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With the Autumn budget fast approaching on 30 October 2024, many business owners may be considering what changes could be imposed that may impact their business operations and their exit plans.

Chancellor Rachel Reeves has identified a £22bn black hole in the public finances.  Whether or not that assessment proves to be accurate, it has prompted increased speculation that certain tax rises are inevitable.

The Labour manifesto ruled out increases to income tax and VAT, and a tapered increase in corporation tax has already been introduced by the last government.  Therefore the taxes which are potentially under review include capital gains tax (CGT) including business asset disposal relief (BADR), and inheritance tax (IHT).

Ignoring any reliefs, the current rate of CGT for shares is 20%. This rate is approximately the median for developed nations, sitting well below Australia (45%) and Denmark (40%) but still much higher than Belgium, Switzerland and New Zealand (all 0%).  Currently, this rate is low in comparison to the maximum level of tax payable on dividends (39.35%) and the higher rate income tax band (45% excluding NIC).

Whilst an equalisation of CGT and income tax rates may in theory reduce the “£22bn black hole”, it could result in the UK becoming an outlier and it may have a long-term impact on business in the UK.

However, there is likely to be a political dimension to any decisions relating to CGT and IHT.  It is notable that although the previous government requested the Office of Tax Simplification (OTS) to review CGT in 2020, the conclusion of that review which broadly advised greater alignment of CGT and income tax rates was ignored.  On the other hand, in the US the current administration is proposing a CGT rate of 44.6% of part of the fiscal year 2025 budget.   Furthermore, discussions are continuing in the US and other countries in respect of potential wealth taxes.

If CGT rates are increased, it is possible that the new rates will be implemented immediately on 30 October 2024, in order to prevent business owners disposing of their holdings before the 2025/26 tax year.

Even if CGT rates are not increased, it seems that BADR is particularly vulnerable – although this is by no means the first budget where its abolition has been anticipated.  The benefit of BADR has already been substantially diluted so that it currently only applies to the first £1m of lifetime capital gains; initially the amount of gains covered by BADR was unlimited, and for a period it was reduced to £10m.

BADR reduces the effective CGT rate to 10% and was originally intended to encourage entrepreneurship. However, the fact that is name was changed from entrepreneur’s relief to BADR, and the significant dilution of its scope, suggests that the Treasury has recognised that it is excessively generous and/or often abused and/or has no real impact on entrepreneurial behaviour.  In FY22/23 it produced £1.1bn of tax savings for individual sellers, and although this is a small amount when viewed within the overall tax take, it may be viewed as an easy relief to abolish.

Company owners will likely be considering whether they can be proactive to take advantage of current CGT rates and/or BADR. Summarised below are a number of options that may allow business owners to crystallise their gains at the current rates.  Given the imminence of the budget, time is of the essence to implement any transaction, especially if HMRC clearance is required (or advised).  Before any transaction is implemented, tax advice should be sought to ensure that the most tax efficient option is chosen and is compliant with current tax legislation.

Exit Structures

Disposal – Third Party

An obvious way to crystallise a gain prior to the budget would a sale of shares to a third-party buyer. However, there are a few things to consider including:

1. Timescale – an amendment to CGT rates could be implemented immediately on 30 October, rather than at the beginning of the next tax year on 6 April 2025. Therefore both buyer and seller(s) will need to be aligned in respect of timescale and the deal process. The parties will need to take a commercial approach to ensure that a standard deal process can be completed on an accelerated timescale. This will be all the more challenging if consent to the sale is required from a third party (eg the FCA or under the NSI regime). The Paris Smith Corporate Team have experience and capacity to assist with accelerated transactions.  In certain circumstances, if either or both parties to a transaction are unable to complete before 30 October, it may be possible to exchange before that date and have an unconditional completion subsequently, whilst “locking in” the  current CGT rate and BADR (if applicable); although a split exchange and completion structure can trigger additional legal and operational complications.

2. Consideration structure – time constraints may complicate a buyer’s transaction funding arrangements, and/or a buyer may leverage their relatively strong negotiating position to increase the deferred/variable element of the purchase price beyond a level that would be considered normal. Even if such a consideration structure is acceptable to sellers as a quid pro quo for avoiding the impact of potential CGT changes, they will still want to ensure that sufficient proceeds are received by 31 January 2026 (assuming no changes are made to CGT payment terms) to ensure that the upfront CGT charge can be funded.
3. Price, negotiation and context – opportunistic buyers may see this as a chance to acquire targets at a reduced price and/or negotiate a deal structure or legal terms which are more buyer friendly than would apply under normal market practice. Sellers should be alert to this risk, and they should also generally consider the pros and cons of undertaking an exit transaction within an accelerated timescale in circumstances which they would not normally have considered to be optimal.

Many advisers involved in M&A transactions will have experience of deals which occurred in circumstances which were primarily tax driven, in particular in 2008 when taper relief was abolished.  If transactions occur before they would normally be implemented, then the risk of disparity between the pricing expectations of the parties is likely to be increased, and often such a valuation gap is at least partially addressed by way of an earnout mechanism.  Depending on the commercial parameters and seller protections of an earnout, these can often generate significantly less consideration than anticipated by sellers; especially if there is a dramatic downturn in the economy shortly after the transaction is completed, which was the case in 2008 (but hopefully that scenario won’t be repeated!).

Disposal – Friendly MBO

Given the timescale, a sale to a third party may not be feasible, especially if a buyer has not already been identified and it is therefore necessary to go through a marketing process. Company owners may therefore consider whether the company’s existing management team (supplemented by new incoming management, if necessary) is (a) suitable to own the company, (b) keen to take ownership and (c) able to obtain funding to acquire the company.

Provided that the transaction is a “friendly” MBO, the deal process can be accelerated because the need to carry out an extensive due diligence and disclosure exercise should be reduced. However, the deal timeline can be impacted if the management team requires third party funding or if a pre-sale reorganisation is required.

Friendly MBOs are normally characterised by extended deferred payment terms, which depending on the “generosity” of the current owners will sometimes allow flexibility if the target (which is often the main generator of profits to fund the deferred payments) suffers from temporary cashflow problems before the sellers have been paid in full.

On these types of transactions, it is important that there is sufficient clarity in contractual arrangements to ensure that the sellers and the management team are aware of the controls which the sellers may want to retain on the operation of the business and extraction value from the business until they have been paid.

Disposal – Employee Ownership Trust (EOT)

Given market conditions, as noted above an accelerated timescale may result in onerous provisions being imposed by a third party or lead to lengthy negotiations with the company’s management team. Therefore shareholders may consider selling either a majority (control must transfer) or all of the shares to an EOT, which is a statutory trust that allows shareholders to sell shares in the company for full market value and claim 100% CGT relief. In addition to the favourable tax treatment the EOT regime, as the name suggests, passes ownership of the company to its employees, which is likely to assist with retention and motivation of employees.

However, if the sellers require at least some upfront payment (in excess of excess cash/working capital already retained by the Company) it is likely that some external funding may be required, even if most of the consideration is payable on a deferred basis.

Also, the value of the sale shares has to be agreed with HMRC.

In any event, because EOTs are designed to facilitate employee participation in ownership of companies, it is possible that from a political perspective their tax treatment is less likely to be amended in the pending budget.  On the other hand, if the 100% CGT relief on sales to EOTs is retained, and if CGT rates generally are increased, then they may become a more attractive exit option in the future.

Alternative Exit Structures

A satisfactory exit (whether a third-party sale, MBO or EOT) may not be feasible on an accelerated timescale, in which case shareholders may opt for a less transactional process.  Alternative arrangements which may allow shareholders to realise an existing capital gain may include the following.  It may be appropriate to review and amend a company’s existing constitutional arrangements (articles of association and shareholders agreement) in conjunction with an assessment of the implementation of any such arrangements.

Share Buyback 

A company may have excess cash that is not required for working capital or CAPEX purposes and which could be utilised to via a share buyback to release value to its shareholders at current tax rates.  Advice should be taken by reference to the company’s particular circumstances including whether the buyback is from profits or from capital; and whether a reduction of capital could be implemented to create sufficient distributable reserves to implement a share buyback. A tax clearance is wise to ensure that proceeds are treated as capital and not a distribution (HMRC have 28 days to provide this from the date of a full application), so whilst achievable before 30 October, starting the process sooner rather than later is advisable.

It is important that all aspects of share buybacks are implemented and documented correctly in accordance with the company’s constitution and statutory requirements, to avoid them being treated as void or voidable.

There are significant restrictions on company buybacks which involve partial shareholdings, and buybacks on deferred payment terms are not permitted – but see below under “reorganisation” to address the deferred payment terms problem.

Solvent Liquidation

If it is not possible to sell a company, but the shareholders agree that the timing is right to wind up the business and distribute the assets after paying creditors, then it may be appropriate to implement a solvent liquidation and capital distribution.

Reorganisation 

It may be possible to crystallise an existing gain in shares in a private company by implementation of a group restructure.  For example, a company could be transferred to a new Holdco, in return for shareholders receiving a mixture of any of consideration equity shares, cash (if third party funding is available and/or the existing company has excess cash that can be utilised), loan notes and redeemable preference shares.

It is likely that a tax clearance will be required if some of the gain is being rolled over.  Also, the shareholders will need to ensure that their consideration is sufficiently liquid to enable them to pay the tax charge when it is due, unless they have alternative funds.  Advice will also be required to confirm if stamp duty is payable on the share transfer or can be mitigated pursuant to a stamp duty relief.

Even if a restructure involving a new Holdco is not intended to crystallise a current gain, ie it involves a straightforward share swap with rollover relief, it may become useful as part of future exit planning because it could facilitate an exit structured as a sale by the new Holdco of the operating company/group, which under current substantial shareholding exemption (SSE) rules would not trigger a tax charge for Holdco (assuming SSE conditions are satisfied). However, there is a risk that the SSE may be amended at some stage, and in any event tax charges are still likely to be incurred when the sale proceeds are ultimately extracted from the Holdco.

Discretionary Trust 

Subject to tax and succession planning advice, it may be possible and appropriate to transfer shares to a discretionary trust (DT).  As the name would suggest, in a DT the trustees of the trust (who may be chosen by the person setting it up) control the trust’s assets, and have power to decide when and if funds are distributed out of the trust to any potential beneficiary named in the trust deed.

If the shares qualify for a business relief (BR) from IHT, and the transfer is implemented correctly, such a transfer will not trigger an IHT charge.  A CGT charge is likely to arise, but this may be deferred via a holdover relief claim.

During a later sale of the business, the share of the proceeds due to the DT will be outside of the individual shareholder’s estate for IHT.

To qualify for BR, a company must be classed as a “trading company”, ie the majority of its activities involve trading (as opposed to investment).  This is another area the government may seek to tighten up, perhaps by increasing the percentage of activities that must be “trading” in order for the business to qualify for BR, thereby aligning the BR regime more with BADR.  If it is felt that the business currently qualifies for BR, but might not retain that status under a future BR regime, placing the shares into trust now can “bank” the BR whilst it is available.

However, specialist tax and legal advice (including an interactive IHT and CGT analysis) will be necessary to analyse the suitability of such an arrangement and ensure it is implemented correctly.

If a substantial proportion of shares in a private company are held in trust, then that may impact on the availability of seller warranties to a future buyer.  However, various options are available to address that issue at the time of a future exit, including W&I insurance.

Paris Smith Team

If you would like advice on any of the potential transactions referred to above, please contact one of the partners in the Corporate Team at Paris Smith.  We will work with your tax advisers and colleagues in our Tax and Estate Planning Team to provide you with coordinated assistance.

Amanda Brockwell – [email protected]

Jonathon Roy – [email protected]

Michael Moore – [email protected]

Richard Atcherley – [email protected]

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