Understanding tax when selling your business.
While we always recommend initiating talks about selling your businesses as far in advance as possible (up to 5 years), it’s true that you have more control over when it enters the market than when the sale completes. It stands to be the case that a business sale can complete at various points throughout the year. However, when a sale occurs at the end of the financial year, it’s only natural that additional questions about the tax you have to pay, and when you will have to pay it, will pop up.
We’ve decided to answer some of the key tax concerns that pop up when selling your business at the end of the tax year.
Do I pay capital gains tax or corporation tax upon selling a business?
You may have to pay capital gains tax if you make a profit (or gains) when you sell all or part of a business asset. For example, a business’ assets you may need to pay tax on includes land, buildings, fixtures and fittings or machinery. However, that does not exclude business-only sales (or any that aren’t lease or freehold) from the tax. This is because assets also includes things that are harder to define, such as a business’s reputation.
Crucially, you will pay capital gains tax if you’re a self-employed sole trader or in a business partnership. Other organisations like limited companies pay corporation tax on profits from selling their assets. To be exact, corporation tax on chargeable gains is only paid by limited companies.
When do you pay capital gains tax?
You pay capital gains tax to the HMRC whenever you sell an asset and make a gain – whether this occurs before the end of a tax year or during a new one.
Capital gains tax is calculated by taking the proceeds from the sale of the asset and deducting the cost of purchase. You can also deduct any costs associated with the sale and purchase, such as legal fees. It’s worth noting that there is also a tax-free allowance, currently £12,300 similar to the personal allowance for income tax.
However, you do not have to pay tax if your total taxable gains are under your capital gains tax allowance. You will still need to report your gains in your tax return if both of the following apply:
- The total amount you sold the assets for was more than 4 times your allowance.
- You’re registered for self-assessment.
How do I calculate capital gains tax on a business sale?
As with any other assets, the basic principles apply, and do so whether you are a sole trader, are in a partnership or are holding shares in a limited company.
Firstly, you should deduct the costs of buying, selling, or improving your asset from your gain. For example, costs you can deduct include:
- Fees, for example for valuing or advertising assets.
- Costs to improve assets.
- Stamp Duty Land Tax.
However, some costs cannot be deducted, such as:
- Any interest on a loan used to buy your asset.
- Any costs you can claim as business expenses.
Next, it’s important you apply any reliefs you may be eligible for – there are more on those below.
When you know the gain amount, you need to work out the amount of capital gains tax you’re required to pay. However, in many cases identifying the different elements of this can be complex and very few sales are straight forward. Selling your business may include deferred consideration, contingent elements, or consideration in a form other than cash. As such, we recommend contacting an accountant, or business adviser like ourselves, should you require additional support.
How can I reduce capital gains tax when selling a business?
It is always important to plan any business sale in advance to ensure that you take advantage of any of the reliefs that you qualify for. Only then can you structure the sale in the most tax efficient way. In addition to this, you will also want to ensure that you are able to maximise its likely sale value. We therefore recommend seeking professional advice as early as possible in order to achieve this.
What is incorporation relief?
It’s possible to delay paying capital gains tax if you transfer your business to a company in return for shares. In this case, incorporation relief means you will not pay any tax until you sell these shares.
To qualify for incorporation relief, you must:
- Be a sole trader or in a business partnership
- Transfer the business and all its assets (except cash) in return for shares in the company.
However, unlike other reliefs, you do not have to claim incorporation relief – you’ll get it automatically if you’re eligible. In order to work out the amount you need to pay capital gains tax on, you merely deduct the gain you made when selling your business from the market value of the shares you received.
Do I qualify for gift hold-over relief?
You may be able to claim gift hold-over relief if you give away business assets (including certain shares) or sell them for less than they’re worth in order to help the buyer. Again, this is something we can provide full support on as part of our advisory service.
In essence, gift hold-over relief will mean that you do not need to pay capital gains relief when you give away the business’ assets. This is because the person you give them to pays the tax when they sell them.
However, conditions for claiming relief depend on whether you’re giving away business assets or shares.
If you’re giving away business assets, you must:
- be a sole trader or business partner, or have at least 5% of voting rights in a company (known as your ‘personal company’),
- use the assets in your business or personal company.
If you’re giving away shares, they must be in a company that’s either:
- not listed on any recognised stock exchange,
- your personal company.
It’s worth noting that you must claim jointly with the person you give the gift to when filling out the self-assessment tax returns of both parties.
Can you claim business asset disposal relief if you sell your business at the end of the tax year?
Business asset disposal relief, which was named entrepreneurs’ relief before 2020, is the tax you pay when you sell a business and is a form of capital gains tax relief. However, a claim for entrepreneurs’ relief must be made before the first anniversary of the 31st of January following the end of the tax year in which the relevant disposal takes place.
It’s worth noting that whenever you sell a business and financial gain is made from said sale, capital gains tax must be paid. To be exact, capital gains tax applies to the overall profits made over the tax-free threshold of £12,300 and is currently charged at a rate of 20%.
Business asset disposal relief allows you to apply a lower rate of 10% capital gains tax on the profits you have made. This rate is lower than the income tax you would otherwise pay, which is 20%-basic, 40%-higher, 45%-additional. This means that business owners can benefit from keeping more profit from the sale of the business. In fact, business owners can claim business asset disposal relief more than once, as long as they don’t exceed the £1 million limit.
To be eligible for business asset disposal relief, there are a few criteria that you must meet, such as:
- You must not have surpassed the £1 million lifetime limit.
- You have been an employee/office holder of the limited, a sole trader or a business partner.
- You must have owned the company for at least the last 2 years.
- You must hold 5% of the business’s share capital and 5% of the voting share capital for at least the last 12 months.
However, if you are only selling part of your business, the part you are selling must be considered to be viable and sustainable. For instance, if you were to sell part of the business that was loss-making then you wouldn’t qualify for business asset disposal relief.
In addition, if you are selling shares rather than assets, the eligibility criteria will differ slightly.
- The company must be a trading company, and you must have traded within the qualifying period of 2 years.
- If the shares you are selling are from an enterprise management incentive (EMI) then they must have been acquired after 5th April 2013 and you must have had the option to purchase them 2 years before you sell them.
To calculate business asset disposal relief, you can follow these steps:
- Firstly, you will need to work out your total taxable gain. You can do this by adding all your capital gains together (this is what you sold your shares or assets for).
- Next, you will need to deduct losses from this figure.
- Now you will need to take away your tax-free allowance, which currently stands at £12,300 (provided you haven’t used it already in the current tax year).
- Now, you will be left with a number.
- Take 10% off this which is what you will pay in tax.
How much corporation tax will I pay?
As of February 2022, the corporation tax rate for company profits for the 2021/22 tax year is 19%. Therefore, a business with £100,000 in annual profit will pay £19,000 in corporation tax. However, a reduced rate of 10% applies to profits relating to patented technologies, a policy known as the ‘patent box’. Higher rates apply to banks and to North Sea oil and gas production. Businesses often strive to pay no more corporation tax than necessary by way of claiming every allowable deduction and expense available. For example, salaries are business expenses, which reduce your profit and, in turn, your corporation tax. Paying into a pension through a limited company is an additional allowable expense.
Should I reduce my business profits to reduce tax?
There’s an argument to be had that hampering profit, even in the form of tax deductions, may seem like a shrewd way to reduce cost, but in the long-term, this will restrict a business from further growth. A business’s Earnings After Tax (EAT) calculation, when used as the sole metric of its performance, will only lead to a very murky picture of its financial standing.
Alternatively, earnings before interest, tax, depreciation, and amortization (EBITDA) is a very quick way to assess a company’s cash flow and free cash flow. EBITDA, like EBIT, is before interest and tax, so it is readily comparable. For example, EBITDA is important as it is an indicator of company performance. It acts as a proxy for cash flow and lets banks and investors assess how much debt a company can take on its balance sheet. As a result, EBITDA gives investors an indication as to a company’s ability to not only generate cash, but to also service its debt. This is because is because an EBITDA margin gives investors insight into the efficiency with which a company is converting revenue into profits. The higher the margin, the more financially stable the company is, and the lesser the investment risk. Fundamentally, businesses need to remind themselves that profit, even that which may increase tax, is critical. As Business Advisors, we stress that it’s essential to place your business in the best possible position before making a sale – this is reflected in your business’ performance.
Dale Pollitt, Director at Ryans Chartered Accountants advises:
“Always take professional advice early!! Tax cannot be planned for retrospectively, upfront and in-year planning is therefore essential. Ensure that all allowances are maximised and consider how family tax planning may be used to utilise any unused allowances of close family members.”
Making use of the Hilton Smythe valuation service
Before a business goes up for sale, it is crucial for the owner to know it’s true value. If the business owner knows the true value well in advance, they have the chance to increase it and potentially achieve a higher sales price before it goes on the market.
However, not only is a valuation important for understanding a businesses’ potential value but it can be used as an indicator and management tool. For example, companies that are preparing to sell, can use valuation as an indicator aimed at building value in order to drive additional money on the sale.
In addition, many business owners get their business valued in order to gain an accurate insight into their companies’ assets. An accurate business valuation allows owners to understand how much to reinvest in their company or how much to sell it for in order to be profitable. With that being true, it stands to follow that a valuation is a way to calculate any reliefs that you may qualify for when selling a business. We offer in-depth valuation reports that provide insight into the selling process and can provide a host of support when working out the tax you will need to pay, and reliefs you may be eligible for when it comes to the end of the tax year.
If you’re interested in finding out how much value is locked away in your business, we offer a FREE, Expert Business Valuation Report. For further information, be sure to contact a member of the Hilton Smythe team today.