Corp Tax - Chapter 18 Flashcards
Sale of shares - seller
Chargeable gain - potential BADR
Management Buy outs
A management buyout (MBO) is where the managers of a company buy the shares or the trade and assets of the company to become shareholder directors.
Advantages of setting up a new company
Clean and no history
Disadv of new company
Losses do not transfer
Hive Down
This is an alternative way for a buyer (a third party or the MBO team) to acquire a clean company (with no history) but through a purchase of shares rather than a purchase of trade and assets. This method would also allow the buyer to acquire just part of the target company.
EOT
An EOT is a trust established for the purpose of holding shares in a company on behalf of the employees.
EOT Tax Incentives
CGT relief for the shareholders on the transfer of their shares into the
EOT. The disposal is treated as taking place at no gain/no loss.
The company can pay bonuses of up to £3,600 to each eligible employee per tax year, free from income tax. Class 1 NICs are still payable on these amounts
EOT Qualifying Conditions
Vendor is an individual or trust
Trading company
The transfer to the EOT must be of at least a controlling interest in the company, being more than 50% of the ordinary shares. Thereafter, the EOT must have power to control more than 50% of the votes and be entitled to more than 50% of the profits available for distribution and more than 50% of the assets on a winding up. Trustee control must be retained on an ongoing basis and failure to maintain continuous control will lead to a clawback of tax reliefs.
All employees apart from 5% holders.
There must be a significant change in the ownership of the company
Disqualifying Events actions
If the conditions are not met in either the tax year of the original disposal or the following tax year, the selling shareholders are treated as having never made a relief claim.
The gain which would have arisen on the disposal to the EOT then reverts to being chargeable. Any claims which could have been made at the time of the disposal (eg BADR) could now be made, assuming the time limit for the claim has not expired.
If a disqualifying event happens after these two tax years, the trustees are treated as selling and immediately reacquiring the shares at market value, thus crystallising a gain in the hands of the trust.
Care must therefore be taken in situations where the disposal to the EOT is of just over 50% of the company’s shares, because any subsequent diluting events (such as raising money by issuing new shares or by the exercise of any share options) will potentially trigger chargeable gains.
Partnerships can also use an EOT by incorporating their business into a Newco (with incorporation relief duly taken under s.162 TCGA 1992) and the new shareholders subsequently selling their shares to the EOT.
Funding the EOT
The transfer of shares by the existing shareholders to the EOT is an arm’s length sale and the EOT must therefore pay for them.
Sale price < open MV of the shares
What makes EOT Attractive for sellers?
- no negotiation of sales price as the sale can take place at full market
value (giving the vendor(s) full value for their shares); - the sale can be organised relatively quickly;
- the vendor(s) can retain some shares and retain a management role going forward, should they so wish; and
- there is no issue with new owners potentially laying-off members of the existing workforce or fundamentally changing the direction or ethos of the company
Problem with retaining shares
You should note that if a vendor shareholder retains some shares, a further sale of shares to the EOT will not benefit from no gain/no loss treatment (although if 5% is retained, BADR will reduce the tax rate to 10%).
How will the EOT buy the shares?
The EOT will buy the shares in one of three ways (or by a combination):
- By borrowing from a bank or other third party with the company providing security.
[A loan from the company itself is not recommended as this would
give rise to a tax charge under the ‘loans to participators’ rules)
- By the company giving money to the trustees to fund the transaction (for which a corporation tax deduction is available).
- By surplus cash in the company funding the initial payment with the balance being paid by instalments (paid out of future company profits).
Will Stamp Duty be paid?
The trust will also have to pay stamp duty on the acquisition (at 0.5% of the agreed consideration). This will also need to be funded.
Benefits of EOTs
The main benefits of using an EOT are as follows:
* There are tax incentives (the CGT-free and ‘hassle-free’ exit for the vendor(s) is particularly attractive).
- The formers owners can retain shares and keep Board positions, enabling them to pass on the culture and values of the business before stepping aside altogether.
- Employee ownership leads to a more highly motivated workforce and helps staff retention. It can also act as a useful recruitment tool.
- There is the possibility of a tax-free bonus up to £3,600 per annum.
