Tax planning for small business acquisitions
Written by Ray Coman
Business owners seeking to expand via acquisition are often faced with tax dilemmas. Usually, some form of restructuring will be required to avoid tax pitfalls. The separation of a business in preparation for its disposal is referred to as a hive. It is typical in company reorganisations especially prior to or after an acquisition. Typically, a vendor will seek sale of shares to obtain business asset disposal relief. A business owner seeking to expand by acquisition could have the choice either to purchase the target company individually or via an existing company under that person’s control.
It could be practical to purchase the existing company, and for instance, through a change of name, operate it as a branch. A benefit of purchasing the company individually is that the cost of shares will have a higher value for any subsequent disposal. This could be beneficial if a swift turnaround and disposal is planned.
A company purchased individually can be subsequently merged with an existing business. The usual process is for the acquiring company to purchase the business of the target company and to hive the business up. The target would have become a shell company and can be disposed of. On disposal of the target company, the business owner would realise a loss. That loss could only be relieved against future gains, for instance on disposal of the main company. It is unlikely that this strategy would be prudent unless the owner has a capital gains tax liability to mitigate in the year of acquisition.
The merging of two companies reduces ongoing compliance costs, for instance resulting from having one year-end for accounting purposes.
The capital gains tax position for the acquirer will not necessarily differ between buying the target company individually compared with via an existing business. Take a scenario where a loan is made to the existing company to purchase the target. The capital loss following loan write off would be equal to reduction in gains by having a higher base cost.
In practice it is likely that the owner will either fund the purchase through funds in an existing company, perhaps bolstered by a bank loan. A tax saving could be achieved to the extent that funds otherwise distributed as dividend are used to purchase the target via an existing company.
If purchased by a company, the business of the target would be acquired by the new company and the difference between consideration and net assets of the target company are recognised as goodwill. The target company which no longer has any assets can be dissolved.
Goodwill transferred between group companies occurs on a tax natural basis under CTA 2009 s.775. For corporation tax purposes therefore, there could be no amortisation of goodwill. Assets are transferred between companies in a group on the basis of no gain/no loss.
However, the goodwill would be amortised in accordance with FRS102. This Financial Reporting Standard requires fair value accounting for goodwill following a reconstruction. The typical amortisation basis would be between five to ten years. The gradual write-off of goodwill against profits would result in a reduction of distributable reserves. This reduces the profits otherwise taxed as dividend in the hands of the owner.
Dividends are typically taxed at a higher rate than capital gains, especially if business asset disposal relief is available, and to this extent, the acquirer would prefer purchasing via the existing company than individually. A further benefit is that the owner does not have to wait until eventual sale to achieve any tax relief on disposal. The reduction in profit reserve caused by amortisation provides some measure of tax mitigation even if the target business does not appreciate. By contrast a capital loss on disposal of the target business which is retained in its original company would only be available to set against current year or future capital gains of the owner.