- Structure the sale of a business to be as tax efficient as possible from a personal perspective
- It can take years to do this so start preparing for the sale of your business years ahead of doing it
- Also make the most of pension contributions while you are still employed by your business
After years of hard work and building up your business, you may feel that it is time to sell up and retire, pursue something new or have a break. But to ensure that you are financially secure after the sale, it is important to plan and prepare for it well in advance so that you get a good outcome and realise the profits in the most tax-efficient way.
Chris Budd, founder of The Eternal Business Consultancy, says that you firstly need to understand how much you need to sell your business for. You need to establish what lifestyle and income you want, and what assets you will need to finance it. Then you should see if the valuation of your business and any other assets you have such as income from pensions and savings, will meet this.
If you are retiring, “what are your income requirements in retirement and how might spending change over the long term in the context of your overall financial position?” asks Rebecca Williams, head of wealth planning at Brown Shipley. “For example, spending on active pursuits may fall in later years and there may be a need for care which presents a significant income need. The sale of your business should be structured to support your retirement aims, and your short-, medium- and long-term financial needs. For example, is there enough cash on offer at the point of sale, and what are the terms of any shares or loan notes?”
Rebecca Aldridge, managing director and founder of Balance Wealth, adds that you should be cautious about accepting payment over several years in either shares or loan notes. “These both rely on the business remaining profitable and that isn’t guaranteed – particularly after such a big disruption as a change of ownership,” she explains. “Get the maximum you can up front.”
It is also important to understand that an offer is not a valuation, as this could change over the course of the negotiations.
It can take years to maximise a business’s value so you should start preparing for a potential sale well ahead of when you might want to do it so that you do not have to sell in a rush and take whatever you are offered at the time. “Planning ahead of time will allow business owners to be prepared for a sale if they are approached by a suitable buyer and need to sell at short notice, or are faced with issues related to the divorce, illness or death of a key business shareholder,” says Aaron McLoughlin, director at James Hambro & Partners.
This includes setting up a power of attorney to ensure that your sale can go ahead, even if any of the key parties involved become incapacitated before the process is complete.
There are different ways to exit a business so it is important to choose the right one for your purposes. You could sell your business to a third party or senior employees via a management buyout (MBO), if they are interested. Or you could sell it to an Employee Ownership Trust (EOT), if you have a business with employees. If you sell over 51 per cent of your company to an EOT the disposal is capital gains tax (CGT) free – one of the main liabilities when selling a business. Part selling to an EOT can work well if, for example, you do not want to wholly sell your business when you move on or retire. It can also mean that you do not have to negotiate offers with third parties so get a fairer price and faster exit, and maybe lower transaction fees.
But to carry out a qualifying sale to an EOT your business has to meet a number of terms and conditions, such as being a trading company. And if you want a sum of money upfront for your business an EOT may not be the best option. When you sell to an EOT, in some cases banks fund the EOT’s purchase. But with some arrangements payments are gradually made to you through future profits of the company. If your former business fails it may never be able to fully pay you what was agreed. And if you want a clean break from your company an outright sale to a third party or MBO might also be a better option.
If there are parts of your business or certain assets that you wish to keep, for example, the premises, a factory or office so that you can let them to your former business or other tenants, it is important to separate them well in advance of the sale. “There is a risk that if you do this too late on you will incur an income tax charge,” explains Julia Rosenbloom, tax partner at Smith & Williamson. Renting out assets such as an office or factory to the business or other tenants can form part of a retirement income. “Make sure that you keep the assets within a company wrapper, because if you hold them personally there will be an income tax charge,” she explains. “De-merge existing company into two parts – the trading company and a company which holds the assets you want to keep.”
'Retirement planning is an important consideration as you may need to use proceeds from the sale of your business for income. And even if you are not retiring you may no longer get contributions to a pension after the sale. So Louise Higham, chartered financial planner at Tilney, suggests funding your pension as much as possible in the run up to selling your business.
Because of the annual limit on pension contributions – at most £40,000 – you should look to maximise this benefit for years before selling your business as you cannot necessarily put in a large amount just in the year of the sale. But if you have not used up your pension allowances from the three prior years you may be able to carry these forward and use them too, although you need to earn as much as you contribute in the year that you do it.
Taking money out of your business and putting it into your pension can help to reduce the corporation tax your company is liable for and is a tax efficient way to remove excess cash out of the business. Your company can pay up to £40,000 a year into your pension each year – even if you have not earned that amount. “Look to fund your pension before sale,” says Higham. “But your company will require cash for operations so don’t take too much. And don’t go over the pensions lifetime allowance limit of £1,073,100 by putting too much money into your pension.”
You could hold your business premises within a self-invested personal pension (Sipp) and lease it to your company, including after you have sold it. The rent, for example, could contribute to your retirement income. Your pension would not pay income tax on the rent it receives and growth in the value of the premises would not be subject to CGT. The premises and other assets could also be passed on inheritance tax (IHT) free within the pension wrapper.
The sale of a business incurs CGT. However, any chargeable gains, after allowances are taken into consideration, can be offset against Business Asset Disposal Relief which reduces the rate of CGT you pay on the first £1m of gains to 10 per cent. Gains above that level are charged at 20 per cent.
But the £1m allowance for gains can only be used once, so if you have already offset previous business sales up to that value you cannot apply this.
To obtain this relief, a number of conditions have to be met. Your business must be a trading company, the holding company of a trading group, or a similar sole trader or partnership. And for 24 months leading up to the sale you need to have held at least 5 per cent of the ordinary shares in the business or be a partner, and have held at least 5 per cent of the voting rights. You also need to be an officer or employee of the company.
You could increase the tax efficiency of the sale by transferring some of your business's ownership to your spouse ahead of the sale. This could potentially result in a tax saving of up to £200,000 rather than £100,000 because you both make use of Business Asset Disposal Relief. The transfer of assets between spouses does not incur CGT and this could be particularly beneficial if you have used up all of your £1m allowance.
But “this gift needs to have happened at least two years in advance of any sale”, says McLoughlin. “This is often one of the major pitfalls we see clients fall into – not having engaged and tax planned appropriately well in advance of any potential business sale.”
Another key consideration is IHT. You can get up to 100 per cent Business Relief on a business you own or interest in a business with respect to IHT, as long as you owned it for at least two years before you die. The business also has to meet certain conditions, for example, it should mainly trade rather than deal with securities, stocks or shares, land or buildings, or make or hold investments.
"If it [does] not, the business owner could look to rearrange the business or its activities,” says McLoughlin.
However, if you sell your business for cash that money becomes part of your estate for IHT purposes, so you need to consider how to you will manage this potential liability. Rosenbloom says that setting up a family trust and transferring shares in your business ahead of a sale can help to mitigate IHT.
If you sell your business, for example, for £1m and then transfer the money to a trust you could incur a lifetime IHT charge of 20 per cent on any value over £325,000. But the transfer of shares in your business to the trust would not incur a lifetime IHT charge provided that it benefits from Business Relief, and you live for seven years after making the transfer.
“For example, if you wish to pass on half of the value of your company to your family you could transfer half of it to a trust ahead of a sale,” says Rosenbloom. “When you decide to sell you could sell the half you own and the trust would sell the other half. This way, a substantial amount of cash goes directly to the trust [rather than from just yourself] so you avoid the lifetime IHT charge.”
If the proceeds from the sale of your business create an IHT liability options for mitigating it include making lifetime gifts to reduce the value of your estate. You could also invest the proceeds in investments which qualify for Business Relief such as Aim shares or Enterprise Investment Schemes (EIS). If your business qualifies for Business Relief you may not have to wait for two years before the sale proceeds are potentially IHT free, points out Higham, because you would be rolling one qualifying investment into another. “But these are higher risk because [the investment is] in smaller companies which are not appropriate for everyone,” she adds.
If you are retiring, for example, and no longer have a salary to fall back on it may be that your assets should have a lower risk profile if they are what is supporting you financially.
EIS investments also allow you to defer any capital gains for as long as the money stays invested. You can defer gains made up to three years before and one year after the EIS investment even if you have already paid the tax. When you realise your EIS investments the gain comes back into charge and you pay CGT at the prevailing rate, unless you reinvest it into another EIS and so continue to defer the gain.