Business Asset Disposal Relief or an Employee Ownership Trust? What’s The Best Way to Sell Your Business?

If you're a business owner in the UK considering selling your business, you may be exploring options to minimize your tax liabilities and ensure a smooth transition. Two popular strategies for achieving these goals are Business Asset Disposal Relief (BADR), formerly known as Entrepreneurs' Relief, and selling to an Employee Ownership Trust (EOT). Both offer significant advantages, but which one is right for you? This article will explore how each option works, their pros and cons, and help you decide which might be the best fit for your business sale.

How Does Business Asset Disposal Relief Work?

Business Asset Disposal Relief (BADR) is a tax relief that allows business owners to pay a reduced Capital Gains Tax (CGT) rate of 10% when selling their business or its assets, up to a lifetime limit of £1 million. To benefit from BADR, certain criteria must be met:

• Qualifying Business: The relief applies when selling a sole trade business, a share in a business partnership, or shares in a personal trading company. The company must be primarily engaged in trade rather than investment activities.
• Ownership: The seller must have owned the business or shares for at least two years before the sale.
• Significant Stake: For company shares, the seller must hold at least 5% of the shares and voting rights.
• Active Involvement: The seller must have been an officer or employee of the company for at least two years prior to the sale.
• Lifetime Limit: The relief is available on qualifying gains up to a lifetime limit of £1 million. Any gains above this limit are taxed at the standard CGT rate.

Pros and Cons of Business Asset Disposal Relief

Pros:

• Significant Tax Savings: BADR reduces the CGT rate to 10%, offering substantial savings compared to the standard rate.
• Incentive for Business Growth: This relief encourages entrepreneurs to grow their businesses, knowing they can benefit from a reduced tax rate when they eventually sell.
• Simplified Process: Claiming BADR is relatively straightforward and can be done as part of your self-assessment tax return.

Cons:

• Reduced Lifetime Limit: The reduction of the lifetime limit from £10 million to £1 million in 2020 has significantly reduced potential tax savings for larger business sales.
• Strict Qualification Criteria: The specific requirements regarding ownership, involvement, and business structure mean that not all sales will qualify.
• Limited to Individuals: BADR is not available to companies, so only individual business owners can benefit.

What is an Employee Ownership Trust (EOT)?

An Employee Ownership Trust (EOT) is an alternative exit strategy that allows business owners to sell their company to a trust set up for the benefit of the employees. This approach can provide a complete exemption from Capital Gains Tax, offering a significant financial advantage over BADR in certain situations.

How Does an EOT Work?

The process of selling a business to an EOT typically involves several steps:

1. Establishment of the Trust: A trust is established to purchase the company's shares.
2. Valuation and Sale: The business is independently valued, and the trust purchases a controlling interest (over 50%) in the company.
3. Funding: The trust is usually funded through the company’s profits, which are used to pay the previous owners over time. Bank loans or external financing can also be involved.
4. Employee Benefits: Once the trust owns the company, all employees become beneficiaries, meaning they share in the profits through bonuses and other benefits.

Pros and Cons of Selling to an EOT

Pros:

• Complete CGT Exemption: Unlike BADR, selling to an EOT offers a full exemption from Capital Gains Tax, which can be a significant financial benefit.
• Employee Engagement: Transitioning to employee ownership can enhance employee engagement and retention, as employees have a vested interest in the business's success.
• Legacy Preservation: For business owners who want to preserve their company's culture and legacy, an EOT is an excellent option.
• Flexibility in Payment: The structure of an EOT sale allows for a more flexible payment schedule, often paid out of the company's future profits.

Cons:

• Complex Setup: Establishing an EOT involves a more complex and potentially costly setup process, requiring independent valuations, legal advice, and potentially complex financing arrangements.
• Ongoing Profit Requirement: Since the purchase price is typically paid from future profits, the company needs to continue generating sufficient profits to pay off the selling shareholders, which could limit available cash flow for other investments.
• Control and Management: Selling to an EOT often involves relinquishing control over the business, as the employees or the trust will have significant influence over the company's future direction.

Comparing Business Asset Disposal Relief (BADR) and EOTs

When deciding between Business Asset Disposal Relief and an Employee Ownership Trust, business owners need to weigh the potential tax benefits against the long-term implications for their business.

Tax Considerations: BADR offers a straightforward way to reduce CGT, but the £1 million lifetime limit might not provide enough savings for larger business sales. In contrast, EOTs offer a complete CGT exemption, which can be a significant financial advantage, especially for high-value sales.

Legacy and Culture: Business owners who value their company’s culture and legacy might prefer an EOT, as it keeps the business in the hands of those who helped build it. BADR, on the other hand, offers more flexibility to sell to external buyers, potentially maximizing the sale price but without guarantees about the company’s future direction.

Complexity and Cost: BADR is relatively simple to claim, involving fewer legal and administrative hurdles. EOTs, while offering potential tax savings, require a more complex and potentially costly setup process.

Conclusion: Which Option is Right for You?

Choosing between Business Asset Disposal Relief and selling to an Employee Ownership Trust depends on your specific circumstances, including the size of your business, your tax situation, and your long-term vision for the company.

• For Smaller Businesses: If your business sale will not exceed the £1 million lifetime limit, BADR offers a straightforward and beneficial tax reduction.
• For Larger Businesses or Legacy Focused Owners: If your business value exceeds the BADR limit, or if you wish to preserve the company’s culture and legacy, an EOT might be a better option, despite the complexity of the setup.

In either case, seeking professional advice is crucial. A financial adviser or tax specialist can help you navigate these options, ensuring that your business sale aligns with your financial goals and values.

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