RSS feedsThe proposed reforms on capital gains tax have hardly been out of the news since they were announced in last October's pre-Budget report. Business owners are dismayed that measures intended to target the much maligned private equity 'barons' instead stand to hit your more typical entrepreneur were it hurts - by removing the taper relief that reduced CGT on business assets for at least two years to 10%, and replacing it with a flat 18% rate.
According to a widely reported CBI survey, almost half of SME owners may put their businesses up for sale before April to avoid the controversial increase. There are numerous advisers in the market place who see this as a great opportunity to generate additional sales that are driven mainly by a desire to achieve the lower tax rates while they still can.
But rarely is it sensible planning to drive a commercial transaction by the need to reduce tax. Many other factors of at least equal, if not greater, importance need to be given full consideration, not least of which is whether it is a commercially viable proposition to sell the company at this particular point in time. In fact, the pitfalls of selling a business in a hurry could wipe out the benefits of paying the current, lower CGT rate. Business owners considering a fast sale would do well to keep in mind the following points.
Don't get burned
As the Treasury may find over Northern Rock, 'fire sales' rarely achieve the best price. The tax bill on any future sale after April 2008 will usually increase from 10% to 18%. Forcing through a sale now could easily reduce the value of the business by more than 8%, leaving the vendor worse off.
For example, if a business is working on a five-year exit plan to achieve a sale of £100m, but is currently only three years into this cycle, it may be that its current worth is only half of this amount. Since it is a buyers market, it is conceivable that the actual sale could be negotiated down to £40m, with tax of £4m pre-April 2008, and proceeds of £36m. If the exit strategy was left to run its course, and the £100m value successfully achieved, the tax would be £18m with net proceeds of £72m. In such a case, the increase in tax rates is more than compensated by the increase in value.
Each company's situation will be different and needs to be considered on its own merit, but the main message is that chasing a quick tax break over years of careful grooming for sale may not always be a good idea.
Beware a false start
The final details of the proposed changes are not yet known - with detailed proposals expected. A return to retirement relief is much anticipated and it may be, depending on the level of relief adopted, that the sale of a small company in particular could pay tax at a lower rate than under the current regime after allowing for any nil rate band. By all means, owners should open discussions on a sale, but where possible, should not close deals until the rules are confirmed.
Entrepreneurs are finding it hard enough to run a business in the current climate, so it is unfortunate that the chancellor Alistair Darling has created an extra month of doubt as to what the tax regime will look like from April 2008. Owner managers are asking how they can reasonably be expected to plan adequately for the future of their businesses and their personal affairs when there is doubt over the tax regime that will be in place in just three months time.
Avoid the deferment trap
It is rare for business sales to involve 100% cash upfront. They are often subject to 'deferred consideration' - typically cash or loan notes paid out subsequently, based on performance. Deferred consideration paid after April 2008 will be taxed at the new rate, even for a pre-April sale, unless taken care of in tax planning. For example, if a sale is agreed pre-April for £10m - of which 80% was expressed as loan stock, shares and earn out - it is possible that one could end up with a significant value deficit on the sale and an additional 8% tax on the bulk of the consideration.
Some would question whether it is fair that deferred consideration relating to a sale within the business asset taper relief 'regime should be subject to tax on its future realisation at a rate over and above that in place of the actual point of sale. It would be preferable for some kind of transitional relief to be available for deals completed before the end of the current tax year.
Deferment of gain?
For gains in the current tax year made and taxable in excess of 18%, it is possible under the current proposals to defer these into an enterprise investment scheme as the deferred gain will on future disposal re-surface at the 18% rate. It is perfectly feasible that gains of up to 40% will have been incurred on investment or property sales and a tax saving of up to 22% is potentially available. However, it's a case of wait and see what happens when the chancellor makes his long-awaited statement in January.
Redeem now?
Loan notes on previous sales that are cashed after April 2008 will be taxed at new rates. Vendors should explore negotiating early redemption of these before then. This will require the agreement of both parties and there may be cost implications where funding is needed to bring these payments forward.
Plan carefully - even where a pre-April sale is not possible. With good tax planning, business owners may be able to bank gains at 10%, though this would entail bringing forward the tax payment date. There are a number of ways of achieving this, depending on the particular circumstances. The most likely route would be via a disposal now into trust which would trigger a charge to tax pre-April at 10%. However, future growth in value would clearly suffer the proposed 18% tax charge. You would also need to carefully consider the effect of bringing forward a charge to tax on cashflow especially if you would need to borrow the tax payment.
Like most other tax-related issues, the real position business owners will find themselves in regarding the CGT reforms is more complicated than the headlines.
If you are in the process of a sale, or have already sold with deferred consideration, look to close by April. But by chasing a quick sale for tax reasons alone, you may lose more value than you save and with good tax planning, this can be avoided.
Perils of chasing a quick sell
• Driving forward a commercial transaction purely by the need to reduce tax is not always a good idea – the pitfalls of selling a business in a hurry could, in fact, destroy the benefits of paying the current, lower, capital gains tax rate. Each company’s situation will be different and needs to be considered on its own merit, but chasing a quick tax break over years of careful grooming is seldom wise.
• Quick sales rarely achieve the best price. The tax bill on any future sale after April 2008 will usually increase from 10%to 18%, but forcing through a sale before then could easily reduce the value of the business by more than the 8% difference, leaving the vendor worse off in the end.
• It is rare for a sale to achieve 100%cash upfront. They are often subject to ‘deferred consideration’ – typically cash or loan notes paid out afterwards, based on performance. Deferred consideration paid after April 2008 will be taxed at the new rate, even for a pre-April sale, unless taken care of in tax planning.
• For gains in the current tax year made and taxable in excess of 18% it is possible under the current proposals to defer these into an enterprise investment scheme as the deferred gain will on future disposal re-surface at the 18% rate. It is perfectly feasible that gains of up to 40% will have been incurred on investment or property sales and a tax saving of up to 22%is potentially available.
• The final details of the proposed changes – and indeed any concessions – are still uncertain. A return to retirement relief is much anticipated. Depending on the level of relief adopted, that the sale of a small company (£1m and below) could actually pay tax at a lower rate than under the current regime after allowing for any nil rate band.
