A look at the options available
Expansion of a business can be achieved by either organic growth or buying an existing enterprise.
If taking over an existing company is the right course of action, there are two options: buying shares or buying trades and assets.
From the seller’s point of view, it is likely that the vendor will usually prefer to sell the shares, as this is likely to result in a lower amount of tax due to HMRC.
From the buyer’s perspective, acquiring shares means purchasing all the assets and liabilities of the target company. As some of the liabilities might not even be known at the time of purchase, this is seen as a higher risk option.
One of the key factors in negotiating the sale price will be the tax consequences, stamp duty, goodwill, use of losses etc.
Below, we look at the tax implication for a buyer company we will call Force Ltd.
As Force Ltd is purchasing shares, it will have to pay stamp duty at a rate of half a per cent of the consideration paid.
The expenditure incurred on the shares will not be a tax-deductible expense in Force Ltd accounts.
The cost of shares will be allowed when calculating the gain on the eventual disposal of the shares in the future.
However, if the shares are disposed after more than 12 months, the gain/loss may be exempt under the substantial shareholdings rules.
Force Ltd will own 100 per cent of shares in the acquisition target, Dark Ltd.
Force Ltd and Dark Ltd will be associated companies for the purpose of corporation tax; this will affect the corporation tax limits for both.
Dark Ltd trading losses brought forward and the losses incurred up to the date of the acquisition will not be available for group relief.
If Dark Ltd continues to make trading losses, any losses made after acquisition will be eligible for group relief.
From the tax point of view, Dark Ltd will only need to consider the existence of an extra associated company and the way on which losses can be utilised.
Dark Ltd trading losses bought forward and the losses incurred up to the date of the acquisition will be carried forward and set off against future trading profits subject to S. 768 ICTA 1988 and S. 673 CTA 2010.
Under S 768, if there has been a change of ownership and a major change in the nature or conduct of trade within three years, the losses made before the change cannot be carried forward against profits after the change in ownership.
A major change in the nature or conduct of a trade includes a major change in the type of property dealt, services provided, customers, outlets and markets. However, every case will be decided on its particular facts.
Force Ltd will need to ascertain the exact breakdown of the consideration given.
HMRC will insist that the total consideration is split on a ‘just and reasonable’ basis between stock, plant and equipment, goodwill and freehold property.
If plant and machinery purchased is used in the trade of Force Ltd, capital allowance will be available under the normal rule on the amount spent.
As the goodwill is purchased from an unconnected third party, the goodwill can be treated as an intangible fixed asset.
Force Ltd may claim relief for amortisation and it will be an allowable expense for tax purposes. Any future profit on sale of this goodwill will be treated as a trading profit.
If the amount attributable to freehold property exceeds the threshold limits for stamp duty land tax, Force Ltd will have to pay the required percentage on the consideration paid.
As Force Ltd did not purchase the shares, any unused losses stay behind in Dark Ltd and if they cannot be used, the losses will be wasted.
Dark Ltd will cease trading on the date it sells its assets and trade to Force Ltd. Dark Ltd chargeable accounting period will come to an end and a tax return will have to be filed up to the date of cessation.
If the amount attributed to the stock exceeds the cost, Dark Ltd will make a trading profit assessed in the final period.
Balancing allowances/balancing charges will arise on the disposal of plant and machinery. Those will decrease/increase the profit/loss in the final period. To determine the balancing allowance/charge, Dark Ltd will need to compare the proceeds received with the tax written down value.
Dark Ltd will have a capital gain on sales of land and buildings.
If the goodwill was created after April 2002, the profit on the sale of goodwill will be taxed under trading profit. If the goodwill was created before April 2002, the profit on the sale of goodwill will be taxed under the capital gains rules.
The capital gain on the freehold property will be calculated by deducting from the proceeds received the original cost less indexation up to the date of disposal.
Trading losses in the final period can be set against the capital gains on the goodwill and freehold property.
However, trading losses carried forward can only be offset against trading profit; any unused trading loses of Dark Ltd on cessation will be wasted.
As the company stops trading, Dark Ltd may be able to claim terminal loss relief. This allows any trading losses that occur in the final accounting period to be set off against profits made in any or all of the previous three years.
Factsheets 167 to 171 provide information on valuations; see the 'Related documents' section on this page.