Tax considerations and wealth planning
Getting the most out of your proceeds
In addition to considering the tax position of the business as part of the sale process, it is important to take advice on your personal tax position – the earlier you take advice, the more planning options are likely to be available.
Tax treatment of consideration and value in the business
The tax treatment of any sale proceeds (whether received on completion or in the future) and of any holdings in the new structure will directly impact how much value you will end up with as a result of the transaction. You will most likely want to structure any transaction to maximise the impact of available tax reliefs.
If you are an individual, you will want any payment for your shares to be treated as a capital receipt (taxed at a rate of 10% on any gain where business assets disposal relief (BADR) applies and otherwise at a rate of 20% for additional rate taxpayers), rather than as income (taxed at a rate of 45% for additional rate taxpayers and potentially liable to deductions through payroll and national insurance contributions).
The nature of payments under the transaction documents will inform their tax status. Broadly, where such payments are disposal proceeds for shares, they should be taxed as capital, but if they are payments for (past or ongoing) individual services (whether as part of any transaction or success fees or otherwise), they are at risk of being taxed as income. For similar reasons, you will also want any amounts reinvested or shares rolled over into the new structure to be within the capital gains rather than income tax regime to the extent possible.
Your interests in this regard should align with the interests of the target company (and buyer), as any applicable employment taxes may have national insurance contributions costs for the target company.
On the basis that sale proceeds will be taxed at capital gains tax rates, individual sellers will normally want to leave cash in the business before any sale (and increase the price per share on disposal) rather than taking it out before the sale via a dividend (taxed at a rate of up to 39.35%). However, this may have to be balanced against a buyer's preference to minimise stamp duty.
In negotiating the price to be paid for the target company, you should bear in mind any embedded tax 'assets' in the company that can arise where:
- amounts are owed by the shareholders to the target company
- the company is expecting tax credits (for example, in respect of R&D) or refunds or repayments of tax or
- there are share options that will be exercised upon completion.
In such cases, you will want to consider positively reflecting any value in these tax assets in the deal price.
Tax rates and reliefs specified in this note were correct at the time of publication but may have since changed.
Consideration structures
Your individual tax position will depend on the type of consideration you receive, the method of calculating it, and the timing of any payment. You may receive any combination of the following types of consideration: cash, shares, or loan notes, and your tax position may be complicated by any entitlements to receive consideration post-sale, possibly by way of an earn-out.
Where you receive cash for the disposal of shares in the target your proceeds should, as a general rule, be subject to capital gains tax on receipt.
Particular care should be taken by individuals in transactions where rollover or earn-out mechanisms are included in the drafting. Although they are useful commercial tools to incentivise founders and senior management to stay in the business (particularly in a private equity context) and bridge valuation gaps between buyers and sellers, they can result in unexpected tax consequences.
You should seek tax advice as early as possible on the appropriate way to structure such entitlements.
Earn-outs
An earn-out can be structured as a future entitlement to shares or loan notes or as payments of deferred and/or contingent cash consideration. Future entitlements to shares may include allocations of sweet equity, as discussed in relation to PE buyers in Understanding your buyers. An earn-out is often contingent on certain future events or performance metrics. The way an earn-out is structured will affect how and when it will be taxed in your hands. Some points to be aware of are set out below.
- Where a sale includes substantial deferred or contingent consideration this can trigger significant tax charges for the tax year on completion of the sale, regardless of when or if such amounts are eventually paid. Accordingly, careful consideration should go into the drafting of these provisions and the mechanisms for calculating any future amounts as described in the transaction documents. (See also Understanding your buyers above in respect of transfer taxes.)
- A seller's entitlement to earn-out consideration should ideally be linked only to the performance of the company (and not any individual) and should not be conditional on any individual's ongoing employment (among other things) to maximise the likelihood that it is taxed as a capital receipt.
Rolled equity
As discussed in Understanding your buyers, a founder seller may be requested to rollover part of their shareholding in the target company into shares and/or loan notes of equivalent value in the new structure (for example, in the institutional strip in relation to PE buyers) or in the buyer itself (relevant to trade buyers). Some tax considerations to be aware of include:
- Where you receive shares (or certain types of loan notes) in the new structure for the disposal of shares in the target, it may be possible for UK tax resident founders or senior managers to rollover any latent gain in the value of the shares in the target and defer the payment of any tax on such gain until any disposal of the 'new' shares. This is often referred to as rollover relief.
- Rollover relief is subject to certain conditions being satisfied. Pre-transaction clearance from HMRC may be obtained to provide comfort on the tax treatment of any rollover, although this is generally not essential.
- UK tax resident founders and senior managers should enter into Section 431 elections in respect of any rolled holdings. This is designed to bring any future disposal of the new shares into the capital gains tax regime.
- If you are eligible for BADR on the disposal of your shares in the target, you should consider whether it is more advantageous from a tax perspective to crystallise the gain on the disposal of the shares in the target (taxed at 10% on completion to the extent BADR applies) rather than to claim rollover relief. This is because you may not qualify for BADR on a future disposal of your 'new' shares.
Loan notes, preference shares, and sweet equity
As discussed in Understanding your buyers, senior management may be required to subscribe for loan notes and may also be invited to subscribe for sweet equity in the new structure. UK tax resident founders/senior managers should enter into Section 431 elections in respect of any such holdings as well as in respect of any loan notes or shareholdings that are rolled. This is designed to bring those securities into the capital gains tax regime with respect to a future exit.
Pre-sale tax planning
There may be steps that you can take in advance of the sale to minimise your tax exposure, or to crystalise the benefit of existing tax reliefs:
- Qualifying gains benefiting from BADR (where gains are taxed at 10%) are subject to a lifetime cap of £1 million, above which gains will be taxed at 20%. As each individual has their own BADR allowance, you may consider re-structuring the ownership of the business in advance of the sale (eg by transferring shares to other family members, whether directly or through a trust, who are involved in the business at least two years prior to a sale) to maximise the amount of the gains taxed at the preferential 10% rate.
- Your shares in the company and certain other business assets may be qualifying assets for business property relief (BPR), reducing the value subject to inheritance tax by up to 100%. If the shares and business assets are sold in exchange for non-qualifying assets (such as cash) the benefit of BPR would be lost on a sale. You may, therefore, wish to 'crystalise' the benefit of BPR pre-sale by transferring all or some of the shares to a trust for the benefit of family members and removing their value from your estate. In contrast, a transfer of the post-sale proceeds into a trust is likely to be limited to £325,000 with any excess giving rise to an immediate inheritance tax charge (at 20%).
- A trust may also form part of a longer-term succession plan, providing a flexible asset holding structure for future generations, asset protection and, if desired, also allowing you to retain a degree of control over the shares and subsequently the sale proceeds.
- If you are non-UK domiciled (and not yet deemed domiciled) additional planning options may be available to you through the use of non-UK structures, allowing for the longer-term growth of the sales proceeds in a tax optimised way. However, please note that on 6 March 2024, the Government announced plans to abolish the tax regime available for UK resident non-domiciled individuals with effect from 6 April 2025.
- If you are considering leaving the UK, it may be more tax efficient to make the move pre-sale, but care will be needed to ensure that your non-UK residency status post departure is certain. In addition, the sale proceeds may become subject to UK tax if you were to return and become UK tax resident within six tax years, under anti-avoidance provisions.
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Post-sale considerations
Wealth structuring
The sale of a business provides an opportunity for you to review your personal affairs to ensure you have a suitable wealth, estate and governance framework in place, including reviewing and updating any existing arrangements.
Key to determining the most appropriate planning and structuring options will be identifying your objectives – for example, whether you intend to retire, wish to invest in new businesses, acquire assets for personal enjoyment or investment purposes, transfer wealth and/or use it for philanthropic aims.
Depending on your objectives, potential structures such as trusts or a family investment vehicle (in the form of a company, partnership, fund or investment bond) may assist during your lifetime to defer tax on investments, mitigate inheritance tax and pass wealth on to the next generation.