Date posted: 27th Mar 2025
There comes a time in every business owner’s life when retirement looms and thoughts turn to succession planning.
Planning should ideally start 2-3 years before the date of disposal to preserve Business Asset Disposal Relief (BADR), if applicable, and optimise the timing of tax payments.
The most tax-efficient structure depends on the seller’s goals:
- If the aim is to minimise risk and tax liability up front, a full cash sale (with BADR) is probably the best option.
- If deferment of capital gains tax (CGT) with spread payments is the aim, then loan notes should be considered.
- If it is felt that the company will grow, an earn-out can increase total proceeds but carries more risk.
BADR
To claim BADR, the company must be a trading company (or the holding company of a trading group) and the director-shareholder must own at least 5% of the company’s ordinary shares for at least two years before sale.
Those shares must permit the shareholder to have at least 5% voting rights and :
- entitlement to at least 5% of the profits available for distribution; and
- 5% of the distributable assets on a winding up of the company; and
- 5% of the proceeds in the event of a company sale.
BADR reduces the tax rate to 10% (increasing to 14% for 2025/26 and 18% for 2026/27) on qualifying business disposals, applying to the first £1 million of lifetime gains, and is therefore particularly beneficial for higher and additional rate taxpayers who otherwise would be taxed at 24%. However, should the gain exceed £1 million, any excess is taxed at the usual 24% CGT rate.
Generally, the disposal will be of the whole business, but it is possible to claim BADR on a partial sale. BADR must be claimed on or before the first anniversary of the 31 January following the tax year in which the disposal occurs.
Deferred Cash Consideration
When a company is sold with cash payments, HMRC treats the gain as taxable in the tax year of completion, i.e. instalment payments do not spread the CGT liability. Therefore, the seller may have to pay CGT by 31 January following the end of the tax year of sale, even though not all of the cash has been received. However, sellers can request HMRC to allow tax payments in instalments, in certain circumstances.
Loan notes
Accepting shares or qualifying loan notes, in all or part payment can enable the CGT to be deferred until the notes are redeemed or sold.
The receipt of shares may be considered to be a “share for share exchange” and therefore CGT does not arise on the receipt of the new shares – instead any gain is effectively taxed once those shares are sold. However, you can elect to pay tax on the full value of the shares as if it were cash. This may be a consideration if you won’t qualify for BADR in the future because as you do not meet the conditions above. Therefore, you may be able to benefit from the 10% tax rate on the value of the shares. When you sell the shares in the future, you will only be taxed on the increase in value from the date you acquired them. However, if they fall in value, you will only be able to claim a capital loss to use against future capital gains, rather than offsetting that loss against prior capital gains.
There are two types of loan notes – qualifying corporate bonds (QCBs) and non-qualifying corporate bonds (non-QCBs) – the type will depend on whether they can be converted into another currency. Again, both have different tax consequences.
The receipt of a non-QCB is treated the same as shares.
QCB shares are different as the gain is calculated on the value received but does not “crystallise” until the QCB is disposed of. Sellers will be liable to CGT on the deferred QCB gain at the prevailing tax rate in the tax year of repayment (when the CGT rate may or may not be higher than the current 24%). Note that the QCB is exempt from CGT, so any increase in value of the QCB will not be subject to CGT.
However, an election can be made to trigger CGT at the time of the disposal, allowing BADR to be claimed on the gain made, chargeable in the tax year of the share sale. Where an election is made, sellers must ensure they have sufficient funds from the deal to cover CGT on both cash and loan note considerations by 31 January following the tax year of sale.
Timing wise, there are some anti-forestalling rules introduced in the 2024 Autumn Budget means that the election is only valid when it is made. It will only be possible to submit a 2024/25 tax return, after 6 April 2025, so in the next tax year, when the BADR rate is 14% and not the current 10%. Essentially, if the election is made after 6 April 2025, it will be a point when BADR is 14%. 14% is still better than the 18% rate that will apply after 6 April 2026 but to overcome this and claim 10% (assuming that some of the £1m BADR allowance is still available), a separate election will need to be made prior to 5 April 2025.
However, advice is critical in this area as once the election is made, it cannot be withdrawn, and it will apply to the entire transaction. Therefore, tax may be lower but it is due earlier than it would be. In addition, as stated above, if an asset value dips, there may be no way to claim “relief” due to the lowering of the asset value.
Earn-outs
If part of the sale price depends on future business performance, CGT is initially calculated based on a reasonable estimate of those future earn-out payments. The additional cash to be received as an earn-out is considered an unascertainable amount and treated as a separate asset.
For example, the seller’s company value increases by 10% in the year after sale, and the agreement states that the seller will receive a cash sum equal to 5% of the net profit after tax. This right to receive 5% of the profit has a value, eligible for BADR as consideration for the sale of trading company shares, taxed in the year of sale. However, when the additional cash gain is ultimately received, it will be considered a disposal of a ‘chose in action’ (rather than the shares) and BADR will not be applicable.
As ever, if you have any queries, please do not hesitate to contact us.
