Dealpoint is a regular briefing on issues relevant to corporate transactions,
notably M & A and reconstructions. Each edition of Dealpoint will
focus in detail on one area of law and practice which may be of interest
to principals and practitioners in the corporate transactions area.
This edition of Dealpoint looks at the impact upon corporate transactions of the proposed changes to Capital Gains Tax announced by the Chancellor in October 2007.
Capital Gains Tax Reforms
Summary of Changes
The Chancellor announced that for individuals, trustees and personal representatives:
- taper relief will be abolished for all disposals taking place from 6 April 2008;
- a single flat rate of 18% will apply for all capital gains realised from 6 April 2008;
- indexation will not apply to any disposals crystallised from 6 April 2008;
- all assets held on 31 March 1982 will have deemed to have been acquired at market value at that date.
Impact on Corporate Transactions
- The increase of the effective rate of Capital Gains Tax for individuals who benefited from taper relief appears to have been driven by a political desire to tax private equity executives more heavily. Entrepreneurs however, have been caught up in this change and their effective rate of Capital Gains Tax will rise to 18% from 10% in relation to all disposals effected on or after 6 April 2008. It must therefore be expected that private companies that may be considering a disposal in the medium term will accelerate that disposal for a completion (or a crystallisation of the disposal for Capital Gains Tax) before 6 April 2008. Private equity backed companies will be among those looking for an exit so that the carried interest arrangements are also taxed at 10%.
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For buyers this will create opportunities with more businesses being offered for sale. Both buyers and sellers may find that there is a downward pressure on prices with more businesses on the market. Buyers may find they are able to negotiate a reduction in price as 6 April 2008 approaches and the prospect of a leap in Capital Gains Tax rate from 10% to 18% looms.
For entrepreneurs who have held shares in private companies since before 6 April 1998 the position is worse as indexation is abolished for all disposals from 6 April 2008. Entrepreneurs will therefore find themselves paying capital gains at 18% on all gains, including inflationary gains, which will no longer be indexed. Those entrepreneurs will find that instead of paying a 10% rate of Capital Gains Tax on indexed gains, they are paying a Capital Gains Tax rate of 18% on all gains, including inflationary gains. This produces a marginal rate of Capital Gains Tax of well in excess of 18%. Again this may contribute to a rush to sell businesses creating opportunities for buyers.
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Existing holders of loan notes are likely to be seeking to cash in those loan notes before 6 April 2008. Loan notes have traditionally been structured so that gains are rolled over into the loan notes. Any loan notes cashed in or redeemed after 6 April 2008 will suffer Capital Gains Tax at 18% and will not have any benefit of taper relief. Issuers of loan notes may well have requests made of them to amend the terms of loan note instruments to allow encashment before April 2008.
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Existing earn-out arrangements which are due to expire after April 2008 should also be reviewed. It may be possible to crystallise a gain in relation to earn-outs prior to April 2008 to take advantage of taper relief and the 10% rate of Capital Gains Tax. Again, it may be possible for the buyer to take advantage of this lower rate of Capital Gains Tax by “sharing” some part of the tax saved.
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Holders of options, particularly put options, who can require others to buy their shares, should carefully consider whether the put options should be exercised before 6 April 2008 to take advantage of the lower rate of Capital Gains Tax. Cross options granted in respect of minority interests are likely to be relevant and corporates which have granted put options should be aware of the possibility that the put options may be exercised against them in the next 6 months.
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Transactions being negotiated between now and the end of the current tax year will need to take into account the changes. Sellers will be very unwilling to accept any element of loan notes or deferred consideration where the Capital Gains Tax is being crystallised after 6 April 2008. It may be possible to structure loan notes or deferred consideration so that the capital gain is crystallised in the current tax year (thereby taking advantage of taper relief). In this situation, of course, sellers will then have a tax bill without receiving the cash, which is still represented by the loan notes. There will be difficult commercial balances to be drawn between the commercial requirements of sellers, buyers and a desire to take advantage of lower tax rates.
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The higher Capital Gains Tax rate of 18% may lead to a revival in the capital gains tax planning market with vendors being more willing to look at aggressive strategies.
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Finally, the announcements made by the Chancellor on 9 October are proposals to take effect in the 2008 Finance Act. Traditionally Finance Acts have not been enacted until July/August of the relevant year. This will produce an interesting dynamic as the new rules are due to come into effect on 6 April 2008, which is 3 to 4 months before the final form of the actual legislation will be known.
October 2007
For further information please contact
Richard Wrigley
T: 44(0)870 763 1586
E: richard.wrigley@martineau-uk.com
This article is a summary of the law of
England & Wales as at October 2007. Its contents are general only
and should not be relied upon in relation to any specific matter or transaction
where advice should be sought.
©
Martineau 2007