Evolving businesses require change as they develop and the extent of change and the actions necessary need to be continually addressed by a company’s directors. It makes commercial sense!
A change in approach will arise from either a vision for the better future for a business, or to resolve problems that are preventing a business from maximising its profit potential. As the environment changes in which a business operates, so there is a need to adapt.
Reasons for change
Reasons for change will include:
- a change in market conditions (for the better or worse);
- the introduction of new products or services;
- technological advances;
- resource requirements, e.g. more or fewer employees, additional premises, more working capital, cash or profit retention;
- de-risking a successful operation from part of a business which is not achieving anticipated profits, e.g. separating investment properties from a trade;
- demerging the interests of shareholders – either to allow shareholders to retain certain business assets to develop for themselves, or to re-categorise shareholdings enabling shareholders’ personal preferences to be met, e.g. capital growth versus income;
- selling or buying a business or company; and
- the introduction of incentive plans for key employees, e.g. share options.
Any change will require the reorganisation of resources and may require a company or group reconstruction.
Changes are to achieve commercial objectives, and the reluctance or inability to create a change in approach can have an adverse impact upon a business, its directors and its shareholders.
HMRC will have an interest where change involves the disposal or movement of business assets or liabilities, or involves a change in shareholdings, the rights of shareholders, or the possible dilution or enhancement of share values, or creates financial rewards for employees.
It is extremely important to consider the tax consequences of any proposed change and to seek tax advice prior to implementing a reorganisation or reconstruction plan. In most instances any potential tax arising can be mitigated or eliminated, by ensuring the change is structured in the appropriate way, while achieving the commercial objectives with the minimum of tax cost.
Transactions requiring tax planning considerations
Transactions requiring tax planning considerations include:
Demerging business activities from a company or group. This normally involves the disposal of assets (shares, goodwill, etc) by one company and could trigger a charge to tax on capital gains. In a worst case position the transaction could fall under the anti-avoidance legislation covering ‘Transactions in Securities’ and trigger a charge to income tax at dividend rates. We would recommend that clearance be sought from HMRC to give certainty on the tax position for all parties.
- For example: A trading company with one or more shareholders may have a mixed business. It may, for instance, own freehold and leasehold properties held as investments. The shareholders may wish to remove the properties to another company or group with a view to protecting the properties from risks associated with the trade.
- The transfer of the properties outside of an HMRC approved reconstruction is likely to crystallise tax on any gain on the disposal where the assets transfer at a profit (market value to be applied). Income tax may also apply. This can be avoided by putting in place a formal reconstruction with HMRC’s prior approval.
A company disposal of shares in a trading company or group. The profit on disposal may be exempt from tax if it meets the tests to qualify under the ‘Substantial shareholding exemption’ rules. Conversely, if the tests are met, any loss on disposal will also fall away.
- For example: A shareholder of a trading company (A) with a significant investment in another trading company (B) may wish to incentivise its management by offering share options in (A). The shareholder does not wish to include the value of the investment in (B) in the option scheme and, subject to meeting HMRC’s qualifying criteria, the shares in (B) can be disposed of to the shareholder or another company owned by him, at full market value, without tax arising on the disposal of (B) – relying upon the ‘Substantial shareholding exemption’ rules.
If there is a disposal or transfer of shares or assets to related or connected parties, e.g. between shareholders, companies or individuals, the ‘Related party transaction’ rules allow HMRC to ensure market value has been applied for tax purposes.
- For example: A shareholder wishes to transfer Company (A)’s trade to a company (B) owned by his son, leaving company (A) with investments to fund the father’s retirement. HMRC will require (A) to value the trade transferred on an arms’ length basis, when computing any tax arising. There may also be a problem for the son as his shares in (B) have been artificially increased in value which could trigger an income tax charge.
- An alternative may be to put in place a formal reconstruction to separate the trade from the investment business and then change the share capital such that possibly the father retains current value and the son the right to future growth.
If shares are to be offered to employees without qualifying under an Employee Enterprise Management Incentive scheme (EMI) – share option arrangements – “Employment related securities” rules will seek to tax any benefit an employee may derive from the acquisition.
- For example: An EMI approved share option is granted to an employee at 10p per share (a value agreed with HMRC). The option is exercised when the shares are worth 110p and will not create a tax charge. The disposal will result in Capital Gains Tax applying to the proceeds in excess of 10p and entrepreneurs’ relief may apply (subject to the other tests) provided the option and / or shares have been held for 12 months.
- Under an unapproved option, the £1.00 per share increase in value between grant and exercise will be taxed as income (potentially 45% and maybe national insurance). Capital Gains Tax will apply on the sale proceeds in excess of 110p and unless the relevant conditions have been met, including holding the shares for twelve months before disposal, entrepreneurs’ relief will not apply.
There are many tax reliefs that cover the movement of assets or shares including the holdover of taxable gains on a transfer of assets by way of a joint election of the transferor and transferee. There is also the ability to roll-over taxable gains where the proceeds are reinvested in eligible assets. The tax consequences of any proposed disposal should always be kept in mind.
Change in the development and management of a business can be challenging but is part of business evolution. If it makes commercial sense, do not fret about the tax consequences - there will usually be a solution. The key to implementing successful change is to research and plan the options and consequences and take tax advice before you implement the change.
Needless to say, reorganisation and restructuring business operations requires commercial resource, tax and legal considerations when designing a plan to maximise the potential rewards.
If you wish to discuss what you have in mind, please let us know.
Date: 13th July, 2016
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