QUESTION: I'm preparing my company for a possible sale in the next few years. Is there anything I can do to ensure that the family shareholdings are tax-efficient?
ANSWER: Experience suggests that entrepreneurs who think about their exit strategy before a prospective purchaser comes knocking on the door usually pay less tax. It makes sense therefore to consider whether your business is ready for a sale well before an offer is made and determine whether the business structure is attractive both from the buyer’s perspective and your own.
You should ask yourself, if an unexpected offer is made are there any adverse tax issues or ownership matters which might need resolved which could delay a sale or potentially weaken my bargaining power? Could I sell immediately and structure the deal tax-efficiently? Are the family shareholdings as tax-efficient as possible to maximise available tax reliefs?
It is surprisingly easy to get caught out by some of the tax reliefs available on a company sale if advance planning has not been considered, particularly with Entrepreneur’s Relief (ER). This relief, which is available on the first £10 million of an individual’s lifetime gains, taxes the individual at a rate of only 10 per cent, instead of the normal capital gains tax rate of 20 per cent. It was introduced to encourage entrepreneurship and facilitate share sales at an advantageous tax rate, however it is riddled with complexity.
Shareholders should be thinking about Entrepreneurs’ Relief well in advance of a sale, if they hope to pay tax at 10 per cent. The complexity of the rules are also highlighted in the number of court cases which hit the headlines year after year.
To qualify for ER tax relief a key condition which must be met is the requirement that the shareholder must have held at least five per cent of the ordinary share capital and voting rights in the company for at least two years before the disposal takes place. It is therefore recommended that family shareholdings and group structures are reviewed at least two years before a sale is contemplated to check if adjustments are needed.
Sometimes an unexpected dilution of equity can arise and if a company has more than one class of shares family members may unwittingly fail to hold the critical five per cent voting right or shareholding threshold.
Last October two new tests were added to the ER tax legislation requiring the shareholders to have a five per cent interest in both the distributable profits and net assets of the company. These changes caused much confusion and so the legislation was further updated in December with a revised alternative ‘economic test’ and an option to elect to crystallise entrepreneurs’ relief early if a dilution occurs, adding further complexity to an already misunderstood tax relief.
As a minimum, to fulfil the new conditions for relief, you should ensure that all family members hoping to benefit from Entrepreneurs’ Relief hold at least five per cent of the economic value of the company. For larger corporate sales and for serial entrepreneurs, consideration should also be given to sharing value around family members well in advance of a sale to ensure that ER availability is multiplied.
Those who believe that by simply holding a shareholding exceeding five per cent will entitle them to entrepreneurs’ relief could be in for a surprise if they don’t take a step back well before contemplating a sale of their business and ensure that all aspects of this complex legislation are considered.
:: Janette Burns (j.burns@pkffpm.com) is associate tax director at PKF-FPM Accountants Limited (www.pkffpm.com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.
