HOW TO TAX-EFFICIENTLY EXTRACT PROPERTY ASSETS FROM A COMPANY
It is not uncommon for companies to own both investment and trading assets. This is often the case when shareholders use the company’s retained cash to purchase investment properties or assets—typically in an attempt to mitigate taxes on the extraction of funds from the company. Companies may also own both investment and trading assets if they had previously held assets for trading purposes, such as property, but then decided to retain them as investments.
While this may be a good strategy in the short term, complications could arise when it is time to dispose of the trade or property.
Normally when a trade is disposed of, the director/shareholder can consider the sale of his/her shares, and, with Entrepreneur’s Relief they could minimise their tax liability to 10%. However, if the investment assets and trading assets are hinged, it may be difficult for the director to find a buyer willing to purchase the company complete with property and other investment assets. In most cases what will need to be done, is that the assets will have to be extracted from the company before the sale.
Not to mention, that if the investment assets of the company are substantial, this could disqualify you from Entrepreneur’s Relief, and cause your Capital Gains Tax liability rate to increase to 20%.
For these reasons, it is typically advised that you separate your investment assets from your trade. But accomplishing this without incurring costly tax liabilities requires careful planning.
If you were to transfer the property from your company to its shareholder, or to another company, this would be classified as a disposal and would result in capital gains based on the property’s market value. In addition, if the shareholders are residents of the UK, they would incur a tax for the undervalued property transfer as if they were receiving a dividend.
Because of these disadvantages, this is not typically the best option.
An alternative, and typically preferable, option is to conduct a demerging of the company in order to separate the investment and the trading activities.
Trading companies that undergo demerging qualify for specific Capital Gains Tax Reliefs and provisions, and they may also be able to use the insolvency act. As a result of this process, the trade could be liquidated and the assets could be split between newcos.
By using this method, the existing trade enters liquidation and the liquidator can transfer the company’s assets to the shareholder’s newco in exchange for the distribution of shares (for example, X Ltd and Y Ltd). At this point, they can dispose of the shares in the X Ltd without having to crystallise a gain in the Y Ltd. This same method can be used on investment assets by treating the shares of the X and Y Ltd as if they are held for the same period as the original trading company. Therefore, using this structure, Newco X Ltd could be allocated the investment properties, and Newco Y Ltd could be allocated the investment assets—effectively achieving a demerger where the existing shareholders still own both companies and can sell investment assets separately from the trade. This method involves many complicated steps and it is important to carefully review details and consult with an expert if possible in order to maximise tax relief.
If the shareholder owns the same proportion of the newco as they did the existing company, they may also be able to avoid stamp duty on the transfer, but the anti-avoidance provisions must be reviewed in detail to ensure no violations.
Once the demerger is accomplished, the shareholder can dispose of the X Ltd and Y Ltd shares and claim Entrepreneur’s Relief on the gain.
Compared to the standard disposal of assets by a company, the demerger method provides significant tax savings in most cases—of course, each company should review their individual account in order to determine the best option when considering any capital losses, the base price of assets/shares, and other important factors.
If your company is considering splitting its investment assets from the trade, a demerger is generally a highly effective option. Ideally, the split should occur well in advance of the disposal of shares to an independent buyer, but if necessary, shares may be disposed of shortly after reorganisation by means of the liquidation route.