Client A established his business with the sole intention of building it up to sell. The business had several locations and properties housing the business in those locations. The corporate structure consisted of a holding company which also provided management and administrative support to its subsidiary. The subsidiary held the assets for each location. When Client A began discussions with potential purchasers, those purchasers were only interested in certain locations.
Client B incorporated his business and inserted a holding company over the trading subsidiary. The subsidiary traded and generated profits which were passed up to the holding company and invested in rental properties. The shareholders were four family members although only three were involved with the trading business. The adult children shareholders held a minority shareholding.
Client C had developed intellectual property in one company, which had claimed research and development credits. Once the IP was significantly developed, investment was required to further advance it. The IP was to be sold to a second company, which investors would subscribe for shares in.
Client D set up a company to provide services through and that business had grown over two decades. The company had also invested its excess cash – that was neither required for working capital nor by the shareholder. The company held significant value in a property portfolio which outweighed the value of business assets held. The income stream from the property was not dissimilar to that from the trade.
Capital gains tax is important to each one of these clients because they hope to make a disposal:
- No doubt Client A will want the sale proceeds in his hands although without a reorganisation, the purchaser would acquire the business assets and trades rather than shares. Without further planning, Client A would not be making a disposal and he would not receive the sale proceeds.
- Client B and D may hold an asset that does not qualify for Entrepreneurs Relief for capital gains tax purposes nor Business Property Relief for inheritance tax purposes. A reorganisation would aim to ensure reliefs could be maximised for the future. A reorganisation also extracts the trading subsidiary from the holding company.
- Client C has two issues: how to structure the investors contribution who are unlikely to want to take on the risks of an existing company and how to plan for future disposal.
Entrepreneur’s relief applies a lower rate of CGT to qualifying disposals made by an individual of their business. The business must be of a trade, profession or vocation and conducted on a commercial basis with a view to the realisation of profits. Businesses comprising of mostly investment activities like property letting will not qualify. There is an exception though, the commercial letting of furnished holiday accommodation in the UK does qualify.
For Clients A, B and D a capital reduction demerger could be a suitable option.
A capital reduction demerger has been possible since 2008 although it now appears that more advisers have recently become aware of them. The legislation allows a private company to reduce share capital with the support of a director’s statement of solvency. A group will be formed. The group is effectively divided out under a new company owned by the original shareholders (some or all of them – in this case all). The demerger requires a reduction of part of the share capital of the group and cancellation of those shares. The share capital represented by those shares must be returned to the cancelled shareholders. This is fulfilled by transferring the demerged assets to a new company owned by those shareholders. The result is that the demerged assets are now held by a separate new holding company, owned by the original shareholders. The retained assets remain within the original group. The new company won’t qualify for entrepreneur’s relief BUT an election can be made to bank at the time of the demerger – thus making a subsequent sale to a third party no gain no loss.
Normal tax reconstruction reliefs are available although advance clearance should be sought from HMRC. Clearance applications need to be thorough because they may be voided in the event they omit detail, thereby leaving the transaction open to scrutiny. If this transaction is not undertaken precisely, the tax costs could in certain circumstances be high. Detailed analysis of all the tax impact is required to ensure unexpected tax charges do not arise and Entrepreneur’s Relief is maintained.
A capital reduction demerger is not the only method that would be suitable for Clients A, B and D. A more traditional route is to use the provisions of The Insolvency Act 1986, which permits a distribution upon winding up – the winding up is not an insolvent winding up although often clients are concerned about the perception to suppliers and business associates of using this method.
Client C has an entirely different set of concerns which are likely to be governed by the need for and the wants of investors. Given investors do not want the risks of the existing company but do want the IP to be held within a new investment vehicle, it could be that a simple sale agreement would achieve the aim. However, the new company and existing company are likely to be associated and the transaction may need to be at market value. Herein is the first problem, what is the value of the IP? IP is notoriously difficult to value where there is no significant track record of performance, demand or income stream. The impact on being able to claim R&D tax credits would need to be considered. However, if the investors are only concerned with the relief for future expense, selling the IP appears sensible.
An alternative for Client C will be forming a group and transferring the IP between group companies with investors becoming shareholders of a holding company. The suitability will probably depend on the longer-term intention for selling the business and any potential exit charges. For Client C, a understanding of the investors’ desires and the plan to exit is essential to determine the route taken. It is imperative to understand the longer-term plan in particular if a business sale is desired.