You’re negotiating the sale of your business. The buyer doesn’t want your company, which runs it, just its trade and assets. How can you reduce the tax when you extract the sale proceeds from the company?
Selling assets
It’s more common than not that a buyer for a business which is run by a company prefers to purchase its assets rather than its shares. The main reason is that when you buy a company’s shares, as well as its assets you acquire and are liable for any skeletons it has in its cupboard. Even with guarantees and indemnities from the shareholders and directors it’s a major hassle and really racks up the legal and accounting costs. The trouble is the company’s shareholders are in effect taxed twice on the sale proceeds.
Example - part 1. Jasmine formed Acom Ltd ten years ago to run her retail business. She set it up with share capital of £100. She received an offer of £500,000 from a buyer but it only wants the goodwill (valued at £400,000) and stock. Acom must pay corporation tax (CT) at 25% on any capital gains it makes from the sale. As it paid nothing for the goodwill the whole £400,000 it receives for it is taxable. What’s more, when Jasmine takes the money from the company as a lump sum she will have to pay income tax at up to 45% or capital gains tax (CGT) of at least 10%. Because of this double tax hit the most Jasmine would be left with after taxes would be around £265,000. If the buyer had instead acquired the business by purchasing Jasmine’s shares in Acom there would be no CT and so the maximum after-tax sum would be roughly £360,000.
Tax planning
Usually the tax position is a factor in the price negotiated for a business. But in practice a buyer is unlikely to fully compensate the seller for the effect of any double taxation. The good news is that depending on the seller’s plans they can easily mitigate this.
Income not capital
If, instead of taking the proceeds from the sale of Acom all at once, by winding up the company Jasmine takes dividends from it - she could then pay income tax at a rate lower than the 10% CGT.
She could also use the money in Acom to pay pension contributions for herself. The contributions would reduce the CT Acom would otherwise have to pay on any income it made from investing its money.
Example - part 2. After the sale of her business Jasmine takes a sabbatical for two years (which for simplicity we’ll say coincides exactly with tax years). During this time she is paid dividends from Acom of £50,000. Her tax bill for this is around £3,200 per year. In effect that’s a tax rate of just 6.4%, just two thirds of the CGT rate. In the same period Acom receives interest (say £10,000) and dividends (say £9,000) from various UK investments. It doesn’t have to pay tax on the dividends (they are exempt from CT) and if Acom pays a pension contribution for Jasmine equal to the interest it receives it removes all liability to CT.
Tip. After her sabbatical, when Jasmine starts earning again she can take dividends from Acom to top up her income. If she keeps her total income within the basic rate she’ll only pay a maximum of 8.75% tax on the Acom dividends. Alternatively, she can leave the money in Acom and use it to fund her pension contributions indefinitely rather than pay it out of her other earnings.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.