A matter of life and death
The Office of Tax Simplifications is very busy these days. Learn about its recent Business Lifecycle Report and why it has concerns about Entrepreneurs’ Relief.
In last month’s Oracle, Liz Hardie explored the consultation issued by the Office of Tax Simplification (OTS) regarding potential simplification of the inheritance tax (IHT) regime
That consultation has now closed and we will need to wait until Autumn when the OTS publishes its Report. It’s fair to say that this exercise has received widespread publicity. Likewise, a recent OTS paper exploring how the taxation of savings income can be simplified will also create headlines (we’ll consider this in our July edition).
In the meantime however, I would like to draw your attention to another OTS Report issued mid-April which has largely fallen under the radar – The OTS Business Lifecycle Report.
Business Lifecycle Report
This considers key events in the lifecycle of a business:
- Start-up and incorporation
- Financing for growth
- Succession (passing on a business)
- Disposal or cessation of a business
The focus is on businesses owned by individuals and families and on events that affect business owners. What’s useful I think, is that it serves as a useful reminder of the tax charges & reliefs that apply to certain business events impacting some of your clients. With that in mind, let’s consider the final two topics - succession and disposal.
Succession (passing on a business)
This relates to transferring a business (i.e. not a sale at market value) typically to family members. These transfers will potentially give rise to capital gains tax (CGT) and IHT implications.
Lifetime transfers - CGT
Where the transferor and the recipient are connected persons or the transfer is a gift, the disposal and acquisition is deemed to be made at market value. The following CGT reliefs are potentially available:
- Relief for gifts of business assets or shares. If a claim is made, the transferor will not pay tax on the gain and the recipient’s allowable CGT cost (the market value at the time of transfer) is reduced by the amount of the gain held-over.
- Relief for gifts of business assets which are immediately chargeable to IHT (e.g. gift into discretionary trust). This has the effect that CGT is not paid at the time of transfer but may be payable in future.
- If gift ‘hold over’ relief is not claimed, relief is potentially available under Entrepreneurs’ Relief (ER), reducing the rate of CGT to 10% on lifetime eligible gains of up to £10m.
Lifetime transfers - IHT
Gifts of a business, or of shares in a company, to an individual will be potentially exempt transfers (PETs). If the transferor dies within seven years of making the gift, the PET is no longer exempt and IHT may then become due depending on the circumstances. However, in those circumstances relief for business property (BPR) or agricultural property (APR) can still be claimed if certain conditions are met.
With regard to trusts, a transfer into a flexible trust is not a PET and will be immediately chargeable, subject to the IHT NRB, although BPR and APR may be claimable if the necessary conditions are satisfied.
Transfers on death - CGT
CGT is relatively simple - assets are deemed to transfer to personal representatives, and in turn to those inheriting them, at their market value at the date of death. The deceased does not therefore make a CGT disposal.
Transfers on death - IHT
The death estate plus any chargeable lifetime transfers made in the seven years before death is taxed at 40% above the NRB. The value of ‘business’ assets will be reduced by BPR or APR as appropriate. Typically at 100% or sometimes at 50%.
BPR is considered here
On the subject of succession, the two most important observations from the OTS are as follows:
- When a business is gifted, CGT relief is potentially available under ER or ‘gift relief’. These reliefs offer the option of paying 10% now, or potentially paying at the full rate at a later point. The two reliefs are mutually exclusive, but determining which is better to claim depends on the future plans of the recipient of the gift, which will often be uncertain.
- These CGT reliefs are available for transfers of shares in trading companies where the non-trading element of the business is not more than 20% of the whole. In contrast, IHT BPR is available where the non-trading element of the business (whether incorporated or not) is less than 50%. This is confusing! Incidentally, in the case of companies with ‘excess’ cash, the potential impact of these surpluses on ER and BPR should be addressed by the accountant. Advisers often encounter such companies when the directors seek the prospect of a better return for those funds (probably in an environment of low volatility). Our detailed corporate investment guide is available here.
Disposal or cessation of a business
The disposal will generally fall into one of the following categories:
- a sale of a business by its owners, or a sale of the shares in a company by its shareholders
- a flotation (rare!)
- the cessation of a business and the disposal of its assets
- the sale or cessation of a business owned by a company followed by the winding up of that company
With regard to 1) above, whether the sale is of business assets in an unincorporated business or shares in a company then CGT consequences arise. A number of reliefs can apply to reduce the tax payable
- ER (if the conditions are met)
- The shares might be qualifying Enterprise Investment Scheme (EIS) or Seed EIS and be exempt from CGT
- The shares might be being sold by an employee under the Enterprise Management Incentive (EMI) share scheme
Regarding 3) above, where the owners of an unincorporated business simply cease to trade then any assets of the business belong to the owner. The disposal of those business assets will give rise to CGT. However, if the disposal is within three years after cessation, the resulting capital gains will qualify for ER, subject to satisfying the other conditions for the relief to apply.
Category 4) often causes confusion.
When disposing of a business owned by a company, which is in turn owned by individuals, a decision must be made whether:
- to sell the shares in the company. This means that the capital gains on the sale of shares can attract ER if other qualifying conditions are satisfied, or
- to sell the business assets, with the owners then accessing the proceeds either by way of dividends or winding up the company
If the decision is taken that the company should sell the assets, any gains on the assets disposed of (whether by sale, or by distribution to the shareholders) are subject to corporation tax within the company, without any tax relief.
A subsequent winding up of the company will involve distributing the company’s cash or remaining assets to the shareholders. This is treated as a disposal of the shares which potentially gives rise to a shareholder capital gain. Such gains will qualify for ER if the qualifying conditions are met.
Accordingly, there is a double charge to tax, one in the company and one on the shareholders. Only the latter can be relieved, by ER.
On the subject of disposal or cessation, two key observations from the OTS are as follows:
- The cost of tax relief for ER is greater than that of any of the other reliefs considered in the report. Its place in the range of reliefs, and its purpose, warrant a closer look.
- The “double taxation” both of the sale proceeds of a business by a company as well as the subsequent capital distributions when the company is wound up is disadvantageous for the seller, compared to the single tax charge on the proceeds of sale of a company itself. In contrast, the purchaser of the business enjoys more favourable tax treatment and reduces their risks by buying assets from a company rather than buying the company. A conflict of interest is therefore created between vendors and purchasers. Aligning the tax treatments would help to reduce such difficulties.
The OTS consider there is a pressing need to undertake a detailed review of the complex patchwork of tax charges and reliefs applying at various points in the business lifecycle. Views from interested parties are welcomed and the next stage is then likely to involve some of these areas being considered in more depth.
We will keep you posted on developments.
ARTICLE by Graeme Robb
Common sense has broken out
The Chancellor presented his first Spring Statement on Tuesday 13 March
ARTICLE by Mark Devlin
A couple of pension titbits
Now that Scottish Rate of income tax (SRIT) has been passed, Mark will look at a particular quirk between the devolved and non-devolved powers to highlight the highest UK rate of tax.
ARTICLE by Helen O' Hagan
Trusts for disabled persons - to elect or not to elect
There are available tax advantages on electing for a trust to be treated as a vulnerable persons trust but is it always the best thing to do for a disabled beneficiary?