Corporate Sales – Choices, Choices!

When selling a company or its business, tax can play a big part. The seller’s ideal would probably be an outright sale of the company for cash, which might be possible if the buyer is keen to buy. However, it is not uncommon for various reasons for part of the consideration to be deferred or contingent. 

The first issue is whether to sell the company itself, or the business of the company. The seller will normally wish to sell the company unless it holds assets or other business activities which are not part of the sale. This is because if the company is a trading company, for capital gains tax (CGT) purposes entrepreneurs’ relief (ER) will reduce the CGT payable to only 10% of gains up to £10 million (as a ‘lifetime’ allowance). 

The sale of the business of the company is likely to give rise to chargeable gains or other profits liable to corporation tax (CT). There may be capital allowances balancing charges and if the goodwill has been amortised for CT purposes under CTA 2009, Pt 8, the sale will result in a gain liable to CT, which could be most of the sale proceeds if the goodwill has been fully amortised. If the company is a trading company, it could be wound up after the sale and the distributions received from the liquidator should qualify for ER. However, selling the business rather than the shares in the company will almost always be less tax-efficient. 

The buyer, on the other hand, may insist on buying the business because they will then be able to amortise the goodwill for CT purposes and so ultimately commercial considerations must prevail.

Earn-outs: ascertainable v unascertainable consideration: effect on ER

Where part of the consideration for the sale of an asset is ‘unascertainable’, special rules apply for CGT purposes. Consideration is ‘unascertainable’ if it cannot be determined based upon information available at the date of sale. 

1. The sale price for a company is £500,000, plus a further £200,000 in cash if profits for the next 12 months exceed £300,000. The deferred consideration is contingent but ascertainable and the capital gains computation would be based on a sale price of £700,000 and adjusted later if the contingency was not met and the deferred consideration was not received. 

2. The sale price is £500,000 up front plus 50% of the profits for the next 12 months, payable when the results are determined. The deferred element cannot be calculated at the date of sale and that part of the sale price is therefore unascertainable.

It was decided in Marren v Ingles HL [1980] STC 500 that the right to unascertainable deferred consideration is an intangible asset in itself i.e. a ‘chose in action’. The capital gains computation at 1) in the above example would be based upon £500,000 plus the value, at the date of sale, of the right to receive further consideration. In such a simple scenario the deferred consideration would be known in the relatively short term, but if the earn-out extended over some years then a value would need to be placed on it for calculating the gain on sale of the shares. 

If the value placed on the earn-out is too high then when the deferred consideration is received a loss may arise, though this is not such a problem since 2003 because the tax legislation (in TCGA 1992, s 279A) allows the taxpayer to elect for the loss to be carried back against the gain on sale. 

On the other hand, if the value placed on the right is too low, when the deferred consideration is received a gain will arise, which will not qualify for ER because a chose in action is neither a business nor an asset used in a business. Some care is needed over valuation of the right therefore, and from the point of view of ER it would be better to ‘over-egg’ the pudding than underestimate.

If the sale consideration consists partly of shares in the purchasing company or debentures, this presents further ER complications. On a share for share exchange the provisions of TCGA 1992, s 135 (‘Exchange of securities for those in another company’) would usually apply, with the effect that the shares received would be regarded as having been acquired at the same time as the sale shares and for a proportion of their original cost. The gain on that element of the purchase consideration would therefore be deferred until the shares are disposed of. That may not be a good thing for ER as the seller is not likely to remain as an officer or employee and/or they may not own 5% or more of the equity of the buyer; in either case the buyer would not qualify as the seller’s ‘personal company’ (see TCGA 1992, s 169S(3)), and ER would not be due. 

Similarly, if part of the consideration took the form of loan notes these are likely to be ‘qualifying corporate bonds’ (QCBs) which are exempt from CGT (under TCGA 1992, s 115). Where QCBs form part of the sale consideration for a company the gain on that part of the sale price is in effect deferred until the QCBs are redeemed/repaid. ER is not available on deferred gains which crystallise on QCBs (ER may be available in respect of non-QCBs provided that the company still qualifies as the individual’s personal company (see above), but further explanation is beyond the scope of this article).

Fortunately, the ER rules do provide an alternative to the above scenarios. In either case, it is possible to elect (under TCGA 1992, s 169Q or s 169R) for the gain which has arisen to the date of sale on the part of the consideration represented by shares or loan notes to be taxable up front. This means paying the CGT on the deferred element of the consideration earlier than is necessary, but does secure ER on the whole proceeds. 

Where loan notes are offered by the buyer, unless these can be secured in some way this will address minds to the possibility of them not being repaid or not repaid in full. A problem which then arises is that if an election were made under s 169R (see above) in respect of loan notes which are QCBs, there is no provision to rework the gain if they ‘go bad’ and so CGT would have been paid on monies not received.

In such circumstances, it may be preferable for the deferred element of the purchase price to be left outstanding as a simple debt. In the unfortunate event of the loan notes not being repaid in full, a claim is then possible (under TCGA 1992 s 48), which basically says that where consideration is due after the time of disposal, e.g. where it is being paid in instalments, the gain is initially based on the full sale price. If part of the consideration later proves irrecoverable, a claim may be made to re-compute the gain by reference to the amounts actually received. As the whole gain is taxable up front there can be no loss of ER.

If part of the sale price is to be left outstanding as a simple debt in order for TCGA 1992 s 48 to apply, it is vital that no debt instrument is created because any debenture received in exchange for shares is deemed to be a ‘security’ (under TCGA 1992 s 251(6)). In that case, we are back in the realms of QCBs, which we want to avoid. There is no statutory definition of ‘debenture’ but it is generally accepted that a debenture is a loan instrument evidencing the debt where the borrower is a company. 

Typically, a debenture would contain the terms of the loan, the amount borrowed, repayment terms, interest charges, security given for the loan, and the terms for enforcement if the company defaults. If part of the sale price is to be left outstanding as a simple contract debt, the sale and purchase agreement must reflect this.