Springfords LLP News

To receive our quarterly e-newsletter filled with the kind of news you can use, register here.

Releasing Value From Your Company

07 April 2014

For a lot of entrepreneurial clients, their pension is their “business”. What does this mean? In a nutshell, they have always planned to use the proceeds arising from the sale of their business to fund the bulk of their retirement – for example, by either investing those proceeds in stocks and shares to achieve an income from dividends, investing in buy-to-let flats to receive monthly rental income or buying an annuity which will give them a set guaranteed monthly income for the remainder of their days – often a combination of all three and lots of other things besides!

This all sounds good ... so what’s the problem?

In the current economic climate, it seems that more and more business owners are finding that they are compromised when it comes to putting their company on the market for sale. Why should this be the case? Well nowadays business owners often find themselves offering employment and/or shares in the company to other family members, often their own sons and daughters, who are unable to find jobs on leaving school or university or have found themselves being made redundant. So, all of a sudden, the business is providing a vital income stream not only to the founding entrepreneur but also to their family. A new family business is born.

As a result of the above, we have seen a rise in the number of “recently formed” family business owners asking our advice on how best to pay for their retirement whilst keeping the company intact to fund the income of the next generation. For some, the position is simple and clear – there are sufficient profits generated by the normal operating activities of the business to fund the founding members during their retirement as well as fund the income of the next generation working in the business. However, it’s very often not possible to fund an income for the retiring founder members from future profits generated from the business - so the alternative is to find a way of unlocking value from the business by withdrawing capital from the company.

If you find yourself in this position, then under current tax legislation, there is an opportunity to take out a significant sum of money from a profitable trading company on retirement whilst only paying capital gains tax at the rate of 10%, by having the company ‘buy back’ your shares. This compares very favourably when you consider that the salaries and dividends you take out of the company are currently charged to tax at rates of up to 45% and 30.6% respectively!

Rather than selling your business to a third party, the company can effectively ‘buy back’ your share of the business using cash funds, provided there are sufficient ‘distributable profits’ available (this condition has recently been relaxed but only where the buyback is paid out of cash reserves and is the lower of £15,000 or 5% of the share capital). The company must pay for buyback shares in full on the day the shares are acquired. Once purchased, the company would normally cancel your shares from the share register. However, it is advisable to get HMRC to agree that the share buy back can be treated as a capital distribution rather than an income distribution otherwise you will find yourself paying tax at the much higher dividend rate (see above).

In order for the gain to be taxed at 10% (rather than 18%/28%) the gain would need to qualify for Entrepreneurs Relief (ER). ER applies to lifetime capital gains of up to £10m per individual – any gains above this will be chargeable at the higher capital gains tax rates.

If you wish to take advantage of this ER relief as well as secure capital distribution tax treatment on the buy back of your shares, then you really need to start planning at least 5 years ahead because, in order to benefit, the conditions below must all be satisfied:

  1. The buy back must be allowed by the company’s Articles of Association.
  2. The buy back must be done for the benefit on the company’s trade and can’t be done simply to secure a tax advantage for the shareholder.
  3. The company must be unquoted.
  4. The company needs to be considered to be a trading business (or holding company of a trading group) rather than an investment business - for example, more than 80% of the income generated and assets in the business must be from trading rather than investment activities. So if the company receives large amounts of rental income or has large sums of cash on interest bearing savings accounts the company may not qualify (generally HMRC will however accept cash sitting in current accounts or sums required to fund working capital as ‘trade’ assets).
  5. You must be UK resident.
  6. You must be an employee or an officer (e.g. director or company secretary) of the company for at least 12 months prior to the buy back.
  7. The shares must be fully paid up.
  8. You must have held more than 5% of the company’s ordinary share capital and voting rights for at least 12 months.
  9. You must have held all the shares being acquired for at least 5 years to obtain capital treatment on own purchase.
  10. You can’t hold more than 30% of the company’s shares after the buy back.
  11. Your interest in the company must be substantially reduced on the buy back, by more than 75%. Your interest will include the interests of your associates (for example your spouse and young children – the interests of adult children are ignored for this purpose).

In addition, you may need to plan the build up of a cash fund in the company (while still ensuring that this doesn’t cause the company to lose its ‘trading’ status). For example, by taking less income out of the business over a period leading up to retirement (income you would normally take out by way of salary and dividends at much higher rates of tax), you can ensure that there is sufficient cash available to withdraw from the business at the time of retirement.

Clearly there is a lot to think about if you wish to go down this buy back route and take advantage of both the capital distribution tax treatment and ER relief. So the sooner your plan is formulated the better to secure the future nest egg you desire.

If you would like to discuss share buy backs or your options for retirement further, please contact Carol Wright

Contact Us
  terms & privacy
Part of Baldwins