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Sherlock Holmes and lost value…potential Capital Gains Tax changes and the impact on business sale proceeds

“It is a capital mistake to theorise before one has data…”

However, as other commentators have also noted, potential changes to Capital Gains Tax (CGT) are worth theorising about, especially given:

  • Arguably the Chancellor put business owners on notice by publishing his letter to the Office of Tax Simplification (OTS) where he asked them to undertake a formal review of the CGT system. The reason for the review is to ensure the system is ‘fit for purpose’. In the concluding paragraph in his letter, the Chancellor noted, “I would be interested in […] how gains are taxed compared to other types of income”
  • Existing manifesto pledges regarding income-based taxes and VAT rates restrict the Chancellor’s options, but with spending during the pandemic at unprecedented levels, tax rises are highly likely for the near term. Whilst increasing CGT may not yield the largest windfall for the Treasury, aligning income and capital rates produces an uplift in tax receipts, in addition to being seen as a simplification of the complex world of tax legislation
  • Whilst the potential for a Government change may be a few years away, the subject of increased capital taxes and alignment with other tax rates has previously also been high up on opposition party agendas

“Oh, hell! What does that matter?!…”

It matters because of the current differential between CGT and income tax and it matters specifically to those who are contemplating selling a business.

My rough and ready illustrative calculations show the impact on value lost by the shareholders if the current CGT rate of 20% on the disposal of a business asset is replaced with an income tax rate of 45% on proceeds above £1m (I am assuming that Entrepreneurs’ Relief remains as it was and Business Asset Disposal Relief as it now is, stays intact).

£ £ £
Deal value 5,000,000 10,000,000 15,000,000
Proceeds under current legislation 4,100,000 8,100,000 12,100,000
Proceeds under potential legislation 3,100,000 5,850,000 8,600,000
Potential value lost by shareholders (1,000,000) (2,250,000) (3,500,000)

 

“You see, but you do not observe…” 

Ok, you see the differentials above, but if we think that the value loss can be eliminated by solely negotiating up the sales price, you would have to achieve the following to stay neutral:

£ £ £
Deal value (as above) 5,000,000 10,000,000 15,000,000
Deal value to achieve current legislation proceeds 6,818,182 14,090,909 21,363,636
Percentage of deal value increase 36% 41% 42%

So, to get to the same proceeds on a £5m deal, consideration would need to increase from £5m to c.£6.8m. Looking at this another way, to get the same proceeds, the maintainable earnings would have to increase by 36%, or the multiple rise from (say) 6 to 8.1.

“You have a grand gift for silence, Watson. It makes you quite invaluable as a companion…”

But presumably not invaluable as a corporate finance adviser. We have been speaking to business owners who we know have been completing a sale and bringing the above to their attention.  Also, the reason for this blog is not to scaremonger, but to raise awareness of the matter being talked about and the potential implications.

“The game is afoot.” 

So, what can be done?

Realistically it may be difficult to start and finish a trade sale before the likely date of the Autumn Statement, specifically if you do not have a potential buyer lined up. But for those already engaged in talks, we would suggest the potential vendors take some time out (but not too much time!) to consider the implications of the changes being mooted and then, if concerned about the impact of a change in tax on their post-tax proceeds, plan accordingly. This may include having clauses in the heads of terms that encourage completion by a target date (e.g. penalties for non-completion) and dedicating proper resource to the deal process, including due diligence responses etc.

It may also be possible to bring forward some planned succession – whether that is, for example, a transfer of the business to future generations or a sale to the management team. There is still time to explore these options at which point an informed decision can be taken on how best to proceed.

At PKF Francis Clark, our Corporate Finance team is working with a number of clients on deals of this kind. Here the vendors have come to an assessment that the ability to get a deal done and mitigate against the tax loss outweighs the opportunity cost of not pursuing a trade sale (which may have historically been associated with a higher potential sale price).

Having advised a number of shareholders on transactions and the risks of changes to Entrepreneurs’ Relief prior to the most recent changes, we have a number of clients and management teams who were retrospectively very pleased with the advice received and actions taken.

I have commented on other factors at play in connection with financing the transaction in the current climate in my blog at link.

If you would like to speak to someone to talk through a potential exit please do not hesitate to contact me or your usual PKF Francis Clark contact.

FEATURING: Nick Tippett
Nick is a Director in the Corporate Finance team. He focuses on business sales, management buyouts, acquisitions and both debt and equity finance raising. He… read more
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