TaxTalk – September 2022
If you are intending to move on from your business, the earlier you start planning the better. You may need to restructure and incentivise key employees. But generally getting all your ducks in a row takes longer than you think.
What is your exit strategy? It’s probably something you’ve thought about, but there are different ways to go about it. A sale to a third party, a management buyout, an IPO or a family succession. Whatever your chosen route it’s important that you and your business are exit ready.
What is sale ready due diligence?
It’s crucial to start planning this at least two or three years before you exit. The tax position will vary depending on whether you have a share or asset sale. But, most importantly, you want to get as much as possible for your exit. If you have any skeletons in the closet it’s best to address them now, so potential buyers have no reason to drive the sale price down.
Tax can present nasty surprises. And if there are things you’ve been putting off, now is the time to act. Sale ready due diligence is an excellent way of identifying any such issues, taking steps to address them and presenting a clean package of tax affairs as part of your buyer’s due diligence requirements.
It’s often employment and indirect tax issues that can cause the biggest headaches. But Corporation Tax can also present some risk areas. We cover indirect tax issues in our VAT: Exiting the business article in this edition, so this piece will not focus on that.
PKF has helped a number of businesses and their owners through exits. Here are some of the common areas that have caused problems:
- If you are a business that operates internationally with a presence or sales outside your home jurisdiction, it’s important to maintain good corporate governance to make sure the corporate residency of your companies is in the jurisdiction that you intended. Activity on the ground in other jurisdictions can trigger local permanent establishments of your business. This may make you non-compliant and produce additional tax burdens that you haven’t accounted for.
- If you are making any claims for incentive reliefs, such as research & development claims, take care to provide robust supporting documentation to substantiate any relief you are seeking…
- Participation in any form of aggressive tax scheme will attract a great deal of interrogation and will often lead to retentions from sale proceeds and require buyer to disclose to HMRC.
- If your business is one that needs to use subcontractors or consultants, lack of compliance with IR35 could cause a transaction to abort should they form a material part of your business. Even if this doesn’t apply to you, you must be able to show you have adequate and robust procedures to manage this risk.
- If you are using equity incentivisation plans, you should set these up with appropriate tax advice for both the entity and the employees being incentivised. Not taking sufficient advice, both on set up and during operation of the plan and maintaining adequate documentation could lead to unforeseen liabilities throughout the lifecycle of the plan and on exit.
These examples have all arisen during transactions when we have helped clients, whether as buyers or sellers. A sale can be stressful enough, so a sale ready due diligence can help you identify such risks and resolve any issues in good time.
Structure of the exit
Have you thought about which parts of the business will be sold? This question may be more difficult to answer if you have multiple streams to your business. Are you selling a business or shares, or will you sell specific assets? The end tax position will vary depending on these factors.
Most business owners hope to qualify for business asset disposal relief (BADR) on the disposal of qualifying shares or business interests. It can attract a favourable rate of 10% Capital Gains Tax, up to a lifetime limit of £1m of gains. BADR now imposes a 24-month ownership condition. To ensure this condition is met, it’s best to seek advice at least two years before the exit.
If your business is made up of multiple streams you may need to demerge or hive out part of the business in order to achieve the desired pre-sale structure. Restructuring your business in this way will need detailed tax advice and possible HMRC clearances as a restructure could trigger immediate tax liabilities or others which arise when you exit.
Consideration can take multiple forms, from cash or shares to loan notes. It could be paid upfront or you could structure an earn-out and deferred consideration. The timing and type of consideration will both affect the tax position. A clearance may also be required if it’s not obvious that an earn-out will attract payroll taxes rather than capital gains treatment.
How to incentivise employees
If you have not already done so, you may need to incentivise key employees to help you drive the business forward. It’s usually more tax efficient to do this when the value of the company is lower so that any tax liabilities that arise are kept to a minimum.
To keep things simple, you may look to provide cash bonuses to staff. But these are inefficient from a tax perspective, attracting both Income Tax and National Insurance. Options schemes such as enterprise management incentives (EMIs) provide a tax efficient mechanism to get equity to key employees. Where the conditions for EMI are not met, alternatives such as growth shares may provide a viable alternative.
Please contact Catherine Heyes, if you have any queries in relation to this article.
