As a business owner, capital gains tax (CGT) may not have been top of your list of concerns over the past few months. With the pressures of business shutdowns, furloughed staff and disappearing revenue streams, you’ve probably had more pressing concerns to deal with. But getting on top of your CGT liabilities is something that should definitely be a key heading on your long-term recovery plan.
Jon Chambers gives you the lowdown on how it can affect your sale and exit plans, and highlights four things you may not know about Capital Gains Tax.
What is Capital Gains Tax?
Capital gains tax (CGT) is a tax on the profit you make when you sell something – or in HMRC-speak ‘when you dispose of an asset’.
It usually applies to the sale of a property, a business, the assets in your business, or your own high-worth personal assets worth £6,000 or more (apart from your car).
The key thing to remember is that you’re only taxed on the profit you make, not on the full amount of the sale. So, if you bought a property for £200,000 10 years ago, and sold it today for £300,000, you’ll only pay CGT on the £100,000 gain you’ve made over that time.
Why should I be planning for Capital Gains Tax?
With the challenging financial times we’re all facing in 2020, and with the threat of a global recession nipping at our heels, you may be asking ‘why should I be thinking about CGT planning at all? Aren’t there bigger concerns?’
Furthermore, there are noises around potential changes to the rules, which could mean the rates of CGT being aligned with income tax rates.
Yes, things like dealing with cashflow issues, accessing urgent additional business finance or looking at longer-term revenue forecasting are all key concerns as we move from ‘COVID-19 survival mode’ to recovery and longer-term success.
However, managing and minimising your tax exposure is a key way to cut costs, keep money in the business and aid recovery.
Knowing the CGT rules, planning your company structure and putting thought into tax efficiency will all help to minimise a potential CGT bill.
With this in mind, here are four key impacts of CGT for business owners, and how to plan for them.
1. Capital Gains Tax and claiming entrepreneurs’ relief on assets used by the business
Entrepreneurs’ Relief (ER) has now been re-badged by the Chancellor as “Business Asset Disposal Relief – BADR”. Whilst it may take some time to adjust to, we shall keep the well-known abbreviation. ER allows you to reduce the CGT you pay on the disposal of an asset, especially when selling part, or all of your business.
Changes made in the Spring Budget 2020 lessened the appeal of ER, by reducing the lifetime limit from £10m to just £1m.
This means the rules will now generally appeal to smaller business owners but, whereas most will tell you about the 10% tax rate applying to sale of their business, not all are aware of the same tax rate available for the sale of assets owned by them personally and used by their business.
Let’s take an office owned personally by the managing director / shareholder Chandni. The company occupies the office rent-free. Chandni sells her shares to a competitor who likes the location of the business. She agrees to sell the freehold of the office as well, which would give her a gain of £300k. She hasn’t claimed ER before so this is within her lifetime limit and she is eligible to pay 10% tax on the gain on the office, as well as her shares.
2. Entrepreneurs’ Relief when selling your business as a sole trader or partnership
Some unincorporated businesses may want to incorporate prior to selling to a new owner – but the CGT implications of this have changed.
If you’re a sole trader or partnership, and you’re running a business in your own name(s), if someone makes an offer to buy the business but via a limited company structure, it is now possible to claim ER on an immediate sale. Before April 2019 you wouldn’t get ER on that sale. You’d get incorporation relief when you turned your business into a limited company and you would have to hold onto the shares in that company for a minimum of 2 years.
The ownership period has now been extended so it includes the whole length of the life of the business. The two years of company ownership could be included in that time, making it easier for you to qualify for ER and resulting in a reduced CGT bill on disposal of the company.
3. Capital Gains Tax when selling one subsidiary in your group structure
If you have a company with two different types of business or divisions, it can be good practice to set these up as separate companies and make them subsidiaries in a group structure. This not only helps with governance, compliance and greater visibility of each business unit, but also with your tax planning.
For example, you might be a recruitment company with specialist industry divisions. Each division is set up as a limited company, within a wider group umbrella.
If you do this early on in the life of the business, and you then want to sell off your construction recruitment division, for example, you can do this tax-free – as long as the new subsidiary company has been held in the group for at least 12 months.
If you were to instead sell the division as a basket of trade, assets and staff, the company would incur corporation tax on any gains arising on the goodwill on the sale.
4. EMI shares
Although this rule has applied since 2013, it is not widely known by ‘the man on the Clapham omnibus’. Many business owners have the fantastic idea of incentivising key members of their workforce by offering Enterprise Management Incentive (EMI) share options i.e. equity in their business.
Employees who hold a stake in the business tend to give more if they know they will benefit on an eventual sale.
A share option is a right to buy a certain number of shares in a company at a fixed price, in the future. It is not the same as owning a share. Therefore, in the absence of special rules, an employee exercising their option and selling their shares on the same day will technically never qualify for ER. This is due to the shares being held for only a small period of time – nowhere near the two years required.
However, employees holding EMI options start their clock from the time they are first granted the options. This means that, provided they have held their options for at least two years leading to the sale of the company, they can qualify for the 10% rate of tax when they exercise and sell.
As with all tax planning, it’s about knowing the rules, planning around them early and knowing when you will (or won’t) be liable for tax on any disposals of assets.
How we can assist with CGT planning
In my experience of working with owner-managed businesses, 95% have directors/shareholders in their limited company. CGT is likely to have an impact on any large assets you dispose of.
We will help you manage CGT impact and maximise any potential savings. It’s possible to plan for a tax-free sale in the future, if you plan ahead.