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Tax Implications of Changes to Company Ownership

May 11, 2016

Advice for property investors on how to reduce tax from Optimise Accountants

The problem — selling shares and understanding tax can be daunting

There are going to be times when you wish to add a new shareholder, or decide to part company with a shareholder and simply buy/sell the shares. You will notice that I have used the word ‘simply’. Sadly, making such changes to a limited company is anything but simple.

When selling shares, you will need to work out the valuation of a company. This means that the exiting shareholder and buying shareholder need to agree what the new valuation is going to be. After what is often a rather sensitive and difficult conversation, both parties need to ensure that the paperwork has been taken care of appropriately and that the tax implications have been dealt with via HMRC.

A real life client example — parting company (pun fully intended)

Jack and Jill decided that they could no longer work together. They had both invested £1 each for the share capital and invested more money into the company via director loans. The company had been used to manage properties for other investors using the rent to rent scheme.

They had been making a lot of money (profit) but decided that they could not work together and Jack was going to buy Jill out. However, there was a difference of opinion over valuation. Jill believed she had built the company up over the past five years and wanted £150,000 for her shares. Jack believed that he put in most of the time and effort and considered Jill’s input to have been mostly administrative. He suggested that the company should be worth £50,000 and he would give her £25,000. As you can see, there was a huge difference in opinion.

Eventually, after £3,500 in legal costs, they agreed that Jack would buy Jill out for £100,000. This was based on the fixed assets of the company, plus the goodwill of the company. Goodwill is an intangible asset and was based on the next two years’ worth of profit.

Jack also had to pay back Jill’s £65,000 loan and made a bank transfer to Jill for £165,000. The goodwill of £80,000 was an accounting adjustment to the company’s balance sheet and share terminations/allotments were duly made via Companies House.

Jill then had a capital gains tax (CGT) bill to pay on her gain of £99,999 (agreed sales price less the £1 share she invested). However, she was eligible for entrepreneurs’ relief given that she had owned the company.

You’ll qualify for entrepreneurs’ relief if you dispose of any of the following:

  • all or part of your business as a sole trader or business partner — including the business’s assets after it has closed
  • shares or securities in a company where you have at least 5% of shares and voting rights (known as a ‘personal company’)
  • shares you got through an Enterprise Management Incentive (EMI) scheme after 5 April 2013
  • assets you lent to your business or personal company

Capital gains tax and entrepreneurs’ relief

As you can see from the above you can minimise your tax liability via entrepreneurs’ relief when selling your shares. There may be times when this relief is not available to you or you may choose not to claim it.

Connected persons and company transfers/sales

If you dispose of an asset to, or acquire an asset from, a connected person, the price paid should be replaced by the market value of the asset in working out your gain or loss. If you make a loss you can only set that loss against gains made on other disposals to the same connected person. These are known as ‘clogged’ losses. Although they will be included in your total loss figure, you must keep a separate record of each clogged loss carried forward to later years to make sure you deduct it correctly from future gains.

Connected persons are:

  • your husband or wife or civil partner
  • your brothers and sisters, and your spouse’s or civil partner’s brothers and sisters
  • your, and your spouse’s or civil partner’s, parents, grandparents and other ancestors
  • your, and your spouse’s or civil partner’s, children and other direct descendants
  • the spouses or civil partners of any of the relatives mentioned above
  • your business partners and their spouses or civil partners and relatives (except for genuine commercial acquisitions or disposals of partnership assets)
  • any company you control, on your own or with any of the other people mentioned above
  • the trustees of any settlement where you are, or any person connected with you is, a settlor

A company is connected with another company if:

  • the same person has control of both companies
  • each company is controlled by a group of two or more persons and the groups either consist of the same persons or could be regarded as consisting of the same persons if in one or more cases a member of either group were replaced by a person with whom the member is connected

If you sell or give an asset to your husband or wife or civil partner, and you are living together at some time in the tax year, there is no CGT to pay. HMRC considers you are living together unless you are legally separated and that separation is likely to become permanent. It treats your sale proceeds as being of such an amount that you make neither a gain nor a loss. However, your husband or wife or civil partner will use the total of your costs to work out their gain or loss when they dispose of the asset and pay tax on any gain over the total period of ownership (yours and theirs) when they eventually sell the asset. If the assets transferred were exempt employee shareholder shares further special rules apply.

Transfers between connected persons where CGT applies

A CGT liability may arise if you transfer assets between another connected person such as a sibling. You need to understand that HMRC will value any transfers between connected persons as having taken place at market value. This prevents people from artificially valuing a company lower to mitigate CGT.

Example

A company was sold by John (father) to Bill (son) for £100,000, which John had originally purchased for £90,000. The gain of £10,000 means that he does not need to pay any CGT at all.

In reality, HMRC would ask to see evidence that the company was only worth £100,000 and may use the valuation methods such as two years’ profit or asset valuations to determine what the market value of the business would be. It would then base the CGT due on this amount.

However, all is not lost if this is the case…

Business rollover relief/gift relief

You may claim gift relief or business holdover relief if you are transferring a company that is considered to be trading rather than investing.

Let’s look at a quick example. John has been running a letting agent for 20 years and wishes to pass the business over to his son Jim. He started the business from scratch and only invested £1 as the rest was taken as loans and has since been repaid. He knows that HMRC would not accept that the business is now only worth £1, as the annual profits are £100,000 and the company assets are worth £250,000. John decides to get an independent accountant to value the business to ensure that he has evidence to support the valuation.

The company is valued at £150,000 and is then transferred to his son (Jim) for £10,000. The gain is as follows:

  • £150,000 company valuation
  • £10,000 proceeds from Jim
  • £140,000 capital gain

John uses holdover relief, meaning that he will not pay any CGT.

Ten years later Jim decides that running the letting agent is not right for him so sells the company for £200,000. You need to remember that he did not buy the company for £150,000 but paid just £10,000. Therefore, the taxable gain would be as follows:

  • £200,000 sales price
  • -£150,000 less company valuation
  • +£140,000 rollover relief claimed by his dad John
  • £190,000 capital gain

As Jim was running the business and owned more than 5% of the business he claims entrepreneurs’ relief as follows (based on 2016-17 rates)

£190,000 capital gain

£11,100 capital gains exemption

£178,900 taxable gain

£17,890 tax at 10% entrepreneurs’ relief 

Please note that buying and holding shares or properties will be considered to be an investment and the above reliefs will not be allowed.

Practical steps you should now take to sell shares in your company 

It is one thing to understand the theory but it is another to put it into practice. Follow this step-by-step guide to implement this strategy:

  1. Determine the company valuation as outlined above
  2. Determine the share price by dividing the total value (from above) by the number of shares
  3. Make the necessary adjustments to the company with regard to asset valuations and goodwill
  4. Work out the CGT due on the sale of shares
  5. Make the necessary changes to the company structure using the appropriate Companies House forms

Next steps — making changes to company ownership the right way

If you want to understand how to implement this strategy or to discuss other finance/tax questions then please book some time with us using the below calendar.
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If you are looking for a new accountant then please book some time with us using the below calendar. Please note that this booking is to describe our services and will not be used to discuss your personal tax affairs.



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Telephone: 0115 939 4606
Email: simon@optimiseaccountants.co.uk