STEP Tax, Trusts & Estates Conference Series Succession planning for owner managed companies

Transcription

1 STEP Tax, Trusts & Estates Conference Series 2015 Succession planning for owner managed companies 16 April - Exeter 24 April - Birmingham 29 April - Leeds 8 May - London Notes and slides to accompany talk given by Peter Rayney, CTA (Fellow) FCA TEP Peter Rayney Tax Consulting Ltd peter@prtaxconsulting.co.uk Web : Twitter : peter4tax

2 Peter Rayney March 2015 This material is copyright and may not be reproduced in whole or part without the express permission of the author or his company. Whilst every care has been taken to ensure the accuracy of the contents, no responsibility for loss occasioned to any person acting or refraining from action as a result of any information in the material can be accepted by the author. The material is intended to be a general guide for the purposes of the lecture and 1

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4 1.1 Succession planning and potential exit routes for owner managers Handing over to the next generation - The key succession planning problem, according to research undertaken by leading business schools, is the founder s reluctance to let go. They often fear their offspring will ruin the business which they grafted so hard to build-up. In many cases, pure ego, the desire for power, and financial security means that stay on longer than they should. Some owner-manager s will hand over management but retain shareholding control (100% or majority). A company purchase of own shares (POS) transaction can also form an important role in extracting funds as a tax-efficient capital gain on the owner managers retirement. MBO - If the business has a strong and committed senior management team, an MBO may be desirable (although the sale value is often lower since it is limited by the manager s borrowing capacity). MBO teams may bid in a competitive auction or be given exclusivity for a short period. They will normally have a detailed knowledge of the business. 3

5 1.1 Succession planning and potential exit routes for owner managers Trade sale - Many owner managers objective is to secure a taxefficient trade sale of their business, perhaps to a competitor or a company that wishes to acquire valuable intellectual property or gain a foothold in the company s marketplace. Sometimes a trade sale may be forced on the owner manager where there is no clear succession path. Partial exit - Typically this would involve the founder/owner manager selling a significant minority stake to a private equity house or industrial partner. Liquidation - This is perhaps the worst outcome for the owner manager and can arise where there is a complete failure to deal with succession planning. It may be necessary to wind-up the company if the owner manager simply wishes to retire or dies in a situation where the family does not wish to continue the business. A winding-up of the company may be the ultimate remedy where the shareholders have come to blows and can no longer work together in 4

6 1.2 Succession planning considerations Some of the most important succession planning issues are highlighted above! 5

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8 1.3 When to transfer shares - lifetime v death? Owner managers may consider transferring at least some of their shares to the next generation now, either by way of an outright gift or through an appropriate trust. Under current legislation, the combination of absolute exemption from IHT and CGT rebasing to probate value at death has provided a persuasive argument for proprietors to hold on to their shares until death. The controlling shareholder may be under some pressure to pass at least some of the shares to the children well before death, to provide a smoother 'succession' path and necessary management motivation. Consequently, the appropriate course of action may be to transfer (at least) part of the shares now. The main current tax consequences of lifetime transfers and transfers on death are summarised in slide 7 above and on slide 11. A straightforward gift or under-value transfer of shares to another family member or close friend etc. represents a disposal of shares at market value for CGT purposes but hold-over relief under s165 TCGA 1992 is often available for trading company shares. 7

9 1.4 Example Hold-over relief on shares in an owner managed company On 8 December 2014, John gave his son 25% of the shares in the family company, Imagine Ltd, which he incorporated in August The value of the shares transferred on 8 December 2014 has been agreed by HMRC - Shares Valuation at 60,000. 8

10 1.5 Trading company and trading group test A company/group therefore qualifies provided it exists wholly for the purpose of carrying on one or more trades (on a commercial basis), subject to the disregard rule for insignificant non-trading activities. A company is permitted to have non-trading activities provided they do not have a substantial effect on the company s overall activities. HMRC take the view that non-trading activities may be regarded as substantial if they represent more than 20% of the company s business. In marginal cases, the 20% test will be applied to various measures, such as turnover, profits, assets employed, management time etc. 9

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12 1.6 Transferring shares on death The transfer on death is effectively treated as the individual s final transfer, which is equal to the value of their chargeable estate immediately before death. The IHT payable must therefore take into account the total chargeable transfers made within the previous seven years (including PETs which crystallise on death). Where the owner-manager continues to hold shares in their trading company, these would normally be excluded from their chargeable estate due to the availability of 100% business property relief (BPR). The prospect of obtaining 100% BPR from IHT combined with a tax-free uplift in base value for CGT purposes will often discourage the ownermanager from transferring their shares before death. 11

13 1.7 IHT BPR and mixed property-related activities Broadly, unquoted shares in a company normally qualify for 100% BPR UNLESS the companies business consists WHOLLY OR MAINLY of property investment or property dealing. This is a less stringent test than the CGT ER one since HMRC regard mainly as being over 50%. Thus, provided more than 50% of the company s business is from qualifying trading activities, the shares should qualify for 100% BPR. 12

14 1.8 The importance of HMRC v Brander mixed trading and investment businesses The Brander case involved a BPR claim for a mixed business of a traditional Scottish landed estate. The estate s activities consisted of agricultural operations (both occupied and let farmland), woodland, forestry management, related sporting interests, and the letting of cottages and other estate properties to estate workers or others. The point at issue was whether the estate business was wholly or mainly the holding of investments, which would lead to a complete denial of the 100% BPR claim. (The case is sometimes referred to as the Balfour case as it involved Lord Balfour!) 13

15 1.9 Key financial data analysed in the Brander case A summary of the key financial data considered by the Upper Tribunal in its assessment of the BPR status of the trade is shown above. 14

16 1.10 Case law summary referred to in Brander The Upper Tribunal helpfully summarised the relevant case law on determining whether a mixed business activity was wholly or mainly involved in the making of or holding of investments. The key points are summarised above. 15

17 1.11 Use of trusts for asset protection In some cases, owner-managers may wish to use an appropriate trust vehicle as an asset-protection measure. The owner-manager (and perhaps their spouse) would normally be trustees of the trust and hence still able to vote on the shares even though they are no longer part of their estate. Under the post-fa 2006 regime, subject to limited exceptions, the main IHT rules applying to all new trusts (which are treated as relevant property trusts ) are summarised above Main IHT trust rules on transferring shares to trust Where shares in a trading owner-managed company are being transferred to a trust, this will be a chargeable transfer for IHT purposes. However, the value transferred will normally be completely exempted from IHT by 100% BPR. Amounts not qualifying for BPR would be chargeable, subject to the availability of the transferor s available nil rate band (currently 325,000), reduced by any chargeable transfers within the previous seven years). Any amount in excess of the nil rate band is taxed at the 20% lifetime rate (with an appropriate increase if the transferor dies within seven years of the transfer). 16

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21 2.1 Summary of main rules for capital treatment The purchasing company must be an unquoted trading company or holding company or a trading group. The purchase must be for the benefit of the purchasing company s trade (or the trade of any of its 75% subsidiaries) (s1033 CTA 2010). SP2/82 outlines the various factors that HMRC uses to determine whether the benefit of trade test has been satisfied. These include the retirement of a controlling shareholder-director who wishes to make way for new management or buying out a disinterested or aggrieved shareholder. To meet the trade benefit text, HMRC expect the outgoing shareholder to sell all their shareholding (although retention of 5% sentimental stake is permitted). If appropriate, the seller must also resign as a director The seller must be UK resident and ordinarily resident in the relevant tax year s.1034 CTA 2010). The seller must have held the shares for at least five years (s.1035 CTA 2010). There are special provisions which look through a prior CGT reorganisation, so that the new holding is deemed to be acquired at the same time as their former shareholding for these purposes (s1035(3) CTA 2010). 20

22 2.1 Summary of main rules for capital treatment (cont d) The seller s holding must be substantially reduced or eliminated (taking account their associates holdings (s1037 CTA 2010)). The seller, together with their associates, must not be connected with the company immediately after the purchase within the meaning of s CTA 2010 (s.1042 CTA 2010). For these purposes, associates includes the seller s spouse, minor children and trusts created by them but excludes their adult children, parents, brothers and sisters. The connection test includes the seller having more than 30% of -the issued ordinary share capital (based on nominal value); -the combined issued share and loan capital ;or -the voting power in the company, Immediately after the POS The POS must not form part of a scheme or arrangement for the avoidance of tax. Advance clearance can be obtained from HMRC under s1044 CTA 2010 that the purchase of own shares satisfies the above conditions. 21

23 2.2 Key ER conditions for share sales Owner managers selling shares would need to satisfy the normal ER conditions within the year before the share sale (as shown above). 22

24 2.3 Multiple completion contracts Given the cash flow constraints, Matthew was advised to use the multiple completion route to buy-back his shares (as blessed by HMRC see ICEAW Technical Release 745). Broadly, this involves the seller contracting to sell their shares back to the company, but with the legal completion of the buy-back subsequently taking place in tranches. Under the multiple completion route, Matthew would have to give up his beneficial interest in the repurchased shares on entering into the contract and therefore the substantial reduction test does not apply. Thus, the seller cannot subsequently take dividends or exercise voting rights over the shares. However, for CGT purposes, the disposal of the entire beneficial interest in the shareholding takes place at the date of the contract [TCGA 1992, s 28]. HMRC have always been prepared to grant clearance for multiple completion POS cases, although sometimes it takes some patience since the clearance staff can ask some strange questions. 23

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28 3.1 Structuring an Newco buy-out A Newco buy-out generally involves the formation of a new company (Newco) to acquire the shares (or assets) of the Target company (Target). Newco acquires 100% of the shares in the Target company with: - the exiting shareholder(s) taking cash and/or debt/loan notes in Newco in consideration for the sale of their shares in Target: - the continuing shareholder(s) being issued shares in Newco in exchange for their shares in Target. 27

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30 3.2 Tax treatment for exiting shareholder In most cases, the exiting shareholder will normally be able to obtain ER on a sale of their shares (for cash and for loan notes (with a s169r or s169q TCGA 1992 election). Tax problems arise where the founder or exiting shareholder wishes to retain a controlling stake in Newco (i.e. the ongoing business). Under the revamped Transaction in Securities (TiS) rules in Chapter 1, Part 13, ITA 2007, HMRC will invariably seek to tax the seller s cash consideration as income as a quasi-distribution under s698 ITA 2007 (unless it can be demonstrated, exceptionally, this was not driven by tax avoidance reasons). Advance clearance under s701 ITA 2007 is always recommended, especially where the fundamental change in ownership exemption is not clearly satisfied). 29

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33 3.3 Section 169R TCGA 1992 elections - QCBs Section 169R deals with ER available on a share sale gain which is being held-over against QCB loan notes. Since 22 June 2010, s169r requires the seller shareholder to make an election to treat their original shares as having been disposed of. Where a QCB s169r election is made, an actual taxable gain arises on the share sale against which the ER 10% rate can be claimed. However, in such cases, the QCB hold-over relief rules in s116(10) no longer apply and therefore the loan note consideration becomes taxable at the time of the share sale (albeit normally at 10%). This is likely to create difficulties in financing the CGT if the tax is due before the loan note is repaid. However, most sellers are likely to prefer paying 10% CGT up-front rather than 28% CGT on encashment. 32