In the buying and selling of businesses, deals can often be completed by way of a sale of shares in the company. It is a fairly common method of transferring ownership but what does it mean for both the buyer and seller, and why does it differ from the sale of assets?
In simple terms, a sale of shares will mean a transfer of the whole company and everything that comes along with it - including liabilities. When compared to a sale of assets, an assets-based sale is generally far simpler. It will see the purchasing of specific items such as stock, leases or freeholds of property, goodwill, etc.
Assets allow for the more ready appointing of value in the sale contract. Tangible items, as well as goodwill and leases can be calculated with a good degree of accuracy, and sales of stock can been calculated on the day of completion, usually by an independent stocktaking company.
A sale of shares is more likely to take place if the owner trades as a limited company. This can prove to be a more lucrative method of sale for the vendor, particularly if assets have risen in value since they were purchased. If this has happened then the company will likely be liable for Capital Gains Tax. Any cash proceeds will also incur income tax when withdrawn, meaning that sales of assets can incur two separate tax levies. In a share-based deal, this can be avoided as the tax payable on a sale of assets is deferred until those assets are actually sold out of the company.
A transaction involving shares, however, is far more intricate than one involving assets, where a complete and clean transferal of ownership takes place - including ownership of actions that took place before the transferal.
The liabilities and obligations of a company don’t alter just because another person or entity now owns the shares. Indemnities may have been obtained from the vendor that state that he/she will reimburse the purchaser for these liabilities. However, these are only as good as the financial ability of the former owner to pay up in the eventuality of a claim.
It is imperative, therefore, that whether it is assets or shares being sold full and comprehensive due diligence is carried out by any buyer. This will bring any potential liabilities to light and ensure that all the right questions and answers have been posed and received.
One needs to remember that just because a share deal has an ostensible tax rate that is lower that that of an asset sale, it doesn’t necessarily mean that this will result in the lowest net tax charge.
In a share sale, gains differ from that in an asset sale for two reasons:
1] shares are completely different assets to the business that is owned by the company,
2] companies are taxed very differently on gains to individuals.
What therefore has to be looked at closely are the gains that accrue under each scenario. Differences may include:
The purchase cost of the company’s assets may have a different base cost to that of the shares. If the company has held assets for some time with a base cost that is relatively high, it could be entitled to a significant level of indexation relief to reduce the effective gain. In these cases, a company sale could lead to an effective lower gain than would arise on a share sale and, so long as the proceeds were able to be extracted efficiently, the amount of income tax payable could therefore be lower. This may not happen for vendors of small businesses that qualify for the Entrepreneurs’ Relief and are eligible for 10 per cent rate of CGT on proceeds of up to £5 million.
A share disposal is entitled to the annual Capital Gains Tax exemption.
Non-UK residents can sell shares free of Capital gains Tax, whereas a UK company is still subject to tax on an asset disposal even if the owner is non-resident.
Individual capital losses can be offset against share gains.
Roll-over relief may be available to a company asset disposal to defer the capital gain. Those selling their company shares can only defer the capital gain by reinvesting in shares qualifying under an Enterprise Investment Scheme.
Where share purchases can become particularly tricky is when a loan is needed for the transaction to be completed, but the only security is in the assets of the company that is the subject of the deal. It is illegal for a company to assist in the purchase of its own shares, but the formation of another company and a 'hive up' of assets into the new company can help complete the transaction while also complying with the Companies Act. This should only be carried out, however, with the services of an experienced company law solicitor who will work alongside the accountant carrying out the due diligence.
It is commonly considered that share purchase transactions should be the preserve of those experienced in the buying and selling of businesses, who have a considerable sum available - generally in the region of £20,000 - to cover accountant and solicitors fees. A sale of shares will be full and comprehensive and transfer any past actions of the previous owner on to the new one. More straightforward asset purchase transactions leave the vendor responsible for tying up issues with liabilities and creditors.
Whether a small or large business acquisition, seeking specialist legal and tax advice at an early stage in the process will help prevent expensive post-sale problems.
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