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Business Services  •  Business Tax  •  Entrepreneur's Relief  •  exit strategy  •  Personal tax  •  Tax Planning

Plan ahead for retirement in order to qualify for entrepreneurs’ relief

By RJP LLP on 26 September, 2013

As employment prospects for young graduates remain competitive, the potential to work in and eventually take over a successful family business is a very attractive proposition. In many instances, an existing family-owned company is able to benefit from new skills offered by the younger generation of family members, and their ability to potentially support diversification into profitable new areas. This article discusses how the principal shareholders of a family owned limited company are able to support their daughter’s new venture and plan for a comfortable retirement by utilising funds built up within their own company and their entitlement to entrepreneurs’ relief.

Any business exit needs to be carefully planned to ensure the transaction is as tax efficient as possible. In the case of a disposal between family members, whilst it may not be a ‘sale’ in the conventional sense, there is the potential for older family members to receive market rate consideration for their shares by extracting funds built up within the company. A retirement of this kind also provides the opportunity to benefit from entrepreneurs’ relief.

Entrepreneurs’ relief is a generous tax relief designed to encourage and reward entrepreneurship in the UK. It currently enables qualifying shareholders to pay just 10% tax on any capital gains realised on the disposal of company shares up to a lifetime maximum limit of £10,000,000. Thereafter, gains are taxed at the full rate of capital gains tax which is currently 28% (or 18% if the gains plus all of your other income fall within your basic rate band).

The example below outlines a not uncommon scenario facing business clients. It highlights how shareholders are able to pass their company to younger family members whilst benefitting from funds built up within the company and qualifying from entrepreneurs’ relief.

Example:

Mr and Mrs Smith are the sole shareholders of their trading company, which offers traditional printing services to local businesses. The business – Smith and Co Ltd -was incorporated as a limited company in 2000 and has been profitable for the past ten years. Their daughter recently qualified as a graphic designer and has used her skills to launch a separate design and printing company, which operates as a complementary sister business to Smith and Co Ltd.

This new company is trading very profitably by offering additional services to existing customers who are seeking more than traditional printing services. Long term growth prospects for the second business, Smith & Sister Ltd are much greater than those of the original Smith and Co, although it continues to be profitable. Mr and Mrs Smith are hoping to retire and want to find a way of transferring their shares to their daughter whilst receiving value for those shares. Unfortunately however, their daughter has no funds to pay market value for the shares.

The type of question we are commonly asked by clients is whether is it feasible in a situation such as Mr and Mrs Smith’s for them to exit their company and receive value from it, whilst transferring ownership onto their daughter and utilising their entitlement to entrepreneurs’ relief?

The short answer is yes - there are a number of ways in which the transfer can be effected whilst enabling Mr & Mrs Smith to be paid for the value of their shares using company funds. This will ensure they qualify for entrepreneurs’ relief and it can also be planned to ensure the resulting group is structured most tax efficiently for Miss Smith.

In order to qualify for entrepreneurs’ relief, Mr and Mrs Smith must each own at least 5% of the shares and voting rights in their company, and they must have held their shares for a minimum period of 12 months. The transaction also needs to be completed at market value since the disposal is between connected parties.

The relevant clearances should be obtained in advance from HMRC to approve the purchase as a commercial, capital transaction, and a company secretary will be able to ensure the correct paperwork is put in place.

There are other factors to consider when planning a company disposal of this nature and one additional element is whether the purchase price can be paid in one lump sum or whether there will need to be an element of deferred consideration. The inclusion of a staged payment agreement in a share sale also has tax implications for the tax payable and the entrepreneurs’ relief available and expert tax advice should be sought in this case.

The key point in planning of this nature is the importance of taking tax advice early on in the process. It can make the difference between extracting value and not, and also in qualifying for entrepreneurs’ relief and paying 10% tax on the transaction or paying tax at a much higher rate.

For more information on exit strategy and tax planning please contact Lesley Stalker by emailing las@rjp.co.uk.

 

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