The tax rules you should be aware of if you’re thinking of selling your business

By Anita Jaynes on 23 October, 2020

Sponsored by Purple Lime

Now may not seem like the best time to think about selling your business, but there are ways to benefit from the value of your company.

The number of businesses sold during the first 3 months of lockdown was at less than half the level it had been for the previous year. While certain industries such as technology and food and drink have escaped unscathed, for many other industries, selling a business is more of a challenge.

There are fewer buyers, those buyers want to pay less and are using earn-out structures to protect themselves, making transactions more difficult to complete. Added to this, changes to tax in the April budget made things even less attractive to sellers.

What has changed in the past 12 months?

Before the April Budget, Entrepreneur’s Relief allowed individuals to gain up to £10m from the sale of private company shares with a 10% rate of tax on the gains.

However, in April the Chancellor abolished this and replaced it with Business Asset Disposal Relief (BADR). This means an individual will pay 10% tax on the first £1m gained, with the rest charged at the capital gains rate, which is 20%.

The cost of supporting businesses through the impact of Covid this financial year could cost around £300bn according to the Office for Budget Responsibility. This is likely to mean higher taxes for all of us, with rates as high as 42% being discussed for Capital Gains Tax.

Someone who sold their business for £10m just 8 months ago would take home over £1m more than someone who sold their company for the same amount today. If Capital Gains Tax was to increase to 42%, the net proceeds would reduce by another £2m.

So what options are there if you want to sell your business? An Employee Ownership Trust (EOT) could be the answer.

What is an Employee Ownership Trust?

EOTs were created in 2014 and work in a similar fashion to businesses such as the John Lewis Partnership. This form of private company ownership consists of an employee benefit trust which holds between 51% and 100% of the company’s shares to ensure the company is run for the benefit of the employees. 

As a company owner, you could sell all or a majority of your shares to the EOT, which solves some of the issues of putting a company on the market, such as:

  • Removing the need to find a buyer, as you already have a buyer in place
  • Following a business evaluation, you’ll get the full market value of your shares 
  • The income received after selling 51% or more of a business to an EOT is exempt from Capital Gains Tax and Inheritance Tax. 

This makes an EOT an even more profitable way of selling your business than the original Entrepreneur’s Relief, as there is no tax to pay – the seller gets it all. Selling to an EOT also tends to have fewer costs than a traditional seller, as an EOT is a ‘friendly’ buyer, so the process incurs fewer costs.

EOTs also have the following advantages for company employees:-

  • They can indirectly buy the company from shareholders without having to use their own funds.
  • They can receive an annual bonus which is exempt from Income Tax and Corporation Tax of up to £3,600 a year. The only condition is that the bonus is given to all employees on the same terms.
  • The business as a whole tends to benefit as employees are more vested in the company and have a personal interest in improving performance. 

Who can sell to an EOT?

If you want to sell your company to an EOT, it must meet a few conditions:

  • The company must be a trading company or the principal company of a trading group.
  • Employee benefits must be allocated to all employees on the same terms, taking into account factors such as length of service, salary and working hours.
  • The trustees of the EOT must have at least a 51% controlling interest in the company to make sure it runs for the benefit of the employees.
  • Shareholders outside the Trust who are also Directors or employees cannot add up to more than 40% of the total number of employees.

How does a company sell to an EOT?

There are three main stages:

  1. An EOT is set up with a corporate as the trustee of the EOT (known as the Trustee Company).
  2. Shareholders sell their shares to the Trustee Company. Shareholders and the Trustee Company need to value the company to determine the figure to be used as the purchase price. Once the shares are sold, they create a debt owed by the Trustee Company to shareholders. This debt is left outstanding.
  3. Trading profits made by the company are used to contribute to the EOT, who will then use it to repay the debt owed to the shareholders. 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.

The wide range of benefits to an EOT may be the most attractive option to anyone looking to sell, or partially sell, their business – it’s a simple and tax-efficient way to get the value of your business when the economy as a whole is looking uncertain.

To find out if an Employee Ownership Trust is the best route for you and your business, or if you’d benefit more from something like selling to trade or a management team, just get in touch by emailing us at hello@purplelime.uk.com or calling us on 01249 691360.

Pictured above: Peter Doe, Client Director, Purple Lime