Business Succession and Restructuring

Incorporation means transferring a SOLE-TRADER or PARTNERSHIP business to a LIMITED COMPANY, typically in exchange for shares. Common reasons: limited liability; tax efficiency; credibility; succession/investment opportunities.

Tax consequences (multiple taxes affected):

1. Capital Gains Tax — Incorporation Relief (s.162 TCGA):

• AUTOMATIC relief when transferring a BUSINESS AS A GOING CONCERN to a company in exchange for SHARES
• Gain on transferred chargeable business assets DEFERRED into the shares received
• Shares' base cost = MV transferred − gain deferred (effectively transferor's original base cost for the business)
• Can ELECT OUT within 2 years of end of tax year of transfer — useful in specific circumstances
• Partial relief if SOME CONSIDERATION IS CASH: gain apportioned (share portion deferred; cash portion crystallised)

Conditions for s.162 relief:

• Transfer of the WHOLE BUSINESS (except cash can be excluded)
• GOING CONCERN basis (trading business continues without break)
• Consideration includes SHARES in the transferee company (even if small)
• Applies to INDIVIDUALS (not trustees — separate rules)

Why elect OUT of s.162?

• Use current AEA (£3,000) to exempt some gain
• Utilise BADR (£1m lifetime at 10%) on the transferor's gain AT THE TIME OF INCORPORATION — locks in 10% rate. Without election: gain rolls into shares; future disposal may not qualify or use higher CGT rates.
• Fit within losses available
• Accept some CGT now to improve the shares' base cost for the future

Worked example — s.162 vs opting out:

Sole trader Emma: business MV £500,000; chargeable assets gain £300,000 (mainly goodwill). BADR conditions met (trading, 2+ years). Emma is higher rate.

With s.162 (automatic):

• No CGT now. Gain £300,000 rolls into shares. Shares base cost: £500,000 − £300,000 = £200,000.
• When Emma eventually sells the shares: gain = proceeds − £200,000 (possibly much larger if company grows). May have BADR then, but conditions must be met at that future disposal.

Opt out of s.162, elect for BADR now:

• Pay CGT on £300,000 gain at 10% BADR = £30,000
• Shares' base cost: £500,000 (full MV)
• Future growth taxed from £500,000 base (lower taxable gain on ultimate sale)
• £1m BADR headroom used: £300,000 of lifetime limit consumed; £700,000 remaining
• DEFINITELY locks in 10% on current value. Future growth at normal CGT rates (or fresh BADR on shares if conditions met)

Decision framework:

• If business is EXPECTED TO GROW SIGNIFICANTLY post-incorporation: consider electing OUT (lock in current 10% rate; future higher-growth gain at 10% only if BADR still applies to shares)
• If business EXPECTED TO STAY STABLE: automatic s.162 likely best (no tax now; normal future CGT when eventually sold)
• Consider time horizon: longer until eventual sale = more likely to use shares' BADR in future anyway

2. Goodwill — post-2015 restriction (important!):

• Since 8 July 2015, the TRANSFEREE COMPANY cannot claim amortisation deduction on goodwill acquired from a RELATED PARTY (e.g., the sole trader incorporating)
• Amortisation on such goodwill is DISALLOWED (capital loss only on disposal)
• Exception (from April 2019): goodwill acquired ALONGSIDE qualifying IP rights — up to 6× the IP value gets amortisation relief
• Major change from pre-2015 position. Formerly, incorporation gave generous amortisation relief to the new company — this is mostly gone.

3. Stamp Duty Land Tax (SDLT):

• Property transferred as part of incorporation: SDLT on market value
• No automatic relief for connected-party transfer (unlike some corporate reorganisations)
• Possible structures to avoid SDLT: keep property owned personally and grant company a lease (but then rent triggers income tax for owner)
• Alternative: SDLT PARTNERSHIP RULES may apply if incorporation from partnership — some relief possible

4. VAT — TOGC:

• Transfer of the business as a TOGC: NO VAT CHARGED on the transfer
• Conditions: same business continues; transferee VAT-registered (or becomes so); no break in trading; same assets used in same way
• Property with OTT: transferee must also opt to tax by transfer date to maintain TOGC on the property element

5. Income tax and NIC:

• Incorporation: cessation of unincorporated trade for the sole trader/partnership
• Final set of accounts to cessation date
• Basis period reform complications for pre-2024/25 — may need to straddle incorporation
• Overlap relief (legacy) used on cessation
• Capital allowances: AIA/WDA for the final period
• Director/shareholder position starts fresh in the new company

6. Other practical considerations:

• Transfer of employees: TUPE may apply (if employees exist)
• Contracts: review for assignment restrictions; novate to new company
• Pensions: personal pension unaffected; new company can set up employer schemes
• Commercial name / trademarks: transfer ownership
• Business banking: new accounts; notify customers and suppliers

Disincorporation is the REVERSE process — transferring a company's trade and assets back to INDIVIDUAL ownership (sole trader or partnership). Usually occurs because:

• Administrative burden of a company outweighs benefits
• Tax arbitrage reduced (since 2023 CT changes)
• Regulatory simplification
• Desire for simpler succession (easier to pass on individual assets than shares)

Disincorporation relief (limited and now CLOSED):

• Was available for qualifying disincorporations between 1 April 2013 and 31 March 2018
• Limit: qualifying assets (goodwill, land and buildings used in trade) up to £100,000 at MV
• Deferred the CGT charge on the qualifying assets
• RELIEF NO LONGER AVAILABLE — expired March 2018

Current tax consequences of disincorporation:

Company perspective:

• Chargeable gains on chargeable assets distributed to shareholders (at MV)
• IFA profits/losses on intangibles (e.g., goodwill) at MV — revenue treatment in IFA regime
• Balancing charges on plant and machinery (if MV > TWDV) or allowances (if MV < TWDV)
• Trading stock: treated as sold at MV → trading income in final period
• Resulting CT liability in the company

Shareholder perspective:

• Receipt of assets is a DISTRIBUTION — could be income OR capital depending on how structured
• If company WOUND UP (formal liquidation): capital distribution. Shareholders have a CGT disposal of shares; possibly BADR if conditions met (10%).
• If STRUCK OFF without liquidation: "capital" distributions up to £25,000 treated as capital (ESC C16 equivalent under ITA 2007 s.1030A). Above £25k: treated as income dividend (33.75%/39.35%).

Disincorporation in practice:

• EXPENSIVE — typically a "last resort" decision
• CT on disposal of goodwill and other assets at MV
• Stamp duty on property transfer (if retained by individual)
• CGT on shareholder's deemed disposal of shares on striking off
• VAT: may qualify as TOGC if conditions met

Alternatives to disincorporation:

• Maintain company but reduce activity; extract reserves via dividends over time
• Sell the business as a TOGC to a third party
• Gift shares to next generation (if family succession)
• Wind up company with capital distribution to use BADR

Key insight: the CT arbitrage between sole trader and company narrowed significantly with the 19%/25% CT system from April 2023. Small businesses below £50k profits still benefit from 19% CT (vs up to 40% + NIC on sole trader). Mid-sized: marginal rate 26.5% + dividend tax 8.75%/33.75% can be less efficient than sole trader at the same profit level. Disincorporation may be considered for mid-profit small companies — but the mechanics are costly.

Company Purchase of Own Shares (POS) allows a company to BUY BACK its own shares from shareholders. Useful when:

• An owner wants to retire/exit but the remaining owners want to continue
• Removing a dissenting shareholder
• Inheritance scenarios (returning shares to company rather than distributing to heirs)
• Avoiding the need for a third-party buyer

Tax treatment — the critical question: CAPITAL or INCOME?

Default treatment: INCOME (distribution):

• Proceeds TAXED AS A DIVIDEND
• Dividend tax rates: 8.75% (basic); 33.75% (higher); 39.35% (additional)
• Often the WORSE outcome — higher rates than CGT

Capital treatment (s.1033-1048 CTA 2010) — preferable:

• Proceeds treated as PROCEEDS OF DISPOSAL of shares — subject to CGT
• Potentially 10% with BADR (if conditions met)
• Much better tax outcome

Conditions for CAPITAL treatment (ALL must be met):

1. Unquoted trading company (or unquoted holding company of trading group)
2. Purchase is for the benefit of the trade (e.g., removing a retiring shareholder, resolving disagreements, facilitating succession)
3. Shareholder is UK RESIDENT in the year of disposal
4. Shares held for 5 YEARS (3 years if acquired on death — measured from the death)
5. "Substantial reduction" in interest: at least 25% REDUCTION in shareholding percentage
   • Example: 50% shareholder reducing to below 37.5% (75% of original 50%)
   • Aggregate with associates (connected persons) — tested collectively
6. CEASE to be CONNECTED with the company:
   • Retained shareholding (if any) must be < 30% of ordinary share capital
   • Tested with associates
   • If owner walks away entirely (0%): easily met

Clearance procedure:

• Advance clearance available from HMRC (under s.1044 CTA 2010)
• Submit application with transaction details, confirming all conditions met
• HMRC's response typically within 30 days
• Clearance gives CERTAINTY — strongly recommended for POS transactions
• Must be the same parties as described in the clearance — any deviation requires re-clearance

Worked example — POS for retiring shareholder:

Trading company X Ltd. Three shareholders: A (50%), B (30%), C (20%). A is retiring; wants to sell 50% stake back to company. A has held shares 15 years; UK resident; base cost £50,000. Sale price £500,000. BADR conditions met for A.

Tax treatment if capital treatment applies (s.1033 conditions met):

• Conditions: unquoted trading company ✓; for benefit of trade (facilitating retirement) ✓; UK resident ✓; 5+ years ✓; substantial reduction 50% to 0% = 100% reduction ≥ 25% ✓; ceases to be connected ✓
• Gain: £500,000 − £50,000 = £450,000
• BADR at 10% (within £1m limit): £45,000 CGT
• Effective rate: 10%

Tax treatment if INCOME (default):

• Proceeds £500,000 treated as dividend
• First £500 dividend allowance at 0%
• Remainder at dividend rates (additional rate likely): £499,500 × 39.35% = £196,553
• Effective rate: ~39.3%
• Much worse outcome

Saving from capital treatment: £196,553 − £45,000 = £151,553. Advance clearance essential to confirm.

Mechanics of POS:

• Company must have DISTRIBUTABLE RESERVES (from profits) to fund the buyback
• Alternatively: purchase from capital (more complex procedure)
• Formal resolution by remaining shareholders (ordinary resolution or special — depends on structure)
• Shares are CANCELLED (or held as treasury shares)
• Remaining shareholders' percentages INCREASE automatically — can create BADR issues for them (e.g., if their shareholding rises above certain threshold for SSE considerations)

Capital treatment not available — alternative planning:

• Sell shares to an EXTERNAL buyer instead (normal CGT with BADR)
• Restructure: MBO approach with a new holding company buying out
• Accept income treatment and plan timing to minimise dividend tax (split across years)
• Consider liquidation of the company (capital distribution) — but ends the business

Demergers separate parts of a group into separately-owned entities. Reasons:

• Family succession (different family members take different parts)
• Strategic focus (each business manages its own strategy)
• Unlocking value (each unit traded separately)
• Resolving shareholder disputes

Three main types of UK demerger:

1. Statutory demerger — DIRECT (s.1075-1099 CTA 2010):

• Parent transfers SHARES OF SUBSIDIARY to its own shareholders as a dividend
• Shareholders then directly own both the original parent and the former subsidiary
• Treated as EXEMPT DISTRIBUTION — no income tax on shareholders

2. Statutory demerger — INDIRECT:

• Parent transfers SHARES OF SUBSIDIARY to a NEW company, which issues its own shares to the parent's shareholders
• Similar effect: shareholders own two separate companies
• Treated as exempt distribution

Conditions for statutory exempt distribution:

• Distributing company is TRADING (or holding company of trading group)
• All three companies (parent + demerged + new) must be UK resident
• Each company trades AFTER the demerger
• Purpose is the BENEFIT of the trade (not tax avoidance)
• No cash or other consideration involved in the transfer (apart from the shares)
• Any disqualifying arrangements (e.g., subsequent sale) within 5 years may retrospectively disqualify the demerger

Tax treatment — statutory exempt demerger:

• Shareholder: no income tax; no CGT (treated as a share reorganisation under s.136 TCGA)
• CGT: base cost apportioned between old and new shares (on MV basis)
• Company: tax-free transfer (exempt distribution)
• SDLT: usually no charge if demerger is structured correctly

3. Non-statutory (or "liquidation") demerger — s.136 TCGA + scheme of reconstruction:

• Used when statutory demerger conditions CAN'T be met (e.g., distributing an investment activity rather than trade)
• Typical structure: place parent into liquidation; liquidator distributes shares in subsidiaries to shareholders
• Tax treatment complex — relies on s.136 TCGA (share reorganisation) and other provisions
• Less preferred than statutory route — more cost, risk, and complexity

Clearance procedure:

• Advance clearance essential for demergers — to confirm tax treatment
• Multiple clearances may be needed:
  • s.1091 CTA 2010: exempt distribution
  • s.138 TCGA: transactions in securities (no tax advantage purpose)
  • s.701 ITA 2007: similar for income tax
  • SDLT clearance

Worked example — statutory demerger:

HoldCo owns 100% of TradingSubA (widgets) and 100% of TradingSubB (services). Two shareholders, Brian and Carol (50% each). Both want independence: Brian wants to focus on widgets, Carol on services.

Structure:

1. Incorporate NewCo
2. HoldCo transfers 100% of TradingSubB shares to NewCo in exchange for NewCo issuing new shares to HoldCo's shareholders (Brian and Carol) — INDIRECT statutory demerger
3. Result: HoldCo owns TradingSubA (widgets); NewCo owns TradingSubB (services). Brian owns 50% of HoldCo and 50% of NewCo. Carol owns 50% of HoldCo and 50% of NewCo.

Next step: brother/sister split. Brian and Carol swap shares:

• Brian gives his 50% of NewCo to Carol in exchange for Carol's 50% of HoldCo
• Share-for-share exchange under s.135 TCGA (if conditions met — usually yes)
• Result: Brian owns 100% HoldCo (widgets); Carol owns 100% NewCo (services)

Tax outcome:

• No income tax on shareholders
• No CGT (share reorganisation + s.135 exchange)
• No SDLT (no property transfer to shareholders)
• Each party owns their preferred business, independently

Complexity: demergers involve multiple steps, clearances, and legal documentation. Professional advice essential.

A Management Buyout (MBO) is a transaction where the EXISTING MANAGEMENT of a company (or a division) ACQUIRES the business from the current owner(s).

Typical MBO structure:

1. Management forms NEWCO (a new holding company)
2. NEWCO raises financing:
   • Management invests equity (typically £50k-£1m per manager, often personally guaranteed)
   • Private equity / investment fund invests (majority of equity, sometimes preference shares with preferential rights)
   • Bank debt / senior lending (secured on assets; typically 3-5x EBITDA)
   • Mezzanine debt (between senior debt and equity)
3. NEWCO acquires the TARGET from existing owner(s) using the funds
4. Post-acquisition, NEWCO owns TARGET; management and PE share ownership
5. Target's debt may be "pushed down" to target (within tax rules to avoid interest deduction restrictions)

Tax planning for MBOs:

1. Seller's tax position (exit shareholder):

• Disposing of shares in target: CGT charge
• BADR at 10% if qualifying (5%+ shareholding, officer/employee, 2-year period, trading company)
• Up to £1m lifetime limit per seller
• If multiple sellers qualify: each gets their own £1m
• If SSE applies (company selling subsidiary): exempt
• Seller may finance part of the price (deferred consideration; earnouts)

2. Management's tax position:

• Management invest in NEWCO — shares acquired at MV (typically)
• For management to later exit with BADR at 10%:
  • 5%+ shareholding in NEWCO
  • Officer/employee role
  • 2-year period before exit
  • Trading company
• "SWEET EQUITY" structures: managers acquire growth shares/ratchets that track value above a threshold — tax treatment can be complex; usually structured to give capital gain on exit

3. EMI options for management incentivisation:

• Grant EMI options to management (post-MBO) to further incentivise
• No income tax or NIC on grant/exercise (if strike price ≥ MV at grant)
• CGT on sale — qualifying EMI options: 2-year period from GRANT can count for BADR (not just from exercise) — valuable acceleration of BADR timing

4. Private equity's structural aims:

• 3-7 year exit horizon (sell or IPO)
• Preference shares with fixed coupon + participation in equity growth
• Ratchet mechanism: management share increases with target return achievement
• Structure aims for TAX-EFFICIENT EXIT for all parties

5. Thin capitalisation and interest deductibility:

• High debt in NEWCO creates large interest deductions — can shelter target's profits
• UK transfer pricing and thin capitalisation rules may RESTRICT interest deductions on related-party debt
• Corporate Interest Restriction (CIR) caps interest deductions at 30% of EBITDA (with £2m group de minimis)
• Plan debt structure to maximise within these limits

Worked example — MBO tax-efficient structure:

Founder Mike sells 100% of TradingCo (worth £20m; base cost £100k) to an MBO team. MBO funded: £5m management equity + £8m PE + £7m bank debt.

Seller's tax position:

• Gain: £20m − £100k = £19.9m
• BADR: first £1m at 10% = £100k
• Remaining £18.9m at 20% = £3.78m
• Total CGT: £3.88m
• Net of CGT: £20m − £3.88m = £16.12m

Management team's tax position:

• Each manager invests, say, £200k equity for 5%+ stake (to qualify for BADR)
• If company trebles in value and exits in 5 years for £60m: management stake worth £3m each (15%)
• Gain: £2.8m per manager
• BADR £1m at 10% + £1.8m at 20% = £460k per manager CGT
• Net proceeds per manager: £3m − £460k = £2.54m on £200k invested
• Plus EMI options (if granted) give additional upside

Planning considerations:

• Management needs 5%+ stake for BADR — may require ordinary + growth shares
• EMI options supplement management equity at low cost
• PE typically gets most voting rights / preferred economics
• Earnouts and vendor loans: affect seller's CGT timing
• Warranty and indemnity insurance for the seller
• Loan notes: can provide rollover of seller's gain (with careful structuring); may qualify for QCB or non-QCB treatment

Section 135 TCGA treats certain share-for-share exchanges as NON-DISPOSALS — no immediate CGT, and the new shares inherit the old shares' base cost.

Conditions for s.135 application:

• Company B (acquirer) ISSUES SHARES or debentures to shareholders of Company A (target) in exchange for their Company A shares
• After the exchange, Company B HOLDS MORE THAN 25% of Company A's ordinary share capital OR the exchange results from a GENERAL OFFER to all Company A shareholders (provisions in the Companies Act to ensure minority shareholders can be dragged along)
• Exchange is a BONA FIDE COMMERCIAL transaction (not for tax avoidance)

Tax consequences if s.135 applies:

• Shareholders: NO CGT on the exchange
• New shares (in Company B) inherit the OLD shares' base cost
• BADR continuity: if the old shares qualified for BADR, the new shares may continue to qualify (provided conditions met on the new shares)
• Gain deferred until ultimate sale of Company B shares

Mixed consideration (cash + shares):

• If consideration is PARTLY CASH: the CASH is a part disposal (taxable immediately)
• SHARE portion: s.135 applies (deferred)
• Base cost of old shares apportioned between cash and new shares in proportion to their market values

Worked example — share-for-share with earnout:

FounderCo takeover: Company B offers 2 new B shares + £50,000 cash for every 10 A shares. Rachel owns 1,000 A shares (base cost £20,000; current MV £300,000). MV of B shares: £25 each; MV of A shares: £30 each.

Calculation:

• Rachel receives: 200 B shares (1000 × 2/10) + £5,000 cash (£50,000 × 100/1000)
• Wait — the question says £50,000 cash per 10 A shares, so 1,000 A shares would receive £5,000,000. Let me adjust for sensible numbers.
• Assume per 10 A shares: £500 cash + 2 B shares. For 1,000 A shares: £50,000 cash + 200 B shares.
• MV received: £50,000 cash + 200 × £25 = £5,000 shares = £55,000 total? Doesn't match £300k MV. Let me redo with proper proportions.

Simpler example: Rachel has 1,000 A shares (base cost £10,000; MV £40,000). Offer: 1 B share + £10 cash per A share. B shares MV £30 each.

• Rachel receives: 1,000 B shares (MV £30,000) + £10,000 cash. Total MV £40,000.
• Split: £30,000 / £40,000 = 75% to shares; £10,000 / £40,000 = 25% to cash
• Base cost apportionment:
  • New B shares: £10,000 × 75% = £7,500
  • Cash element: £10,000 × 25% = £2,500
• Cash element = part disposal: gain = £10,000 − £2,500 = £7,500 (immediately taxable)
• B shares: base cost £7,500 (for future disposal)

If Rachel has BADR available: £7,500 × 10% = £750 immediate CGT.

Earnout / contingent consideration:

• If part of the consideration is CONTINGENT (payable based on future performance), special rules apply
• "Ascertainable" contingent: treat as an immediate asset (calculate CGT now on its value)
• "Unascertainable" contingent: treat as a separate right (Marren v Ingles asset — CGT on later receipt of payments)
• Managing earnouts for CGT efficiency is a specialist area

Clearance:

• Advance clearance under s.138 TCGA available to confirm s.135 applies (not for tax avoidance)
• Complements s.701 ITA clearance (transactions in securities)
• Recommended for all significant share-for-share transactions

A "scheme of reconstruction" is a statutory concept (defined in s.1129 CTA 2010, s.136 TCGA for CGT). It allows tax-free transfer of trade/assets between companies as part of a genuine commercial restructuring.

Typical reconstruction scenarios:

• One trade run by TWO companies merged into one — assets transferred to the surviving company
• One company split into two (demerger structured as reconstruction)
• Holding company interposed above existing company
• Change in domicile/restructuring for regulatory reasons

Tax treatment — s.139 TCGA:

• Transfer of chargeable assets as part of reconstruction: NO GAIN / NO LOSS — transferee inherits base cost
• Conditions similar to those for any intra-group transfer under s.171:
  • Reconstruction is GENUINE COMMERCIAL (not tax avoidance)
  • Shareholders of the transferor receive shares in the transferee (or new group)
  • Shareholders' interests in the combined structure roughly mirror their interests before

s.136 TCGA — shareholders' position:

• Shareholders of old company receive shares in new company in exchange for their old shares
• Treated as a SHARE REORGANISATION — no CGT on the exchange; new shares inherit base cost
• Similar economic effect to s.135 (share-for-share exchanges) but with different mechanism

Conditions for s.136:

• Scheme of reconstruction (within statutory definition)
• Shareholders of old company receive ordinary shares in the new/surviving company
• Commercial purpose (not tax avoidance)
• All shareholders of a particular class receive equivalent treatment

Clearance procedure:

• ESSENTIAL for reconstructions
• Multiple clearances typically needed:
  • s.138 TCGA — confirms s.135/136 applies (share exchange/reconstruction)
  • s.701 ITA 2007 — transactions in securities (no income tax advantage)
  • SDLT clearance (for property-related reconstructions)
  • Stamp duty clearance (s.77 FA 1986 for share transactions)
• Typical HMRC response time: 30 days

Comparison — key rules:

Stamp taxes and reconstructions:

• SDLT: group relief available (s.61 FA 2003) if 75% group — beware of 3-year clawback
• Stamp duty on shares: reconstruction relief (s.77 FA 1986) available for certain reconstructions
• SDRT: exemptions may apply

Practical reconstruction example — interposing a holding company:

Bob owns 100% of TradeCo. Wants to introduce a holding company above TradeCo for succession/investment planning.

1. Set up HoldCo
2. Bob transfers his TradeCo shares to HoldCo in exchange for HoldCo shares (same value)
3. Share-for-share exchange under s.135 TCGA — no CGT for Bob
4. Bob's base cost in HoldCo shares = his original TradeCo base cost
5. Clearance obtained
6. Result: Bob owns HoldCo; HoldCo owns TradeCo. No tax cost to the restructuring.