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Reducing tax on sales for management buy-out teams

Courtesy of Goldsmiths LLP, UK leaders in accountancy practice sales and support

Members of a management buy-out team often hold less than 5% of the voting shares in their company. 

Prior to April 2008 this was of little concern because such individuals would have qualified for taper relief and secured an effective 10% tax charge on the sale of their shares.

Since April 2008, however, a member of a management team holding a sub-5% share, even in a trading company, have faced a significantly higher potential tax liability if selling their shares at a gain. It was bad enough when such individuals faced an 18% tax liability, but since 22 June 2010 they have faced the prospect of a 28% tax liability on sale.

The plight of such unfortunate individuals caught in this position cannot really be rectified by issuing them with additional shares or options. The complex employment-related securities rules come into play with a vengeance if directors or employees acquire additional shares essentially forcing them to pay full market value on an acquisition which often proves too costly.

With options the individuals can postpone payment until they are exercised but, unless they exercise those options at open market value at least 12 months before the sale, they will not hold the resulting extra shares long enough to qualify for the10% tax rate on sale.

It is, however, possible to reorganise the shareholding of the MBO company to allow members of the management team to qualify for 10% tax on sale provided that reorganisation takes place at least 12 months before any eventual final sale of the business.

The reorganisation required involves applying the detailed rules governing entrepreneurs' relief and joint-venture companies to enable members of management teams who otherwise would be below the 5% threshold to qualify for 10% tax on sale. This solution can apply even to those who otherwise would hold only a 0.5% stake in the MBO company.

Often, such a reorganisation involves no up-front tax charge for the individuals concerned. Where that is not possible, a small tax charge arises based on the heavily discounted value of their minority shareholding which pales into insignificance when compared to saving a full 18% tax on the undiluted value of their shares on an eventual exit. That small tax liability is often a price worth paying.

Converting an otherwise 28% tax liability into a 10% tax liability certainly brings a smile back to the face of the hard-working members of a management team.

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