Changes to Substantial Shareholding Exemption (SSE) rules open new possibilities on company sales
Craig Simpson explores how the changes to the SSE rules can lead to an interesting decision for entrepreneurs selling a trading company.
The market for company sales continues to be active. Bates Weston has dealt with a number of sale transactions in the last year and for many, the focus is generally on the 10% question; securing the valuable Capital Gains Tax Entrepreneurs’ Relief on the disposal proceeds.
Most sales are concluded at shareholder level with the shareholders selling their interest in the company to the purchaser in return for the agreed consideration. The type of consideration received depends on the Capital Gain Tax rate and whether the tax is payable now or in the future and at what rate. Doubtless, a well- advised client will also be considering the maximisation of Entrepreneurs’ Relief depending on the structure of the consideration received, but in this article we focus on whether it is ever appropriate, from a tax perspective, not to sell the shares at shareholder level?
What if a client has a group structure, at a very simple level a holding company with one trading subsidiary? Could it ever be attractive to sell the shares in the subsidiary leaving the proceeds in the holding company?
Lots of considerations but worthy of further exploration.
The majority of transactions Bates Weston has dealt with over the years have been a share sale at shareholder level not at holding company level. This is because most Entrepreneurs will want the cash in their hands to buy the sports car, holiday home or simply to pay off the mortgage. But what if they are a serial entrepreneur? They may have already utilised their Entrepreneurs’ Relief lifetime limit, or the family are already wealthy and don’t need the cash in their hands. Would it be better to leave it in a company environment for investment purposes?
Let’s consider the headline tax position of such a sale at holding company level of the sole trading subsidiary of a holding company. The proposed changes in Finance Bill 2017 No 2 to the Substantial Shareholding Exemption (SSE) rules are helpful in this regard.
SSE provides for a corporation tax exempt disposal by a company if the conditions for the relief are met. At time of writing these changes have not become law as they were left out of the Finance Act No 1 pre-election. The Finance Bill 2017 No 2 should be given Royal Assent very soon after the summer recess. The changes should be back dated to 1 April 2017. It would be a brave tax advisor who advises on draft legislation so let’s assume the changes do become law.
The proposed SSE changes remove the requirements for the investing company (i.e. the holding company) to be a trading company after the disposal of investee company (i.e. trading subsidiary). Previously, in order to qualify for SSE, one would have had to rely on the second subsidiary exemption, possibly one of the most unclear sections in the legislation to comprehend. But broadly in order to qualify for SSE on the disposal of the last remaining trading subsidiary, one would have to liquidate the holding company as soon as practically possible after the sale (assuming all the other conditions for the relief had been met).
Needless to say all other conditions for SSE need to be met to enable a tax free disposal at holding company level. I will not repeat them here as they can be found in Pete Miller’s imaginatively titled article Substantial Shareholder Exemption 3 May 2017.
The client could therefore choose either a disposal of the holding company shares (owning the trading subsidiary) or a disposal of the trading subsidiary shares owned by the holding company. It will be necessary to assess each case on its merits, the plan the client has for the monies and how the plan fits in with the family wealth planning and income requirements.
By way of example, let’s assume a client is selling a trading company (Tradeco) for £10m cash on completion. Tradeco is owned by a holding company (Holdco) that is owned equally by two brothers who are serial entrepreneurs and the base cost of the shares is negligible. It is also assumed Holdco has negligible value in its own right. They have both used £7.5m of their Entrepreneurs’ Relief previously and the balance of £2.5m each is available for use against their £5m gain on this disposal. The purchaser is open to buying either Holdco or Tradeco. It is assumed the conditions for SSE are met.
Shares in Holdco Shares in Tradeco
Proceeds £10m £10m
Tax on sale £1.5m £nil
Net proceeds £8.5m £10m
You don’t have to be a rocket scientist to see the immediate benefit in terms of funds available to invest being £1.5m higher if Holdco sells the shares in Tradeco. But the major downside is that the funds will be trapped in Holdco. In addition the Entrepreneurs’ Relief is lost if the company is not wound up within 3 years of the disposal of Tradeco assuming that Holdco does not commence a new trade.
But there will be clients who find the prospect of the additional £1.5m attractive and the prospect of investing gross proceeds may well be attractive depending on the clients’ wider wealth position or investment plans. The Holdco could become a family investment company where other family members are introduced as shareholders and provide an income for the generations.
The client may also be looking to invest in further trading projects and having an additional £1.5m to play with will be most helpful.
It is possible to model the overall tax position of the two proposals based on some assumptions. Let us assume the following fact pattern:
The proceeds are invested in listed stocks and shares,
- The portfolio provides dividend income of 5% per annum consistently and the dividends are reinvested in the same portfolio.
- The portfolio is left undisturbed to grow over 10 years.For this example we assume no capital growth (or loss).
- No funds are extracted from the company.
Concentrating purely on investment growth performance in this simplistic example investing £8.5m personally or £10m through a company the value of the investments at the end of year 10 would be?
|Personal Ownership of Assets||Year|
|Cash Invested £’s||8,500,000||8,763,033||9,034,205||9,313,768||9,601,983||9,899,116||10,205,444||10,521,252||10,846,832||11,182,487|
|Dividend Income (5%)||425,000||438,152||451,710||465,688||180,099||494,956||510,272||526,063||542,342||559,124|
|Personal Taxation (38.1%)||161,968||166,980||172,147||177,474||182,966||188,628||194,465||200,482||206,686||213,082|
|Value at end of year||8,763,033||9,034,205||9,313,768||9,601,983||9,899,116||10,205,444||10,521,252||10,846,832||11,182,487||11,528,529|
|Cash Invested £’s||10,000,000||10,500,000||11,025,000||11,576,250||12,155,063||12,762,816||13,400,956||14,071,004||14,774,554||15,513,282|
|Dividend Income (5%)||500,000||525,000||551,250||578,813||607,753||638,141||670,048||703,550||738,728||775,664|
|Corporation Tax (0%)||0||0||0||0||0||0||0||0||0||0|
|Value at end of year||10,500,000||11,025,000||11,576,250||12,155,063||12,762,186||13,400,956||14,071,004||14,774,554||15,513,282||16,288,946|
Taking this very simplistic example the sale at holding company level followed investments held for ten years results in c.£4.7m higher value compared to owning personally.
Readers will be shouting “but what about the tax on extraction!?”, and it is true if the company were to be liquidated and CGT of 20% on extraction this would leave the individuals with c.£13m, which is still £1.5m more than selling Tradeco and investing the money personally.
Accepting that this is a very simplistic example, it is thought provoking and challenges the thought process of which entity to sell where the fact pattern allows.
There are other factors to consider in the two proposals. Inheritance Tax planning should not be overlooked. If Tradeco is sold gifting shares in a valuable investment company with large inherent gains later will be problematic. One potential solution to this issue might be to give shares away whilst Holdco still owns Tradeco and has a valuable tax status, being the holding company of a trading group that attracts Business Property Relief (BPR) for IHT. The shareholders could make a gift of shares into trust or directly to family members holding over the gains; or not if they wish to trigger Entrepreneurs’ Relief. Where an individual makes a gift then readers will be familiar with the requirement to survive 7 years for the gift to be effective for IHT purposes. Where the donor dies within 7 years of making a gift if the shares are no longer owned by the transferee the BPR is lost on the original gift. But the BPR on the original gift is not lost if the shares are still owned by the transferee even if the company is now an investment company. This may be attractive for an ageing shareholder.
The above example shows the importance of probing a client to establish what they intend to do with the proceeds from a sale. To focus too heavily on the value of Entrepreneurs’ Relief might not always be the right answer.
But then rarely in tax is there just one straightforward answer.
If you would like to speak to Craig regarding this article, please call him on 01332 365855 or email email@example.com.
As always we must remind you that this article is generic in nature and you should take no action based upon it without consulting your professional advisor.