as ‘pre-entry’ losses.  A ‘pre-entry’ loss includes capital losses brought forward by the target company and unrealised losses on assets owned by the target company before it became part of a group.  Broadly, a pre-entry loss can only be set against a pre-entry gains, i.e. a gain made by that subsidiary before it became part of the group.  The loss will not be available to reduce capital gains on assets which are part of its new group.

 

Corporate Capital Loss Restriction

 

Announced in the 2018 Budget, from 1 April 2020, a restriction on the amount of losses that can be deducted from gains applies to companies with capital gains of over £5 million.  Broadly, the capital gains that can be relieved is the sum of 50% of the capital gains plus £5 million.  This loss restriction is not directly related to purchase of shares by a company.

 

Trading loss restriction

 

From 1 April 2017, there is a restriction on the carry forward of losses of over £5 million.

 

Tax relief on purchase

 

 

Sale of trade

Share sale

Busines asset rollover relief

Any gains on the disposal of business assets (including property) in the preceding three years can be deferred if the proceeds are re-invested in assets acquired as part of the takeover.

It is the shares that have changed hands.  The assets are still owned by the same company, and therefore there is no business assets disposal relief available.  There is no roll-over relief on shares.

Goodwill

It is possible to obtain tax relief on amortisation of goodwill

There is no tax relief on internally generated goodwill.

 

Rollover relief

 

For the purposes of rollover relief, a group of companies are treated as one company.  Gains on business assets in one company can be rolled over to the extent that a business asset is purchased by another company in the same group.

 

VAT and stamp duty considerations

 

 

Sale of trade

Share sale

Stamp duty land tax

SDLT may be payable, for instance on commercial property, by the acquiring company.

It is the company that owns the land and therefore the land has not changed hands as such.  Therefore, there is no SDLT.

VAT

There is no VAT on the sale of a business as a going concern

There is on VAT on the sale of shares

Stamp duty

 

The acquiring company will be liable for stamp duty which is 0.5% of the consideration.  Consideration is usually the same as purchase price.

Assumption of liabilities

 

Sale of trade

Share sale

VAT and PAYE liabilities

The buyer does not assume any liabilities of the target company beyond those attached to the asset.

The shareholders are exposed to liabilities following the outcome of a negative tax enquiry into the corporation tax, VAT or PAYE affairs of the company being acquired.  This liability can be mitigated by warranties and indemnities.

 

Double tax charge where sold as assets

 

If a business is sold separately from its company, the seller would be subject to a double tax charge.  First corporation tax profits arise on the disposal of the trade, i.e. in the form of goodwill.  Second the proceeds of the sale need to extracted from the company.  A dividend withdrawal could expose the owner or owners to considerable income tax.  If the company ceases to be trading following disposal of its business, capital gains tax relief could still apply.  Business asset disposal relief still applies provided shares are sold within three years of the company ceasing to trade.  Extraction of proceeds as capital gain on liquidation of the company would likely result in lower tax for the shareholders of the disposing business, however there would still be a two-tiered taxation.  (For instance, 19% plus 81% of 10% or 27.1%.)

 

Business assets disposal relief where sold as shares

 

Where a proprietor disposes of the shares of a business, he or she would be subject to capital gains tax.  However, it is likely that business assets disposal relief would apply and therefore that the gain would be subject to tax at just 10%.

 

Non-tax considerations

 

The employment obligations of the vendor transfer to those of the acquirer following a share transfer.  This requirement is covered by the Transfer of Undertakings (Protection of Employment) Regulations 2006, is known as TUPE for short.

A trade sale tends to progress faster as there is less due diligence.

A buyer can negotiate on more favourable terms in a trade sale.

A share sale would likely result in higher legal fees associated with the writing up of tax covenants.

Share sales allow the business to carry on without changing its name and could therefore be more discrete.

 

Summary comparison of share purchase and trade purchase

 

Key benefits for purchaser of asset purchase

 

  • Tax relief can be obtained on goodwill.  This is at a fixed rate of 6.5% per annum.
  • Capital allowances can be obtained on plant and machinery
  • Higher base cost for any land or buildings
  • Lower due diligence cost as not assuming liabilities of company
  • No stamp duty payable on the shares.

 

Key benefits for vendor of a share sale

 

  • Business asset disposal relief available on sale of business
  • Double tax charge avoided, so proceeds not subject to income tax on dividends.
  • No balancing charge on disposal of equipment, buildings and stock.  A realisation of gains in one year could cause a spike in the year of disposal where gains are all realised at once.  This increases potential liability to income tax.

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