Taxation logo taxation mission text

Since 1927 the leading authority on tax law, practice and administration

Pregnant property

15 December 2005
Issue: 4038 / Categories: Forum & Feedback
'If the assets and trade are sold, the directors will suffer a substantial corporation tax charge and another charge to extract the profits'

My client is a trading company, which is not really 'going anywhere'. It makes sufficient to remunerate the directors and employees, but the profits are flat and the directors would like to get out of the business if they could.
On the plus side, the limited company owns a newish property, which is currently worth in the region of £1 million.
It acquired its original premises about thirty years ago for £40,000. In the mid-1990s, the premises were redeveloped, the deal being that the developer provided a new site and building nearby, which was valued at about £600,000, in exchange for the old property.
The gain on the old property was rolled over into the new, so the current property is now 'pregnant' with a substantial gain.
The company has an interested buyer for the property. They are in the same business and might be tempted to purchase our client's business as well, although they seem reluctant to purchase the limited company that owns the property and carries on the trade.
Could readers provide a summary of the tax issues relating to such a transaction? It seems to me that our clients would be better off selling their shares in the company rather than the assets, etc. Is this thinking 'up to date' or are there any ways that the transaction could be structured to make it fiscally appealing to both parties?
Query T16,730   — Midwife.


Reply by Inverclyde Racer

Midwife's thinking is correct; the directors would be better off selling the shares, because the directors' capital gains will presumably attract a 75% deduction for business asset taper relief. If the assets and trade are sold, the directors will suffer a substantial corporation tax charge and another charge to extract the profits.
However, the interested buyer may prefer not to buy shares and the directors must set down all the advantages of shares and use these to negotiate. Assuming the interested buyer is a company, the following apply.
If the interested buyer will not take the trade and other assets, then the directors should consider a reconstruction. The trade and other assets can then be transferred to New Co, leaving the target property in Old Co. The Old Co shares are then sold by the directors to produce the same tax effects as above. This may be the compromise option which would suit both parties.
However, in this scenario the directors are left with the trade and other assets in New Co. The directors could consider a management buy-out in addition to any option of sale to a third party.
The transfer of the other assets to New Co are automatically at tax written down value as both companies will be under 75% common ownership. Trade losses do not seem to be an issue here, but if any exist they must be transferred to New Co if the trade is transferred. As defined at TA 1988, s 343, Old Co will be prevented from making a three-year terminal loss carry back where the trade is transferred to New Co.
The worst case scenario for the directors would be the sale of the property only. This would produce a double tax charge; first, a corporation tax charge on the company at 30% would produce a tax liability in excess of £300,000, then a charge on the directors to extract the profits.
It is most likely that the interested buyer will attempt to negotiate the purchase of the assets and possibly the trade only and will be reluctant to make a share purchase.
A share purchase will add an associated company reducing corporation tax limits if the trade is included. The purchase price will also increase where the trade is included in the deal. Although the directors should be aware of the fact that the interested buyer will incur a greater stamp duty charge if only the property is bought at 4%, all share purchases incur stamp duty at 0.5%. This could be used as a bargaining tool for the directors to negotiate a share sale.
Other points worth consideration are as follows.
VAT — although this is most likely not a main concern. The vendor and interested buyer being in the same business will make the transaction a mirror image in each. Both are most likely either standard rated or exempt.
Timing is important and steps required must be completed on a timely basis. Note for capital gains tax purposes that the date of the disposal takes place at the time the contract is made and not when the assets are transferred.
The directors could extract dividends just before the sale of the shares; this reduces the value of the company and the gains chargeable, but note the anti-avoidance provisions in place in this scenario at TA 1988, s 703. However, an advance clearance application may be made to HMRC.
Whichever eventual sale occurs, payments to the directors' pension funds must be considered. These would be tax efficient and provide benefits in future years.
The fact remains that the company has a large potential gain, which will put off any buyer to take the shares and the option for the interested buyer to take the property with an increased base cost may be difficult to overcome. However, the directors appear to have time to find a suitable buyer to take up the shares.

Reply by Exile.

The basic rule is that, if the company is a trading company and the shares have always qualified for business asset taper relief, the vendor will want to sell the shares. The purchaser, however, will want access to any allowances attaching to the goodwill, plant and building and will not want to take on the history of the company or the pregnant gain on the property. The purchaser will also want to acquire the property with its current market value as the base cost. The way to structure the transaction so that it is acceptable to both, based on values shown, will be to negotiate the price.
If the company's shares are to be sold, the vendor should be willing to reduce the price to recognise the tax that they are saving. If trade and assets are being sold, the purchaser should be willing to increase the price to compensate the vendor for the tax that will have to be paid as a result of having a double tax charge, once in the company and once on extraction. Remember, also that the sale of shares will have stamp duty at 0.5%, rather than stamp duty land tax at 4%.
Any other planning will probably cost more than any tax to be saved.

Issue: 4038 / Categories: Forum & Feedback
back to top icon