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In corporate finance transactions, the simplest way to sell a business is to sell the shares for cash on the date of completion. However, this is not always the most tax efficient or the most financially or commercially appropriate method for either the buyer or seller. As a result, there are a number of ways to structure a transaction which does not call for all of the cash to be paid up front. In this brief note we introduce the tax issues which arise where the consideration for the shares is paid in tranches or at a later date.
The type of consideration used to purchase the business will have a significant implication for capital gains tax (“CGT”). The most popular forms of consideration used to purchase a business are:
Of those types of consideration, cash consideration is generally taxable to CGT immediately. In comparison, loan notes and shares are taxable when they are realised, at a later point. Therefore, the type of consideration used will have a significant impact on the point when CGT is payable.
1.1 Interaction with Entrepreneurs Relief (ER)
ER reduces the rate of capital gains tax from 20% to 10%. The rules are detailed but for the immediate purposes an individual must have own 5% of the ordinary share capital ( giving him 5% of the voting rights and economic ownership)for a minimum of two years. Where the consideration for the shares being disposed of is partly in shares in acquiring co or more typically loan notes either QCBs or non – QCBs the issue becomes the availability of ER when the shares or QCB’s are ultimately redeemed ( or the shares sold ).
QCB’s are exempt from CGT and in general l terms where QCBs are taken in exchange for the disposal shares the gain on those shares is deferred into the QCB and does not crystalise until they are redeemed , at this stage the vendor will have lost entitlement to ER. However, the vendor can disapply the normal provisions and treat the original shares as disposed of; the risk here is that if the QCB loose value there is no tax relief for the loss or adjustment to the initial tax computation.
By comparison non QCBs are a security into which the gain on the original shares is rolled over and deferred so that it only crystalise when the non QCB is redeemed. A gain so deferred is reduced or eliminated if the non QCB goes bad. Again, an election can be made to crystalise the gain in the year of exchange. ER may be available on the later redemption of the non QCB if ordinary shares are held which qualify for ER in their own right.
1.2 Stamp Duty
Stamp duty is payable on the value of the consideration, whether paid in cash, or non-cash consideration. If there is no marketable value of the non-cash consideration, stamp duty is payable on the ‘amount due’ under the agreement.
2.1 Capital Gains Tax
Broadly, there are two different groups that dictate a difference in tax treatment in relation to deferred consideration, these are:
2.1.1 Contingent and ascertainable
Where assets are purchased for contingent and ascertainable consideration, whether paid immediately or at a later date, the seller will be accountable for CGT in full on the whole of the taxable consideration. This may occur where a payment is made in instalments. A discount is not provided where consideration payments are deferred. From a cash flow perspective, this may cause a significant problem for the seller.
Where consideration is payable over 18 months, the seller may request that HMRC consider payment of tax in instalments. However, this is limited to a maximum of 8 years.
2.1.2 Contingent and unascertainable
Difficulty arises where consideration in whole or in part is unascertainable. This may occur where, for example, the purchase price includes a percentage of future profits, often referred to as an ‘earn out’.
At the point of completion, where all or part of the consideration is unascertainable, the seller will be deemed to make 2 disposals for CGT purposes.
(a) The first disposal includes the property (Target Co), plus the right to receive the deferred consideration (a chose in action); and,
(b) The second disposal occurs on the realisation of the deferred consideration.
However, this rule will not apply where the unascertainable consideration is only satisfied by a payment of shares or loan notes, the number of shares or loan notes is based on a future unascertainable event and the seller did not elect to disapply section 138A Taxation of Capital Gains Act 1992.
Notably, the substantial shareholding exemption does not apply (for companies) to relieve any gain where there is unascertainable consideration.
2.1.3 Interaction with Entrepreneurs Relief
Many sellers will wish to relieve their gains through entrepreneur’s relief, where possible. Where the consideration is contingent and ascertainable, this will not cause an issue for the seller as they are taxed in the year of sale on the whole sale. However, where the consideration is contingent and unascertainable, this may result in an inability to claim entrepreneur’s relief, because the business is sold over two transactions, one in the year of completion and the remainder at a later date, on satisfaction of the contingency. Therefore, to satisfy the conditions for entrepreneur’s relief, a seller would need to dispose of the shares for the maximum potential payment, on completion of the first transaction.
2.2 Stamp Duty
As a general rule, stamp duty is payable on the consideration at the date of execution. As with CGT, the stamp duty treatment of ascertainable and unascertainable consideration similarly applies.
Where the consideration is ascertainable, stamp duty is paid within 30 days of executing the transfer instrument, unless the consideration is payable in instalments exceeding 20 years. In this case, only the stamp duty relating to the instalments within the first 20 years will be payable to stamp duty.
Where the value of the transaction is ascertainable but dependant on some event post-completion, stamp duty is still payable. Practically, this may cause difficulty and underpayments of stamp duty attract interest. As a result, it is advisable for buyers to make payments on account, up to the maximum potential value of the stamp duty.
Where consideration is wholly unascertainable, any deferred amount is not subject to stamp duty, unless:
Conclusion – transaction tax
The structuring of a transaction can quickly become quite complex. Where any complexity is injected in to the deal then the tax implications can, unfortunately, also become highly complicated
If you have any queries regarding transaction tax, or tax matters more generally, then please get in touch
Transaction tax was last updated on 11 April 2019