UK Tax, Trusts & Estates Conference 2018 Succession strategies for owner managers and dealing with shareholder disputes Autumn 2018 Delegate notes and slides to accompany talk given by Peter Rayney, CTA (Fellow) FCA TEP Peter Rayney Tax Consulting Ltd www.peterrayney.co.uk Follow us on Twitter @peter4tax Peter Rayney August 2018 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 professional advice should always be obtained in relation to each specific case.
TABLE OF CONTENTS SUCCESSION PLANNING CONSIDERATIONS AND STRATEGIES... 2 Main exit routes... 2 When to transfer shares - lifetime v death... 2 Use of family discretionary trusts... 3 BUYING OUT SHAREHOLDERS VIA A PURCHASE OF OWN SHARES ( POS )... 4 Case study POS - Ravi & Daughter Ltd... 4 Summary of main rules for capital POS treatment... 4 Key ER conditions for POS sales... 5 Multiple completion contracts... 5 USING THE NEWCO BUY-OUT ROUTE TO FACILITATE AN EXIT... 6 Using a Newco buy-out structure... 6 Case study - structuring the purchase of Ravi s shares via a Newco buy-out... 6 DEMERGERS FOR CORPORATE DIVORCE SCENARIOS... 7 Use of corporate demergers for shareholders wishing to separate... 7 Case study capital reduction demerger for divorcing couple... 7 STEP UK Tax, Trusts & Estates Conference 2018 Page 1
SUCCESSION PLANNING CONSIDERATIONS AND STRATEGIES Main exit routes 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! Company purchase of own shares (POS) A POS transaction can form an important role in extracting funds as a tax-efficient capital gain on the owner managers retirement. Trade sale - Many owner managers objective is to secure a tax-efficient 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. 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. 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 often the normal route for personal service type companies, where the owner wishes to retire. It may be necessary to wind-up the company if the owner manager simply dies in a situation where the family does not wish to continue the business. A winding-up of the company may also be the ultimate remedy where the shareholders have come to blows and can no longer work together in the business. 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. Page 2 STEP UK Tax, Trusts & Estates Conference 2018
Use of family discretionary trusts In some cases, owner-managers may wish to use an appropriate trust vehicle as an asset-protection measure rather than transfer shares directly to the next generation. The owner-manager (and perhaps their spouse) would normally be a trustee of the trust and hence still able to vote on the shares even though they are no longer part of their estate. Subject to limited exceptions, the main IHT rules applying to all discretionary trusts are summarised below. 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). STEP UK Tax, Trusts & Estates Conference 2018 Page 3
BUYING OUT SHAREHOLDERS VIA A PURCHASE OF OWN SHARES ( POS ) Case study POS - Ravi & Daughter Ltd Ravi currently holds 75% of the issue share capital of Ravi & Daughter Ltd, which has a 100% trading subsidiary, Sunrise Ltd. Ravi & Son Ltd was the vehicle used to buy-out Ravi s business partner in 1998, so that it became the holding company of Sunrise Ltd. Ravi gifted his daughter a 25% shareholding in 2014. He now wishes to hand-over the shares in Ravi & Daughter Ltd to his daughter, whilst taking out a reasonable value for his shares. Ravi has asked his advisers how this can be achieved in a tax efficient way. His advisers have proposed a company purchase of own shares (POS). Ravi has indicated that he would be happy with (say) 3 million for his shares. Although this valuation probably undervalues the company, it considers the affordability of the buy-back from the group s viewpoint. The group has been recently been making trading pre-tax profits of around 800,000. Summary of main rules for capital POS 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 (s1034 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). Page 4 STEP UK Tax, Trusts & Estates Conference 2018
Key ER conditions for POS sales Although the relevant qualifying period for ER is just one year before the disposal, the seller must have owned the relevant shareholding for at least five years to bring themselves into the CGT regime. Thus, the qualifying period of share ownership for a POS would normally be five years, although the strict ER conditions will also need to be satisfied in the year before the POS. In this context, make sure that any resignation as a director occurs on or shortly after the POS, otherwise HMRC are likely to deny ER on the grounds that the director condition had not been fulfilled throughout the one year leading up to the POS! (see case of J K Moore v HMRC [2016] UKFTT 115 (TC)). Multiple completion contracts Given the cash flow constraints, Ravi (see case study above) 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, Ravi 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 (s 28 TCGA 1992). Experience suggests that HMRC are normally prepared to grant tax clearances for multiple completion POS cases. Multiple completion transactions are invariably implemented to ensure that the financing of the POS is Companies Act compliant - there is no tax avoidance involved. STEP UK Tax, Trusts & Estates Conference 2018 Page 5
USING THE NEWCO BUY-OUT ROUTE TO FACILITATE AN EXIT Using a Newco buy-out structure A new company ( Newco ) can also be used to buy out one or more shareholders of the original company. Management buy-outs are typically structured in this way. A Newco buy-out generally involves the formation of a new company (Newco) to acquire the shares (or assets) of the Target company (Target). This enables the buyer(s) to fund the acquisition using low-taxed company trading profits. Case study - structuring the purchase of Ravi s shares via a Newco buy-out In the case of Ravi s buy-out, his daughter would set up Newco, which would then acquire 100% of the shares in Ravi & Daughter Ltd in consideration for: - an issue of shares in Newco to Ravi s daughter (the continuing shareholder), which would be subject to s135 TCGA 1992 share exchange relief; and - cash consideration of 1 million and Newco loan notes of 2 million to Ravi (as the exiting shareholder). Ravi will need to make an s169r, TCGA 1992 (QCB)/s169Q, TCGA 1992 (non- QCB) to obtain ER on the loan note consideration. Tax problems can arise where the founder or exiting shareholder wishes to retain a controlling stake in Newco (i.e. the ongoing business) although this is not the case with Ravi s buy-out as he is selling all his holding in Ravi & Daughter Ltd. Under the Transaction in Securities (TiS) rules in Chapter 1, Part 13, ITA 2007, HMRC have the power to tax the seller s consideration as income at penal distribution rates under s698 ITA 2007 where the seller has a significant equity stake (unless it can be demonstrated that the transaction has not been mainly been entered into to avoid income tax, under the so-called Cleary principle). Page 6 STEP UK Tax, Trusts & Estates Conference 2018
DEMERGERS FOR CORPORATE DIVORCE SCENARIOS Use of corporate demergers for shareholders wishing to separate Many owner-managed or family businesses develop to the stage where different members of the owner-managers/family team become responsible for separate parts of the business. Sometimes, the owner-managers may subsequently have a fundamental disagreement about the direction of the business or simply find that they cannot work together. In such cases, they may decide to partition the company so that each shareholder takes over the relevant part of the business. A split of a company s or group s businesses may also be driven by a number of other reasons, such as divorce situations in a husband and wife-owned company, the need to manage different risk profiles of attaching to various businesses. Case study capital reduction demerger for divorcing couple Wings Properties Ltd ( Wings ) owns a portfolio of commercial investment properties, and is equally owned by Heather and Paul (who have been married for ten years). The company is currently worth some 3.4 million (broadly made up of the properties valued at value 3.7 million less 0.3 million bank debt). Heather and Paul are going through a reasonably amicable divorce. They have agreed that they wish to split Wings property investment business between them. It is proposed that Paul retains ownership of Wings (with the small amount of debt), and Heather will acquire four of Wings properties (worth some 1.7 million) via her new company - Heather Company Ltd ( Heatherco ) - in return for giving up her 50% holding in Wings. Without any proper tax structuring, the above proposals would give rise to distribution income tax charge of around 648,000 ( 1,700,000 market value of properties distributed x 38.1%) in Heather's hands and stamp duty land tax ( SDLT ) of some 82,000 (First 150k x 0%, Next 100k x 2%, Balance 1,600k x 5%) Furthermore, Wings would have to pay corporation tax at 19% on the deemed disposal of the four properties, estimated to be 171,000 ( 900,000 gain after indexation (frozen at Dec 2017) x 19%). Unfortunately, there are no special reliefs for divorcing couples in these situations. Step 1 - Insert new holding company ( Heatherco ) above Wings A direct transfer of property business assets would be very expensive from a tax viewpoint. It is therefore recommended that a suitable capital reduction demerger is implemented. Due to the various tax reliefs that are available, this will keep tax costs to an absolute minimum. It is important that the necessary tax clearances should be obtained before proceeding to ensure that HMRC is satisfied this demerger is being done for genuine reasons. STEP UK Tax, Trusts & Estates Conference 2018 Page 7
As a preparatory step, it is therefore recommended that a new holding company ( Heatherco ) is inserted above Wings. Heather and Paul will therefore both sell their Wings shares to Heatherco for a consideration equal to the current value of Wings (say 3.4 million). The consideration would be entirely satisfied by an issue of new shares in Heatherco to Heather and Paul (in proportion to their shareholdings in Wings). This transaction would therefore fall within the s135, TCGA 1992 share exchange rules and hence Heather and Paul will be treated as not making any capital gains disposal of their Wings shares. Normally share exchange relief under s77 FA 1986 would be available to exempt Heatherco s stamp duty liability on its acquisition of 100% of the shares in Wings. However, since there will be arrangements in place for the ultimate change in control of Heatherco, there is a potential stamp duty cost of some 17,000 (being 3.4 million x 0.5%). The legal and accounting treatment of the share exchange is likely to involve using merger relief so as not to recognise any share premium account on the issue of the new shares in Wings. Step 2 - In-specie distribution of Heather s four properties to Newco Wings makes an in-specie distribution of the four properties allocated to Heather (worth 1.7 million). These will be transferred along with the relevant part of the property rental business. The relevant properties will be distributed at their carrying value of around 1.7 million (for Companies Act 2006 purposes). Wings can treat the part of its revaluation surplus relating to the four properties as realised profits for legal distribution purposes. The directors must ensure that Wings has sufficient distributable reserves to implement a legally compliant distribution of the carrying value. It is possible to create additional reserves if required by certain arrangements involving the residual revaluation reserve. The transfer of the four properties to Heatherco takes place on a no gain/no loss basis for corporate gains purposes under s171 TCGA 1992. Thus, Heatherco will acquire the properties at their base cost-plus indexation (up to December 2017). There would be no SDLT on the in-specie distribution since Heatherco does not provide any consideration (para 1, Sch 7, FA 2003 ). This avoids having to rely on SDLT group relief and the potential clawback charges that arise when the recipient company leaves the group. Step 3 - Reorganisation of Heatherco s issued share capital Heatherco will reclassify its single class of ordinary shares into two separate classes, as follows: H ords - these shares will participate in the profits and assets relating to the part of the property investment business allocated to Heather Page 8 STEP UK Tax, Trusts & Estates Conference 2018
P ords - these shares will participate in the profits and assets (together with the associated debt) relating to the part of the property investment business allocated to Paul. The value allocated to Heather s and Paul s part of the property business must be equal (otherwise this could give rise to value shifting tax charges). Assuming this represents an equal division of the business, the reclassification of the share rights would be a reorganisation within s126 TCGA 1992. Thus, the H Ord shares and the P Ord shares would step into the shoes of Heather s and Paul s existing ordinary shares for CGT purposes. Consequently, this step does not involve any tax liability. Step 4 - Heatherco implements capital reduction demerger of Wings Paul must form a new company Paul s Properties Ltd ( PPL ) - to ensure that the relevant tax reconstruction reliefs would apply. Using the Companies Act 2006 capital reduction procedures, Heatherco will reduce its share capital by distributing its shares in Wings (now just containing Paul s share of the property portfolio) to PPL in consideration of an issue of new PPL shares to Paul. The Paul Ord shares in Heatherco are then cancelled (as they no longer have any remaining economic rights). The distribution of Wings would result in a repayment of the capital subscribed under Step 1. Consequently, there is no income distribution since the value of the inspecie distribution of Wings received by Paul is equal to the new consideration arising at Step 1, given by him for the new Heatherco shares. PPL s acquisition of the Wings shares will give rise to a stamp duty liability of 8,500 (i.e. 1,700,000 x ½%). Paul would not have any CGT liability on the receipt of PPL shares due to the protection of s136, TCGA 1992 shareholder gains reconstruction relief. This means that Paul would be treated as acquiring his PPL shares at his original nominal base cost in Wings. At the corporate level, the capital reduction demerger distributions of the shares in Wings to PPL would not give rise to any taxable capital gain. This is because the s139, TCGA 1992 corporate gains reconstruction relief should apply to treat the disposal by Heatherco as taking place on a no gain/no loss basis. Although Heatherco leaves the capital gains group, there should be no capital gains degrouping charge under s179, TCGA 1992 (since reliance can be placed on HMRC s two company group exemption). The various transactions (including the final demerger of Wings) are reliant on numerous reorganisation tax reliefs. These reliefs are all underpinned by commercial purposes/non-tax avoidance conditions. It is therefore important that STEP UK Tax, Trusts & Estates Conference 2018 Page 9
various advance tax clearance applications are made to transactions take place. Clearances will be required under: HMRC before the S138, TCGA 1992 (to cover the s135, TCGA 1992 share exchange in Step 1 and s136, TCGA 1992 relief in Step 4); s139 (5), TCGA 1992 (to cover the s139, TCGA 1992 relief in Step 4); and s701, ITA 2007 - to confirm that the Transactions in Securities rules cannot be applied by HMRC Page 10 STEP UK Tax, Trusts & Estates Conference 2018
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Succession strategies for owner managers and dealing with shareholder disputes Presented by Peter Rayney FCA CTA (Fellow) TEP Peter Rayney Tax Consulting Ltd 1 Succession strategies for owner managers and dealing with shareholder disputes 1. Succession planning choices 2. Buying out shareholders via a POS 3. Exit via Newco buy-out 4. Corporate divorce via demerger 2 Succession strategies for owner managers and dealing with shareholder disputes 1. Succession planning choices 3 1
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 MBO TRADE SALE HANDING- OVER TO CHILDREN PARTIAL EXIT POS WINDING- UP 4 Succession strategies for owner managers and dealing with shareholder disputes 2. Buying out shareholders via a POS 5 Case study Ravi & Daughter Ltd 75% Ravi Daughter 25% RAVI & DAUGHTER LTD 100% Reserves - 1k Cash - nil SUNRISE LTD Reserves - 5 million Cash - 2 million 6 2
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Case study planning the POS 3 million Ravi Daughter 100% RAVI & DAUGHTER LTD Reserves - 1k Cash - nil Dividend 100% SUNRISE LTD Reserves - 5 million Cash - 2 million 7 POS - main rules for capital gains treatment Unquoted trading company/group Shares owned for five years Benefit of trade UK resident seller Dispose of all shares or substantial reduction Must NOT be connected immediately after the purchase 8 Tranche 1 Buy-back contract POS with multiple completion contract Completions Tranche 2 Tranche 3 Tranche 4 1.5m 0.5m 0.5m 0.5m 2018 2019 2020 2021 Lose beneficial ownership 9 3
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Ravi s expected CGT liability on POS CGT Proceeds 3,000,000 Less: Base cost (negligible) - Capital gain 3,000,000 CGT @ ER rate 10% 300,000 10 Succession strategies for owner managers and dealing with shareholder disputes 3. Exit via Newco buy-out 11 Structuring a Newco buy-out - 1 Ravi Daughter 75% 25% RAVI & DAUGHTER LTD 12 4
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Structuring a Newco buy-out - 2 Daughter NEWCO 100% Forms Newco as acquisition vehicle 13 Structuring a Newco buy-out - 3 Ravi Issue shares in Newco Daughter NEWCO 100% Cash = 1 m Debt/loan note = 2 m 100% RAVI & DAUGHTER LTD 14 The Cleary case Cleary Sisters M. J. GLEESON LTD Cash - 121,000 Sale Cleary Sisters GLEESON DEVELOPMENT CO. LTD Retained profits - 180,000 5
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Succession strategies for owner managers and dealing with shareholder disputes 4. Corporate divorce via demerger 16 Capital reduction demerger case study - 1 Heather Paul 50% 50% WINGS L L Capital reduction demerger case study - 2 If properties transferred without thinking about tax! Dividend tax on MV of properties + SDLT HEATHERCO Heather Paul 50% 50% WINGS CT on gain on disposal of properties L L 6
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Capital reduction demerger case study - 3 Insert new company Heatherco - above Wings Heather Paul 50% 50% HEATHERCO WINGS Capital reduction demerger case study - 3 Heather s properties distributed to Newco Heather Paul In-specie distribution of Heather s properties 50% 50% HEATHERCO WINGS Capital reduction demerger case study - 4 Heatherco carries out a share reorganisation Heather Paul = H Ord shares = P Ord shares HEATHERCO Heather s properties WINGS Paul s properties 7
SUCCESSION STRATEGIES FOR OWNER MANAGERS AND DEALING WITH SHAREHOLDER DISPUTES Slides to accompany Peter Rayney s talk STEP UK Tax, Trusts & Estates Conference 2018 Autumn 2018 Heather Capital reduction demerger case study - 5 Heatherco implements a capital reduction demerger H Ords Paul P Ords Issue of new shares in PPL to Paul HEATHERCO Heather s properties 100% WINGS Paul s properties PPL In-specie distribution of Wings Capital reduction demerger case study - 6 Final shareholding structure Heather Paul H Ords 100% 100% HEATHERCO Heather s properties PPL 100% WINGS Paul s properties Succession strategies for owner managers and dealing with shareholder disputes 1. Succession planning choices 2. Buying out shareholders via a POS 3. Exit via Newco buy-out 4. Corporate divorce via demerger 24 8