Selling your small business in Great Britain?

Tax sting when selling a small business: deferred benefits liable to income taxes.

Anyone who has recently sold or is looking to sell a small business needs to be aware of changes passed as part of 2003’s Finance Act. Deferred benefits or “earn-outs” in the form of securities that are offered to the seller of a business may now be subject to income tax at 40% rather than capital gains tax at 10%.

It is common practice for a buyer to offer a cash sum at the time of sale, and in addition deferred benefits in the form of securities (eg shares or loan notes) to be paid at a later date, depending on the performance of the company. If the seller has been offered a substantial earn-out sum, for example £1m two years after the sale of the business, they could face a potential tax bill of £400,000 instead of £100,000.

The Inland Revenue can now attack any earn-outs which it views as employment-related bonuses rather than strictly related to the sale of the business. Earn-outs related to an individual’s performance may therefore be on especially shaky ground.

Inland Revenue enforcement unknown

The extent to which this new stance will be enforced is not yet known, and the Inland Revenue is expected to publish further advice to clarify the situation. In the meantime, individuals selling small businesses should monitor the way the new legislation is used in practice.

The clampdown will also affect anyone involved in brokering corporate deals, such as corporate finance professionals.