A key part of the life cycle of any business comes when one or more of the owners or key directors wishes to step away from the business. This might be on planned retirement or for unforeseen reasons such as ill-health. Sometimes, a group of owner managers will be replaced by an ambitious management team as part of a management buy-out (‘MBO’), often assisted by external finance. Possible a senior family patriarch or matriarch may want the business they own to pass to the next generation. It may be that a single departing shareholder will make way for one or more replacements.
Whatever the circumstances, succession can be an occasion for anxiety but can also present opportunity. The appropriate planning will depend upon whether succession is into the hands of management, family, external buyers or a combination of parties. The nature and size of the business will dictate, to some extent the planning that is most suitable.
An example of planning
A couple owned a trading company valued at around £5m. Approaching retirement, they saw no sign of the company being an attractive target for a third-party purchaser. No children or other family were involved in the business. They enjoyed the support of a loyal and highly competent workforce ably managed by an Operations Director. However, neither the director nor any of the 40-strong workforce had shown any real entrepreneurial drive. It seemed unlikely that any would want to incur debt to fund a purchase of the company.
The couple were also concerned that the changes to ‘Business Asset Disposal Relief’ meant that the larger part of any sale proceeds would be taxed at 20% rather than 10%.
The tax planning opportunity
The couple were able to sell the company to a specially created trust for the benefit of employees (an ‘Employee Ownership Trust – ‘EOT’). This HMRC-approved arrangement allowed the couple to sell their shares to the trustees (for an amount ultimately agreed with HMRC as being the market value of the shares) entirely tax-free. The consideration will be paid over a 5-year period using contributions made by the company to the EOT. In other circumstances, arrangements where the sale proceeds come from the profits of the company can trigger income tax charges. In the case of an EOT, HMRC confirm that no such charge can arise.
The couple retained a ‘Golden Share’ conferring upon them control over certain key aspects of the operation on the company.
The couple will receive 5 equal tax-free payments over the next 5 years.*
The shares will be held for the benefit of employees. As the debt is paid down, the shares will produce a significant profit to be held for their benefit. This is effectively a ‘John Lewis’ employee ownership model with all the incentives for staff that that entails.
(*) Based on applicable tax rates and policy in the 2020/21 tax year
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