A look at the ways in which you can structure your company and some of the reasons for, and potential tax benefits of, using group structures.
Owner managed businesses come in a variety of forms ranging from sole traders and partnerships to large multi-national corporations and, as ever, there is no one size fits all approach.
What is a group structure?
A group structure is created when one or more other companies that are owned (directly or indirectly) by a single parent company. All companies in the group are therefore under the ultimate ownership and control of the parent company.
Types of group structures
Group structures can themselves take a variety of forms, from a horizontal group structure, vertical group structure to various forms of hybrid structures (examples of which are illustrated below).
An alternative is to form a separate standalone company or companies that are owned by the same (non-corporate) shareholder or group of (non-corporate) shareholders.
In that case, the companies are associated (sometimes referred to as 'sister companies'), being under the common control of an individual or group of individuals, but they do not form a group.
Another alternative is to organise the business into divisions within a single company.
Why form a group?
So why form a group as opposed to simply creating a division or setting up a separate entity?
There can be a range of potential commercial, regulatory, legal and tax benefits in forming a group but perhaps the most common rationale for doing so is the management or mitigation of risk.
Ringfencing assets and liabilities
A subsidiary company can be used to ringfence assets or liabilities, each company within the group having limited liability.
If, for example, you want to expand into a new product or market, using a subsidiary can ensure that the assets of the existing business are safeguarded and are protected from any liabilities that may arise in relation to the new venture. A divisional structure cannot provide such protection.
As well as ringfencing financial liabilities, the use of a separate group company can also assist diversification and allow the new venture to build its own brand or reputation (albeit with such support as may required from the existing business). A group structure can therefore also help to protect against reputational and commercial risk.
That is not to say that the use of a group structure can always ringfence all commercial risks and liabilities as, from a practical perspective, this may not be possible.
For example, lenders and suppliers may require the parent company to guarantee or underwrite the subsidiary’s liabilities. However, even in those circumstances, the risks and liabilities are nevertheless generally restricted and quantifiable.
Whenever moving assets around a group, as opposed to acquiring new assets where the assets can be acquired directly into the relevant holding company, care is required to ensure that creditors are not being prejudiced.
Whilst assets that tend to appreciate in value, such as property and IP, can generally be transferred to another group company at their book value rather than market value, if they are not transferred at market value and the transferring company runs into financial difficulties the transfer is likely to be reviewed and an application could potentially be made to set it aside by the administrator or liquidator (or other affected party such as creditors).
A sale of the assets (at market value) and leaseback to the trading company may be an alternative option that would help to protect against such insolvency risks.
In summary, forming a group and moving assets such as property and IP out of the trading company into a new holding company (or separate asset holding company in the group) can help to protect or ringfence those assets going forward but requires careful planning and advice.
The use of a separate subsidiary company to carry out different activities or hold certain assets (such as intellectual property) can also help from an administrative or regulatory perspective.
Certain regulatory authorisations can, for example, be extended to cover other group members (and in many cases the process for doing so is either automatic or truncated to reflect that there is common control and the group from an economic perspective effectively forms one consolidated whole).
Another use of group structures is to provide a central holding point for certain functions or assets.
If, for example, the business occupies a number of sites or properties, a group company can be formed to hold all the property assets (and to lease or licence the properties as required to the other relevant group members.
Similarly, if the business involves the exploitation of IP across a range of markets or products, an IP holding company can be used which then grants licences of the IP (restricted as necessary to the relevant product of market) to the group companies. This ensures that if a business wants to divest of any particular product/division and it is organised in a group structure it can do so on a relatively straightforward and cost-efficient basis by disposing of the relevant subsidiary which only holds the IP rights that it needs. The rest of the IP rights are kept within the retained group.
One of the key advantages of a group structure as opposed to operating through the use of sister companies is that, subject to certain conditions being met, groups of companies are afforded a number of tax exemptions and reliefs in relation to transactions between group members.
For example, certain tax losses and reliefs can also be utilised across the group rather than just in the company in which they arise. These reliefs do not generally apply to sister companies.
Transfers of tangible assets between companies within the same group for UK capital gains tax purposes are also deemed to take place on a tax neutral basis (regardless of the price at which they are actually transferred) allowing the easy transfer of assets between group companies.
There are also, subject to certain conditions being met, exemptions from UK corporation tax in relation to profits from a disposal of shares in a subsidiary and reliefs from stamp taxes on the transfer of shares and properties between group members.
Many of the tax reliefs and regulatory benefits require certain economic ownership conditions to be met i.e. the parent to own (directly or indirectly) a specified percentage of the ordinary share capital of the subsidiary.
Subject to the impact upon the relevant group reliefs, there is nothing to prevent individual investors, directors or employees from holding shares in any of the subsidiary companies in the group. In a diversified group, providing employees or directors with shares in their employer company, rather than in the parent company, may be considered more appropriate.
For employees or directors to be able to qualify for Business Asset Disposal Relief (previously known as Entrepreneurs’ Relief) thereby reducing the rate of capital gains tax payable on any lifetime gains of up to £1m arising on the sale of their shareholdings to 10% then (other than any shares acquired pursuant to the exercise of qualifying share options granted pursuant to an Enterprise Management Incentive scheme – which will be explored in a later article in the series) they need to hold 5% of the ordinary share capital of the company (in terms of nominal value, and either income or capital rights).
This may be easier to achieve in relation to shares in a subsidiary than in the parent company when dealing with more than a couple of employees given the dilution in voting rights.
For example, if there are three subsidiaries, it may be more palatable to the existing shareholders of the parent company to allow the key employees in each subsidiary to hold up to 20% in each subsidiary (allowing up to four key employees in each subsidiary to potentially hold 5% of the shares and qualify for Business Asset Disposal Relief) than allow minority shareholders to hold shares and voting rights in the parent company.
Allowing employees (or indeed any other investors) to acquire shares in any of the subsidiary companies within a group structure does, however, require careful consideration and needs to be viewed in the context of whether there is likely to be a sale of the subsidiary or of the group.
A sale of the subsidiary would result in the sale proceeds of such sale flowing into the hand of any minority shareholders and the immediate parent company of the subsidiary not the ultimate shareholders of the group.
Unless, therefore, the shareholders in the ultimate parent company only wish to divest of a particular subsidiary they will generally look to a sale of the group i.e. a sale of the shares in the parent company. This then ensures that the sale proceeds are received directly by the shareholders and are subject to capital gains tax in their hands.
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.Read article
In that case, having other shareholders in the subsidiary companies could potentially complicate matters as the buyer will not be acquiring 100% of the subsidiaries and may therefore also need to negotiate to buy out the minority interests in the subsidiaries. For buyers looking to acquire the entire group this may not be an attractive prospect and, although any issues are surmountable, it could cause delays and is likely to result in an increase in the overall costs of the transaction (for both sides).
It should also be noted that approved employee share option schemes, for example, the Enterprise Management Incentive (EMI) scheme, and the various venture capital schemes (such as EIS) only apply to shares in the ultimate parent company (and not to any shares in a subsidiary).
The issues raised by having minority shareholders are explored further in future articles.
Holding assets outside the group
Another question that arises is whether to hold assets such as properties or IP within or outside the group.
Ultimately this depends upon a variety of commercial and tax considerations and the precise individual circumstances.
Separate income stream
Holding income-producing assets outside the group can provide an income stream for the owner. For example, holding the trading property from which the business operates outside the group in the personal hands of the shareholders or pension funds allows the shareholders to extract an income stream from the business by charging rent (and the company will be able to claim a corporation tax deduction for such rental payments).
Similarly, if any IP is held personally it can be licensed to the group. Any such rental/licence charges should be on an arms-length basis.
No shared ownership
Holding certain assets outside the group also ensures that if the ownership base is subsequently diversified so as to include employees and investors etc they do not acquire any direct interest in the assets concerned which remain within the personal ownership of the relevant shareholder(s).
Impact on sale
The impact of holding assets outside the company/group also needs to be considered in the context of any future sale and the likely requirements of any potential buyer.
If the IP is essential to the business or the nature of the business is such that the premises are integral to the business, so that the buyer will either require the shareholders to also sell them the IP or property or grant a new licence or lease to the company/group prior to the acquisition, the likely costs and tax impact of this will need to be assessed.
For example, the associated sale of a trading property held outside the group cannot qualify for Business Asset Disposal Relief to the extent that a market rent has been charged by the shareholders to the company. The buyer is also unlikely to bear any tax costs associated with the grant of any new lease or licence or otherwise in putting the assets back into the company/group (this having been a personal choice of the shareholder(s)).
Holding assets outside the group, particularly those assets which are necessary for the proper operation of the business, could therefore potentially increase the overall tax (and costs) payable on any sale and this needs to be weighed against the benefits of providing a separate income stream and ringfencing the ownership of such assets (although there are potential ways this can be achieved within the company/group by way of the relevant class rights attaching to the shares).
Holding assets within a pension scheme rather than personally could potentially ameliorate some of the tax costs in that a) any income stream will not be subject to tax within the pension fund and b) any gain on a sale of the assets by the pension fund will also be tax-free.
If assets are held outside the group within a pension fund there are, however, other practical issues and complexities to consider.
The relevant trustees will have separate fiduciary duties and need to act independently. They will, therefore, need to ensure that they are receiving full market value for the rental/licensing of any assets to the group and in relation to any sale of assets held by the pension fund. This may entail separately negotiating the terms of sale of any assets to any buyer (and any warranties and indemnities to be provided to the buyer).
The ability to access the pension funds are also restricted and the relevant annual and lifetime limits will also need to be considered in relation to any initial contributions to the pension fund of the relevant assets.
Another practical issue to be aware of is that if a property asset within a pension scheme is held for the benefit of more than one pension scheme member, difficulties can arise if one member wishes to draw his benefits or take a transfer payment and the scheme has insufficient liquid assets to pay. Sometimes it will be necessary to sell the property. Agreements can be put in place at the time of the property acquisition to address certain issues, for example by conferring pre-emption rights for the benefit of the remaining members.
There are a number of reasons as to why a group may be formed many of which are concerned with the management of risk.
If you have any questions or need advice, contact our tax solicitors.