Potential CGT Revisions and the impact on the EOT Structure
CGT relief when vendors sell their companies to an Employee Ownership Trust (EOT) is been a headline benefit for vendors looking to transition to the next stage of their life and career. Under the EOT legislation contained in the Finance Act 2014, vendors who sell a controlling interest to an EOT and comply with the additional requirements are eligible for full CGT relief on the gain resulting from the sale.
Earlier this year, the Chancellor and government changed the lifetime Entrepreneurs’ Relief (now referred to as Business Asset Disposal Relief or BADR) allowance, reducing it from £10,000,000 in gains to £1,000,000. This had the result of making a sale to an EOT even more attractive. There are now reports that the government is considering additional changes to the CGT tax regime. If we take an extreme view and assume that the lifetime allowance is completely eliminated or CGT rates increase, the EOT would become an even more attractive alternative. Let’s walk through a short example illustrating the benefit of the EOT CGT relief based upon the lifetime allowance being eliminated.
If we assume a vendor sells their business for £5,000,000 and the cost basis in their shares is nil (meaning in general they founded the company), the CGT payable at the BADR CGT tax rate of 10% in a third party sale prior to the changes earlier this year would have been £500,000. There would have been no CGT payable if the vendor sold to an EOT, resulting in an increase in net proceeds to the vendor of £500,000.
Assuming the same sale price of £5,000,000 under the current BADR provisions, the CGT payable when selling to a third party would be £900,000. This is calculated as 10% (the BADR CGT tax rate) on the first £1,000,000 of gain and 20% for additional and higher rate taxpayers on the next £4,000,000 of gain. Selling to an EOT would therefore result in an increase in net proceeds to the vendor of the CGT not paid of £900,000.
Looking at our hypothetical third scenario, where the BADR lifetime allowance is completely eliminated, the full amount of the gain would be taxed at the additional and higher rate taxpayer level of 20%. This results in CGT payable by the vendor of £1,000,000. Selling to an EOT would provide the vendor with full CGT relief and an increase in net proceeds of the full £1,000,000 in CGT that would have otherwise been payable.
In looking at the impact of reducing the amount of third party sale proceeds that would be subject to the lower BADR CGT rate of 10%, it is obvious that selling to an EOT becomes an increasingly attractive sale option for vendor looking to sell their company. This, of course, assumes that the CGT relief available under an EOT sale is not changed by the government going forward and doesn’t include the impact of any fees paid to establish the EOT. This discussion also does not take into account any increase in CGT rates that might happen to bring the rates more in line with income tax rates.
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