When selling a business, the headline price is only part of the story. A £10 million offer might be paid through cash, loan notes, rollover shares, an earn-out or a combination of all four. The form of consideration can materially change the timing of tax, the risk retained by the seller and the value ultimately received.
Cash
Cash is the simplest option. The seller receives the money and generally pays Capital Gains Tax on the gain arising on the disposal. Business Asset Disposal Relief may reduce the rate on qualifying gains within the individual’s remaining lifetime allowance, but simply reinvesting the cash elsewhere does not normally defer the tax.
Loan notes: QCBs and non-QCBs
A buyer may issue loan notes instead of paying all of the price immediately. These are formal debt instruments and, for tax purposes, can broadly fall into two categories: Qualifying Corporate Bonds (QCBs) and non-QCBs. A conventional sterling, non-convertible note will often be a QCB, while convertible or differently structured securities may be non-QCBs.
Importantly, simply issuing a loan note does not automatically defer Capital Gains Tax. The wider transaction must also satisfy the relevant share-exchange conditions.
Where QCBs are issued in a qualifying exchange, the gain relating to the original shares is broadly calculated and frozen, with the tax generally arising when the notes are redeemed or disposed of. With qualifying non-QCBs, the historic base cost effectively carries into the new security, so later changes in its value can affect the eventual gain.
The commercial risk matters too. A seller taking loan notes becomes a creditor of the buyer and should consider repayment dates, security, interest and what happens if the buyer later experiences financial difficulty.
Rollover shares
A seller may instead receive shares in the acquiring structure. Where the relevant conditions are met, the historic gain can generally follow those replacement shares rather than being taxed immediately. Rollover is common in private equity but also arises in trade sales and mergers.
The new shares may have different voting, dividend and exit rights, so a £1 million rollover should be assessed by reference to the economics of what is received, not simply its headline amount.
Earn-outs
An earn-out makes part of the price dependent on future performance. The tax outcome depends on whether the amount is fixed or uncertain.
If £1 million is definitely payable in two years, that fixed amount will generally be included in the original sale proceeds even though the cash has not yet arrived. Being paid later does not automatically mean being taxed later.
Where the amount depends on future profits or another uncertain measure, a value may need to be placed on the earn-out right at completion. Later payments can then create a further gain or loss. Special treatment can sometimes apply where an earn-out can only be satisfied with shares or securities, but the contractual wording is important.
Be careful if the seller stays employed
If an earn-out is heavily dependent on the seller remaining employed, meeting personal targets or providing future services, there is a risk that part of the payment is treated as employment income rather than sale consideration.
HMRC clearances
Transactions in Securities rules can become relevant where a transaction involves share exchanges, holding-company insertions, reorganisations or extraction of accumulated profits. Advance clearance can provide useful certainty. Separate Capital Gains Tax clearance may also be relevant to a share exchange; one clearance does not amount to HMRC approving every tax consequence of the deal.
The right consideration structure balances tax, cash flow, credit risk and future upside. It should be reviewed before heads of terms become fixed, not after the sale agreement has already been drafted.
