Thinking of selling your business? How would you like to pay no tax?

If you’re a business owner currently looking for a full or partial exit of your business, you could be forgiven for rueing your bad luck.

The number of business sales completed during the first three months of lockdown was less than 50 percent of the previous five quarters.

Significantly, businesses transacting in resilient sectors such as tech, pharma, and food and drink have continued to do so at close to pre-Covid volumes and have held firm on their pre-Covid valuations.

However, if you own a business outside of these ‘safe’ sectors, you face the challenges of finding a buyer in a contracting market, achieving an acceptable price as supply begins to outstrip demand, and, securing a satisfactory deal structure – faced with uncertainty buyers will look to protect themselves by increasing the use of earn-out structures.

And as if this wasn’t bad enough already, changes announced in this April’s budget, have created a significantly more hostile tax environment for sellers.

Things Just Got BADR

If you had sold your business 12 months ago you would have benefited from Entrepreneur’s Relief (‘ER’). Quite simply, this allowed an individual to realise up to £10m from the sale of private company shares and pay tax at a rate of 10 percent on the gains.

In the April 2020 budget, the chancellor announced the abolition of ER and introduced Business Asset Disposal Relief (‘BADR’). BADR allows an individual to pay tax at 10 percent of the first £1m of gains on private company shares. Any gain over the first £1m will be taxed at the capital gains rate, which is currently 20 percent.

The Office for Budget Responsibility estimates that the cost of supporting businesses through Covid in the current financial year (April 2020 – April 2021) could be anywhere from £263 billion to £391 billion.

At some point, this will need to be repaid and experts predict that this will mean higher taxes for all of us. Capital Gains Tax is no exception – rates as high as 42 percent have been discussed.

As the table below illustrates, a business owner who sold their company for £10 million only eight months ago is in a considerably better position than one who sells their company for the same value today.

If CGT rates increase to 42 percent, the net proceeds received by the vendor reduce further to £5.7 million.

If you’re not in a ‘hot’ sector, it feels as though we’re painting a rather bleak picture: lack of active buyers, market pricing below expectation, and a punitive tax regime. Perhaps Employee Ownership Trusts (‘EOTs’) are about to enjoy their time in the sun.

 What is an Employee Ownership Trust?

Similar to the model used by John Lewis Partnerships, EOTs were created in 2014 as a new form of private company ownership. It’s an employee benefit trust which holds between 51 percent and 100 percent of a trading company’s shares for the benefit of the company’s employees.

Rather than going to market to find a buyer for their business, a company’s owner could instead choose to sell all, or a simple majority, of their shares to an EOT. This solution addresses three key issues that sellers might experience in the current market:

• There is a ready purchaser for the company’s shares. No need to search for a buyer.
• Sellers will receive full market value for their shares (although a business valuation will be required).
• Critically, the sale of 51 percent or more of a business to an EOT is exempt from Capital Gains Tax and Inheritance Tax. The impact of this is significant to the net proceeds that a vendor might receive.

Following the previous example:

In addition to the above, the sales process often goes more quickly and with fewer fees, as an EOT is seen as a ‘friendly’ buyer.

But it’s not just the vendor who benefits from an EOT, employees also receive significant advantages:
It allows employees to indirectly buy the company from its shareholders without them having to use their own funds.

Any employees of a business with an EOT can receive an annual bonus of up to £3,600 a year without having to pay Income Tax, as long as every employee gets a bonus on the same terms. These bonuses are also exempt from Corporation Tax.

Employees are often more engaged with the company and more interested in improving the businesses performance, so the company as a whole sees improvements.

What companies qualify to sell to an EOT?

There are a few conditions which need to be met if a company wants to sell shares to an EOT, including:

• The company must be a trading company or the principal company of a trading group
• Any benefits to employees must be allocated on the same terms (although the Trust can take into account factors such as length of service, salary and working hours)
• The trustees of the EOT must have at least a 51 percent controlling interest in the company. This ensures it continues to be run for the benefit of the employees
• The number of shareholders with shares outside of the Trust and who are also Directors or employees cannot add up to more than 40 percent of the total number of employees.

How does a sale to an EOT work?

There are three key steps:

1. An EOT will be set up with a corporate as the trustee of the EOT (the Trustee Company).
2. The shareholders sell their shares to the Trustee Company. Critical to this is the necessity for the shareholders and the Trustee Company to value the company: the Trustee Company will use this value as the basis for determining the purchase price. On the sale of the shares, the purchase price will create a debt owed by the Trustee Company to the shareholders which will be left outstanding.
3. As the company generates trading profits, it will use these profits to make contributions to the EOT. The EOT will use these contributions to repay the outstanding purchase price that it owes to the shareholders.

So if you’re looking to exit, or partially exit, your company in the current, uncertain economic environment, perhaps an EOT might provide the simplest and most tax-efficient route for realising value from your business.

Peter Doe is client director at Corsham-based accountancy firm Purple Lime www.purplelime.uk.com