OMBS, the Budget and beyond

From a tax perspective a lot of the detail is not announced in the budget itself but buried in the supporting documents that are subsequently released by HM Treasury and HMRC.

As ever, the devil is in the detail, and now the dust has settled on this year’s budget there are some clearer indications as to how it will impact upon OMBs and as to the general direction of travel.

However, rather than try and summarise all the relevant measures (which have been amply covered by updates circulated by various firms of professional advisers) we want to focus on the ramifications of a couple of the measures on succession planning for OMBs.

Capital Gains Tax (CGT)

In recent years speculation has always been rife prior to the budget about potential increases in capital gains tax (including a possible alignment with income tax rates). Whilst no direct increases in CGT rates were announced this year there were some indirect measures that do have the effect of increasing tax on the sale of businesses, namely the reduction of the lifetime limit for Business Asset Disposal Relief (BADR), formerly known as Entrepreneurs’ Relief, from £1m to £500,000. With BADR now resulting in a tax rate of 18% as opposed to 24% this means the maximum relief (per individual/trust) will be reduced from £60K to £30k from 6 April 2027.

The tax system has always been used as a lever to encourage investment, growth and innovation through a range of incentives for both businesses (such as R&D reliefs and enhanced capital allowances) and individuals.  In the latter case there has long been a reduced rate of capital gains tax for the disposal of business assets via taper relief and then Entrepreneurs’ Relief which was first introduced in 2008 and provided for a reduced rate of 10% CGT on qualifying lifetime gains up to £1m. This limit was later increased to £10m between 2011 and 2020 providing a tax saving of up to £1m.

Since 2020, when Entrepreneurs’ Relief was rebadged as BADR, the benefit of BADR has been gradually eroded, particularly with the 10% rate being increased to 14% in 2025 and 18% in 2026. This, coupled with the halving of the lifetime limit announced in this year’s budget, significantly reduces the value of the benefit (and is an effective tax increase by the back door). It also appears to lay the ground for the potential scrapping of the relief altogether in the near future.

For those smaller businesses who are already in the process of, or looking to sell, a sale pre 6 April 2027 (before the lifetime limit) is halved can however still provide a material benefit.

For example, for a company jointly owned by two individuals that is to be sold for a gain of £2m, a sale pre 6 April 2027 will provide a total tax saving of £120K versus a tax saving of £60k post 6 April 2027.

This “saving” would likely cover all (or the substantial majority of) the relevant costs of the sale.

The sale of a company or business often takes longer than anticipated so for those in the process of, or looking to, sell it is important to move quickly and get the process started as soon as possible to try and ensure everything can be completed pre 6 April 2027. For those in regulated sectors, where regulatory consents or approvals may be required, it is important to remember that those approvals or consents must also be in place pre 6 April 2027 (as for tax purposes where the contract is conditional the date of sale is the date the condition is satisfied not the date the deal is signed).

But what about the newly announced Founders’ Relief?

Founders’ Relief

Although stated to be a world-leading tax offer for founders offering a reduced 10% CGT rate for founders on up to £10 million of lifetime gains from 6 April 2027, the reality is that the conditions required to qualify for the relief (as summarised below) mean that, by the governments own predictions, only around 400 businesses and 600 individuals a year are likely to qualify.

The proposed conditions make it clear that the relief is effectively targeted at high growth companies, primarily in the tech sector, and is unlikely to benefit the vast majority of family owned businesses whose tax bill on exit will instead be raised by the BADR changes noted above. 

The current proposals are that in order to qualify for Founders’ Relief:

• the shareholder (founder) will need to be UK resident and have held at least 25% of the ordinary share capital (voting, capital and dividend rights) at the point the relevant trade commences and to hold the shares for at least 5 years before sale; and

the company must:

• be a UK tax trading company, or the holding company of a trading group, without substantial non-trading activities or excluded trading activities (essentially the same rules that apply to EIS investments) and have £10m turnover at time of sale and at least 15 full time employees (not including directors); and

• meet at least 2 of the following 3 criteria

  1. Turnover test: Annual average compound growth in turnover of 25% across three consecutive accounting periods within the ten years before disposal, with turnover of at least £10 million in the accounting period before the first of these three periods.

  2. Headcount test: Annual average compound growth of at least 25% in qualifying full-time equivalent employees across three consecutive accounting periods within the ten years before disposal, with at least 15 full-time employees in the accounting period before the first of these three periods.

  3. Innovation test: the company must (1) have incurred qualifying expenditure of £1.5 million or more on research and development (R&D) for which it met all of the conditions to make an R&D tax relief claim and (2) have claimed R&D tax reliefs for that expenditure for an accounting period or periods ending within the three years before disposal.

For those limited number of shareholders and companies who may qualify (bearing in  mind also that the precise requirements may change — albeit there are more likely to be relaxations than anything else) and who are currently in the process of selling their shares they may wish to look at deferring the sale until post 5 April 2027.

Demergers and share buybacks

Another measure announced in the budget, which has received less coverage, is the proposal to press ahead with reforms to the “taxation of company distributions” and the extraction of value from companies to shareholders.  

Essentially these changes, which are intended to come into effect from 6 April 2028, will impact share buybacks, capital reductions and demergers.  There are a wide range of commercial reasons that underpin such transactions and the current rules which have been in place for some time are, for the most part, well understood. There are already ample measures in place to prevent these rules being used for tax avoidance purposes and it is therefore difficult to understand the rationale for the changes or the perceived issues they are intended to address.

While it was announced by the Chancellor that “the reforms are designed to protect capital treatment for genuine changes in ownership, including families passing down their business, and in some cases make the relief more generous for demergers”, based upon the current proposals (which do remain subject to some further technical consultation) it is not clear if this stated intention will be fully achieved in practice and it is hard to see the changes as anything other than as a revenue raising measure.

There are a range of measures within the proposals but the changes that are likely to have the widest impact on OMBs are those to share buybacks and demergers.

Looking at each in turn:

Share buybacks

The default position is that a buyback of shares for more than their original subscription price is treated as a distribution (i.e. taxed as a dividend).

The buyback of shares in a private limited company can, subject to certain conditions being met, qualify for capital treatment. Broadly speaking in order for a buyback to be subject to capital gains tax the requirements are:

• The company is an unquoted trading company or holding company of a trading group

• The purpose of the buyback must be wholly or mainly to benefit the trade of the company or any of its subsidiaries (or finance an inheritance tax liability) and must not form part of a scheme the main purpose, or one of the main purposes, of which is to avoid tax or to enable the owner of the shares to participate in profits without receiving a dividend (it is usual to seek clearance from HMRC to this effect)  

• The seller must be UK resident and have owned the shares for at least 5 years (3 years if the shares were acquired under a will or an intestacy)

• The seller must be reducing their shareholding (and entitlement to profits) by at least 25%

• The seller must not be connected with the company following the buyback.  

The main proposal is to dispense with the “trade benefit” test and replace it with requirements for the seller (the departing shareholder):

• to hold at least 5% of the shares and have worked for the company for at least 2 years (5 years where they retain family connections with the remaining shareholders or directors) before the buyback; and

• to sell all their shares and any directorships on departure.

There will also be an effective withdrawal of relief if they become a director or shareholder of the company again at any time within 5 years of leaving (although this will not apply where shares are received following departure via inheritance provided that reasonable steps are taken to dispose of the shares as soon as practicable).

Concerns have been raised about both the 5% minimum shareholding and 2 year holding requirement and the government has acknowledged that a person may leave employment for a number of reasons some time before disposing of their shares in the company and therefore intends, subject to further consultation, to relax the requirement that a person must have been an employee for the two years immediately prior to the sale but, although indicating they will engage further on the 5% minimum shareholding requirement, have not committed to any relaxation of this requirement at this point.

They have however also indicated they will look at relaxing the provisions withdrawing the relief to allow former shareholders to support the business as a consultant for a period post the buyback.

So in summary, for those companies who have small (sub 5%) minority shareholders who are no longer involved in the business it may be more beneficial to look to tidy up the share structure now, or at least pre 6 April 2028 when the reforms are intended to come into effect, to take advantage of the current rules.

Demergers

Demergers essentially involve the separation of businesses and/or assets into separate entities. There are wide variety of commercial reasons for demergers from ring-fencing risks and resolving shareholder disputes to facilitating succession planning or exit strategies.

How those business or assets are separated is largely dictated by tax considerations, it being important to ensure the steps required to implement the demerger fall within relevant conditions to ensure the demerger qualifies for tax reliefs and exemptions.

Presently there are two broad types of demergers:

• statutory demergers which, as the name suggests, rely on certain specific statutory reliefs put in place to facilitate demergers; and

• non statutory demergers which rely on a different set of reliefs for company reorganisations and distributions

One of the main disadvantages of the statutory demergers is that the tax reliefs currently do not apply where separating out property or investment assets (as opposed to businesses) and there are anti-avoidance rules that apply whereby certain of the tax reliefs can be clawed back and income tax charges can arise on the shareholders if any of the companies involved in the demerger are sold or wound up within 5 years of the demerger.  The current rules also require the distributing company to have sufficient distributable reserves to distribute out the shares of the relevant trading subsidiary or trade and assets of the relevant business that is to be demerged.

Whilst more complex than statutory demergers, non-statutory demergers (a s110 demerger or capital reduction demerger) are used where the conditions relating to the tax reliefs for statutory demergers may not be met such as if looking to separate out a property or investment business or assets from the trading business, or if there are insufficient distributable reserves to be able to undertake a statutory demerger.

The government is proposing to scrap capital reduction demergers thereby forcing increased reliance on the statutory demerger routes. As such they have recognised the need to re-examine the rules on statutory demergers, as to which the key proposals set out in the consultation are:

• to widen the rules to allow the statutory demerger reliefs to apply to the separation trading activities from property or investments;

• to amend the restrictions re statutory demergers not being used to facilitate an onward sale so that it only applies to onward sales within 5 years of the demerger (with an exception to the 5-year restriction for cases where all trading activities are disposed of); and

• to amend the requirement that there should be no change of control after a demerger (so as to allow for better succession planning) so that there should be no change of control within 5 years of the demerger

It has been flagged that a five-year restriction on sales or changes of control is disproportionate and potentially unworkable and whilst the government has indicated it will allow demergers made in advance of onward sales to qualify in some circumstances, such as the sale of divisions of trading groups to third parties, this is subject to further technical consultation.

The clear indications are that, although the rules on statutory demergers will be widened in some respects, there will remain restrictions where such demergers are in anticipation of or to prepare part of a company or group for sale. How restrictive the new rules will be, and what the relevant conditions are, is not know at this time and the details will emerge over the next 12 months or so.  It is however clear that the new regime will be more restrictive than that which currently applies to capital reduction demergers and although it may remain possible to use a liquidation demerger (not mention has been made of scrapping this non-statutory route), they are generally more costly and time consuming than capital reduction demergers.

Whilst it is important to consider in the round, for those companies or groups who are looking to restructure — whether to move investment assets into a separate entity for estate planning purposes in order to prevent them tainting the potential availably of business property relief for inheritance tax purposes, or to separate different trades or a property or other assets (trading or investment) that a potential buyer may not want or require in anticipation of a future sale — due consideration should be given as to whether to do so prior to 6 April 2028 as it is clear that the changes will be more restrictive than those that currently apply to capital reduction demergers.