Dealing with sale proceeds of a business
A look at the personal estate planning issues which arise following a sale and the tax implications of selling your business.
In our article on preparing your company for sale we looked at the steps business owners could take to maximise the value of their business prior to a sale. In this article we look at the personal estate planning issues which arise following a sale and the tax implications of selling your business.
The tax position
Hopefully the sale has gone though as a share sale attracting entrepreneurs’ relief and so capital gains at 10%.
However the tax consequences of sale do not of course end there.
Assuming that the company which has been sold is a trading business as opposed to an investment business, a key point to acknowledge is that a valuable relief from tax has in fact now been lost. An interest in a trading business owned for two years or more qualifies for Business Property Relief from inheritance tax and this could have been key to an individual’s estate planning, providing reassurance that a significant part of his or her wealth was not going to be subject to inheritance tax on death. Post sale, where the sale proceeds are in the form of cash a potential 40% inheritance tax charge has been created which will be levied on the sale proceeds when the business owner passes away.
Gifts – trusts and family investment companies
This is where the help of an experienced financial planner can be crucial. Knowing how much will be needed personally to achieve his or her lifestyle goals, a former business owner may be able to afford to give away some of the sale proceeds. If this were by an outright transfer to children, say, it would be a potentially exempt transfer which would be exempt from inheritance tax after seven years. Placing significant sums of money into the hands of others, however, carries its own risks. The recipients may not be sufficiently financially mature or matrimonially secure.
A standard approach is therefore to consider putting some of the funds into trust so that an element of control could be retained over the funds given away. However, if the amount involved exceeds £325,000, the surplus would be subject to an immediate inheritance tax charge at 20% which is unattractive to an individual who has already just paid Capital Gains Tax on the sale proceeds of the business.
As an alternative to a trust, a former business owner could set up a Family Investment Company and thereby retain control of assets but give away value, in the form of non-voting shares, to other beneficiaries (see our article on family investment companies).
Making outright gifts, creating a trust or setting up a family investment company all involve a former business owner having to give away assets and then survive seven years to be fully effective for inheritance tax. The risk of not surviving long enough can be insured against but it may also be worth considering making use of reinvestment relief. If within three years of a sale, an individual invests some of the proceeds into shares which qualify for business property relief, then those shares will immediately qualify for relief without the owner having to survive for seven years or to own the shares for the usual two year period. That reinvestment could be into products specifically designed for the purpose or into an AIM listed portfolio. A reinvestment into shares that qualify for EIS relief can attract even more tax benefits (such as income tax and capital gains tax reliefs).
Selling a business is complicated. Often the needs of the business and the steps being taken to prepare it for sale become all consuming. The immediacy of a deal usurps any thoughts of personal planning.
Ideally, personal estate planning would have taken place before a sale was pending. As mentioned in our article preparing your company for sale the input of a financial planner with cash flow forecasting may well have helped determine an acceptable sale price but considering the tax position from an estate planning perspective prior to a sale also presents opportunities that dissipate afterwards.
Trusts established pre-sale
As mentioned above, putting cash into a trust in excess of £325,000 carries with it an unattractive 20% tax charge. Transferring shares into trust (or more than one trust depending on the amount involved) prior to a sale will avoid the charge as 100% business property relief will be available. The end result would be that a significant sum is in trust for beneficiaries once the shares convert to cash on sale with a corresponding reduction in the estate of the former business owner.
By way of an example and referring back to James, the 100% shareholder in Quddich Supplies Trading Limited mentioned in our earlier article death of a shareholder:
Suppose James instead of dying in May 2018 decides to sell the business for £5M. He has a teenage son and wants to provide for him by helping him with university fees and perhaps a significant deposit on a house in the future. He decides that he will need a fund of £1M to do that.
If he puts £1M worth of shares into trust for his son, he will still have an element of control over the shares as he will be one of the trustees, the other potentially being his wife. On an eventual sale, the trustees will then hold £1M of the sale proceeds in trust. James has managed to put £1M into trust without having to pay any inheritance tax up front (but see section below regarding Capital Gains Tax implications).
However, if James allows the sale to go through and only thinks about putting the £1M of the sale proceeds into trust at that stage, then he will have an immediate inheritance tax charge based on 20% of the difference between £1M and £325,000 (i.e. £135,000)
Capital gains tax
Good though it is for inheritance tax planning, a transfer of shares into trust pre-sale will constitute a disposal for capital gains tax purposes. It is possible for a business owner to ’hold over’ the gain so that it is assessed on the trustees later. The trustees, though, would not qualify for Entrepreneurs’ Relief for at least a year and then only if there was a qualifying beneficiary who is given a sufficient interest in the trust and holds at least 5% of the shares in the company for a year. If a sale is imminent, using a trust could end up doubling the Capital Gains Tax payable from 10% to 20%.
A possible solution if a sale is certain could be for a business owner to transfer part of his or her shareholding to a trust without claiming holdover relief so triggering a tax charge. Entrepreneurs’ relief should be available on that transfer and when the sale completes, and the remaining shares disposed of, funds will be available to pay the capital gains tax on the transfer into trust.
Non-tax issues of a Trust owning shares
From a tax perspective, using trusts to hold shares in a business prior to the sale can provide flexibility and achieve a number of key objectives for a business owner. The commercial considerations, however, have to be taken into account. There may be provisions in the Articles or a Shareholder’s Agreement which effectively preclude a transfer of shares into trust (although it may be possible for these provisions to be amended).
Perhaps a bigger issue is that a buyer may prefer to deal with individuals rather than trustees in concluding a deal particularly if warranties and indemnities are being given. Trustees especially professional independent trustees will not often be willing to give warranties or indemnities or if they do so only to the extent of the assets still held in trust and this can complicate a sale. Solutions to the issue can involve the original settlor still giving the warranties and indemnities (provided of course the buyer is satisfied he will have the cash to meet the warranty or indemnity claim) or for warranty and indemnity insurance to be taken out.