Tax Implications of Selling a Business

What are the tax implications of selling a business? A guide for SMEs in 2024

After all the hard graft involved in entrepreneurship, ensuring you achieve the best value for your business is vital. Part of an effective exit strategy, then, should consider minimising the tax liabilities you will incur upon disposal of your business assets – from taking advantage of BADR and other reliefs through to opting for a tax-efficient deal structure, such as an EOT or share sale.

This guide covers:

• Capital Gains Tax
• Business Asset Disposal Relief (BADR)
• Incorporation Relief
• Corporation Tax
• Income Tax
• The Substantial Shareholding Exemption
• Strategies for minimising your business sale tax burden

Capital Gains Tax

If you intend to sell your shares to a trade buyer, you will generally pay Capital Gains Tax (CGT).

For the 2023/2024 tax year CGT rates are:

• For basic rate taxpayers (total taxable income below £50,270), the Capital Gains Tax rate is 10% for most assets and 18% for residential property
• For higher or additional rate taxpayers (total taxable income above £50,270), the Capital Gains Tax rate is 20% for most assets and 24% for residential property

The tax-free allowance for 2024/25 is £3,000 – down from £6,000 in 2023/24.

With a general election pending in the UK, it is all the more important that those looking to exit their business ventures do so promptly in order to lock in the current rate of CGT – before any tax regime changes.

Business Asset Disposal Relief

Business Asset Disposal Relief (BADR) can cut your capital gains tax rate to just 10% on certain assets.

To qualify, both of the following eligibility criteria must apply for at least two years up to the point you sell your business:

• You’re a sole trader or business partner
• You hold at least 5% of the shares and voting rights for two years

There’s a lifetime limit of £1 million on BADR, translating to a maximum tax saving of £100,000 per person.

For this reason, you may wish to transfer some shares to a spouse or civil partner, which incurs no CGT charge.  This strategy, if done well in advance and meets all criteria, can potentially double the available CGT allowances, basic rate bands, and BADR that can be offset against CGT, leading to substantial tax savings.

Incorporation Relief

Incorporation Relief is a tax benefit offered to incentivise transferring a business from an unincorporated structure (sole trader or partnership) to a limited company.

Incorporation Relief allows you to defer paying Capital Gains Tax (CGT) on any profit you make when transferring business assets to a limited company. Instead of paying the tax immediately, the gain is rolled over and deducted from the cost of the shares you receive in the new company.

Corporation Tax

Corporation tax on chargeable gains during a business sale may apply in a few scenarios, such as:

• An asset sale will generally incur a taxable income arising to the vendor company at a main rate of 25% and a small profits rate of 19% (companies with profits under £50,000).

Asset sale versus share sale

Share sales typically incur a lower tax liability for the seller than asset sales.

Asset sales, however, can incur a double tax charge – an initial Corporation Tax charge on any capital gains made by the company post-sale, and a further tax charge on the shareholders when the sale proceeds are distributed as dividends and/or the company is liquidated to extract the proceeds in capital form.

For this reason, sellers usually opt for a share sale – especially if the shareholders stand to benefit from reduced capital gains tax rates under the Business Asset Disposal Relief regime.

Income Tax

In some cases, earn-out consideration may be classified as employment income by HMRC. Under current rates, this could mean up to 37% additional tax on the consideration amount, plus Employer National Insurance Contributions (NICs), as compared to the lowest capital gains rates.

This only applies to individual sellers who hold or have held directorships or employee positions. It does not affect corporate vendors or individual shareholders who are not employees.

The Substantial Shareholding Exemption

This is an exemption on corporation tax for companies selling shares in other trading companies, provided that:

• The shares are in a trading company or a holding company of a trading group or sub-group
• The selling company must have owned at least 10% of the ordinary share capital for a continuous period of at least 12 months, and this ownership period needs to have begun within the past 6 years before the sale of the shares

Strategies for minimising your tax burden when selling your business

As you approach the sale, leave any profits that you don’t need within the business

Business owners should consider structuring the sale to favour Capital Gains Tax (CGT) over income tax.

For example, as you approach the sale of your business, consider leaving any unneeded profits within the company, especially if you are a higher or additional rate taxpayer. This is because if you pay yourself a salary from the company, you’ll face income tax rates as high as 45%, and taking out profits as dividends triggers dividend tax, with an additional rate of 39.35%. Both options significantly exceed the CGT rate you’d pay on the sale proceeds when you sell the business.

Take advantage of investment schemes such as EIS or SEIS

Planning to reinvest your sale proceeds into a new business venture? You might be eligible to defer Capital Gains Tax (CGT) payment through government investment schemes like the Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS).

Deferred gains do, however, become taxable again when you sell your EIS shares.

Consider an employee ownership trust (EOT)

Employee ownership trusts are one of the most tax-efficient ways to exit your business. Disposal of shares into an EOT does not incur any capital gains tax or inheritance tax liabilities for owners, while value of bonuses will be subject to corporation tax reductions. An EOT can also pay annual bonuses of up to £3,600 to employees free of income tax.

They also allow you to transfer business control to a trusted group of directors, even if they lack the immediate capital to buy you out. Typically, the EOT will pay for your shares through future company profits, spread out over time.

Ensure that earn-outs are structured in such a way as to avoid income tax charges

HMRC considers any earn-out consideration to be taxable as employment income unless the seller can prove that the earn-out is further consideration for the sale of shares or the underlying business itself (in an asset sale).

For this reason, you should ensure that earn-outs are structured in such a way as to avoid income tax charges.

While not determinative, HMRC’s official guidance outlines “key indicators” that help determine if earn-out payments are considered part of sale consideration rather than remuneration. For example, the value received from the earn-out should reflect the value of the securities given up, and where the vendor continues to be employed in the business, the earn-out should not be compensation for the vendor not being fully remunerated.

Plan your exit well in advance

You ought to plan your exit at least two years in advance to meet holding periods required for Business Asset Disposal Relief.

With time, you can also explore various exit strategies with different tax implications, such as an EOT, an MBO, or a trade share sale.

For example, if an earn-out looks likely (e.g. the target business is expected to experience significant growth in the near future, or there is expected to be a value perception gap between the buyers and sellers), ensure that you understand the tax implications of any earn-out mechanism and clauses.