Peter Rayney considers key tax issues to look out for on the sale of a distressed business.
----------------------
This is a sample article from our business tax saving newsletter - Try Business Tax Insider today.
---------------------
Against a fragile economic background, a large number of owner-managed companies are still facing financial difficulties and will need to be aware of the early warning signs of insolvency.
In some cases, the directors may have given the business some ‘breathing space’ from creditors by putting the company into administration. However, for some owners, the only realistic option to ensure survival is to find a buyer for the business.
‘Distressed’ sellers invariably find they are in a relatively weak position when negotiating the sale structure of their business. Unless there are special issues (the need to preserve the continuity of important contracts, licences, and so on), this often means that the buyer will succeed in buying the trade and assets out of the owner-manager’s company, as opposed to purchasing the share capital of the company.
A trade and asset purchase are generally less risky and may be more tax-efficient for the buyer, although it does prevent the potential future benefit of any unrelieved tax losses.
Sale of trade and assets
The sale of a company’s trade and assets is likely to trigger a number of tax costs within the owner-manager’s company. Following a trade and asset purchase, the business owner will have to ‘tidy-up’ and will often then liquidate their company. It is assumed that the distressed company would be solvent, and therefore its shareholders would be implementing a members’ voluntary winding-up.
In the case of a ‘distress sale’, there are unlikely to be any material corporation tax charges relating to the sale of the goodwill since it will normally have little value. Furthermore, the company is likely to be generating significant tax losses that would be available to shelter any other profits and gains.
A major downside is that the ‘selling’ company still retains any contingent commercial, legal and tax risks relating to its previous dealings and transactions. The shareholders will therefore wish to liquidate the company to minimise the risk of being subject to future financial exposure in relation to any contingent liabilities (although in certain cases, creditors can still bring claims against the company).
Tax consequences: Sale of trade and assets
The overall price paid for the assets that make up the business would be determined commercially. Because a bundle of assets is being acquired, this may give rise to an opportunity for tax savings by an appropriate allocation of the global purchase price amongst the individual assets.
The tax objectives of the seller and buyer may conflict and, in practice, a compromise allocation is usually negotiated. The breakdown of the sale price amongst the various assets should be included in the sale and purchase agreement. This will carry considerable weight, although it does not necessarily bind HMRC.
The main tax consequences of a sale of assets are summarised as follows:
(a) Company’s corporation tax accounting period
The sale of the company’s trade and assets will normally trigger the end of a corporation tax accounting period (CTAP) (CTA 2010, s 10(1)(d)(e)). This is likely to accelerate the payment of the company’s tax liabilities.
(b) Unrelieved trading losses
Since the company is ceasing to trade, it may be possible to secure valuable tax repayments or tax deductions under the terminal loss offset rules. Under these provisions, trading losses generated in the final 12 months of trading can be carried back against the total taxable profits of the three immediately preceding years. The loss offset is made on a ‘last in, first out’ basis, so that the offset is first made against the first CTAP before the loss making period and so on.
Unused (post-31 March 2017) trade losses can be carried forward for offset against future total taxable profits subject to certain restrictions – provided the company has specified the ‘deductions allowance’ in its return (CTA 2010, s 279ZZ).
The ‘general’ offset against total taxable profits can only be made if the company is carrying on the trade in that CTAP (CTA 2010, s 45A). However, if the trade has become small or negligible, the loss can only be offset against future trading profits (CTA 2010, s 45B). The combined effect of these rules means that unless there is potential for terminal loss relief, any unrelieved trading tax losses would effectively be forfeited on the cessation of the trade.
(c) Sale of trading stock
The closing trading stock will be brought into the company’s corporation tax computation at the actual transfer price (provided that it is sold at arm’s length).
Consequently, a degree of flexibility is available in agreeing the disposal value of trading stock.
(d) Capital allowances on plant
The sale of the trade will trigger a balancing adjustment on plant and machinery for capital allowance purposes.
If the sale proceeds exceed the tax written-down value (TWDV) of the plant, etc, a taxable balancing charge arises. Conversely, if the TWDV exceeds the sale proceeds, there would be a balancing allowance to deduct against the company’s profits (CAA 2001, s 61(1)(f), (2); Table, item 6).
Special rules apply to create a balancing charge where the plant originally attracted either the temporary ‘super deduction’ capital allowances or full expensing. Furthermore, it may be necessary to enter into an election under CAA 2001, s 198 to agree the tax disposal value for any embedded fixtures in buildings.
(e) Sale of goodwill and intangibles
In a distressed business scenario, it is unlikely that any significant sum would be obtained for goodwill. However, the business may have some valuable intellectual property (IP) that would form part of the sale.
The sale of ‘old-regime’ goodwill or IP (i.e., goodwill or IP held on 1 April 2002) is taxed as a capital gain under the normal rules – it is not treated as an income receipt under CTA 2009, Pt 8. Where the goodwill was held at 31 March 1982, its value at that date can be used as the base cost (plus the accrued indexation up to December 2017).
Where a company sells ‘new’ goodwill or other intangible assets, such as IP (that it previously created or acquired after 31 March 2002), this will result in an income (trading) profit. The profit is based on the excess of sale proceeds over the tax written-down value of the cost of the goodwill or other intangible. If tax amortisation relief has previously been allowed, the tax written-down value would be the original cost less the cumulative amortisation relief. There is no relief for indexation.
(f) VAT treatment
The sale of the trade usually qualifies for VAT transfer of going concern (TOGC) relief and therefore no VAT is accounted for on the sale of the assets or trade (the VAT (Special Provisions) Order 1995, Art 5).
Where the goodwill of the trade is being transferred, the buyer is taking on the employees, and the same business is being carried on post-sale, HMRC will generally accept TOGC treatment.
Key legal issues
Where a company sells its trade and assets, it is likely that its employees would be transferred under The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE). The main principle of TUPE is that, on the transfer of the trade, the employee’s contracts cannot be terminated. The buyer is therefore legally obliged to provide the same employment terms and conditions to the employees.
It is not legally possible to transfer creditors to a third-party buyer without the consent of the relevant creditor. The seller company should, as far as is practicable, settle any outstanding liabilities.
Sale and purchase agreement
There should be a simple sale of trade and assets agreement covering (amongst other things):
-
details of the assets being transferred (including the consideration allocated to each asset);
-
details of any liabilities being assigned;
-
the assignment of any trading agreements, leases, licences and so on;
-
the total consideration for the transfer and how this is dealt with; and
-
confirmation by the parties that the transfer is intended to be that of a going concern (this may assist in obtaining VAT transfer of going concern relief).
Hive-down of trade and assets
In some cases, a ‘hybrid’ approach is used, which involves the company in distress hiving down its trade and assets to a new subsidiary company (Newsubco) and then selling the shares in the Subco to the third-party buyer. The consideration agreed for the various trading assets to Newsubco would mirror those that may have applied on a trade and asset sale.
The buyer acquires a clean company and, in some cases, the buyer may obtain the benefit of the trade’s unused tax losses – this will be covered in my next article.
Practical tip
Both the seller and the buyer should agree the consideration given for each category of asset. This should be recorded in a schedule in the sale and purchase contract. A pre-agreed form of completion accounts could be used.
