This article, written by Head of Insolvency Partner Richard Gardner, appeared in the Scottish Motor Trade Association (SMTA) magazine ‘Auto Insight’ in May 2022.
As we move from the uncertainty of COVID to an increase in the cost of living and a global economy struggling to cope with the war in Ukraine, some motor dealers may be considering their exit strategy or retirement plans.
In a previous article we explored the valuation of the motor dealers’ business. Here we consider the next stage where you are selling your business and, in particular, how to extract your hard-earned cash in a tax efficient way. Tax is calculated based on either receipt of capital or revenue with both having distinct tax treatments. If you are selling your business or retiring and closing the business you may benefit from capital treatment through Business Asset Disposal Relief (BADR) (previously known as Entrepreneurs’ Relief (ER)).
What is BADR?
The relief was designed to be an incentive for entrepreneurs to start a new business by reducing the amount of capital gains tax payable when the time came to dispose of the business. The capital gains tax rate when you dispose of any ‘qualifying asset’ is 10%. This is a reduction in the rate of capital gains tax rather than a capital gains tax exemption and is a very attractive proposition. There is no limit to the number of times you can claim BADR but the relief is subject to a £1m lifetime limit on gains.
Who can claim it?
The relief is available to individuals disposing of their personal businesses or interests in a partnership, as well as directors and employees selling shares in the limited company they work for.
Three conditions usually apply when it comes to disposing of any shares or securities, for the two years leading up to the date of disposal.
- the company’s main activities need to be a trading company or a holding company of a trading group.
- you need to be employed by the company or hold an office within the company to qualify.
- you must hold 5% of both the shares and voting rights in the company.
If the company stops trading, you must dispose of the shares within three years to be eligible for BADR.
Where the only profit you make in a tax year arises from the disposal of any business asset or your business itself, and qualifies for BADR, only one capital gains tax rate applies. The gain is calculated and the annual capital gains tax allowance, which is £12,300 in 2022/23, is deducted which further lowers your tax bill. Once this allowance has been applied, the capital gains tax bill will be 10% of that final figure.
By way of an example, we were approached by a husband and wife, who each held 50% of the shares in a company which operated a garage. They had sold the shares held in their company. The sale proceeds of the shares were £250,000. All qualifying conditions were met and both husband and wife qualified for BADR.
50% share of proceeds 125,000
Annual CGT exemption (12,300)
Amount taxable 112,700
Tax payable at 10% 11,270
Both husband and wife received £125K and have tax payable of £11,270.
This is a very effective tax relief and is widely used. However, it is essential to ensure that all qualifying conditions are met and to seek advice prior to any thoughts about selling or retiring from the business.
When limited companies are being sold, often the new owner purchases the trade and assets from the company. This leaves the shareholders with a company that is no longer trading and has assets available to distribute. Can the shareholders still gain the tax advantage of having the proceeds received being taxed as capital? The answer is more than likely yes, but will involve putting the company into a Members’ Voluntary Liquidation (MVL).
What is an MVL?
An MVL can only be carried out by a Licensed Insolvency Practitioner and the company needs to be solvent and capable of paying all creditors within 12 months. Although the formalities of an MVL need to be met this is a common process for Insolvency Practitioners.
The Directors are initially responsible for calling a Meeting of Directors to resolve to wind the company up and agree that a Declaration of Solvency (DOS) should be signed in front of a Solicitor. The DOS is a statement disclosing the assets and liabilities of the company and should demonstrate that the company is solvent. A majority of the Directors are required to sign the statement to declare that the company is solvent and that all creditors will be paid within 12 months.
The Directors are then responsible for calling a General Meeting of the Members (shareholders) in which the shareholders resolve to wind the company up and appoint a liquidator. This meeting is generally called on 14 days’ notice, but this can be waived and held at short notice if sufficient shareholders agree. The Insolvency Practitioner will guide the Directors through the process.
Once the Insolvency Practitioner is appointed, they will ingather the company assets, which are typically cash at bank but could also include stock, property, investments etc. They would then settle any remaining creditors. Once the liquidator is satisfied that there are sufficient funds remaining, they will make a distribution to the shareholders. It is this capital distribution that forms the basis for BADR.
In most cases the Liquidator can distribute an asset ‘in specie’, (in its current form) this could be the premises in which the trade operated or a motor vehicle. The assets must be transferred at market value but it may, for example, allow a motor dealer to retain the garage personally and rent to a new dealer who doesn’t have sufficient funds to buy the property at the same time as the trade.
The Liquidator will require to seek tax clearance before the liquidation is brought to a close.
Selling a business or deciding to cease trading is a complex area. Taking professional advice and having a plan is essential to ensure that full advantage is taken of the tax planning opportunities that may exist. We have extensive experience advising business owners in this area. For a free consultation to discuss your situation, please email us at firstname.lastname@example.org.