Contractors' Questions: How to split my IT company tax-efficiently?

Contractor’s Question: I have received an unexpected but very welcome offer from an investor to buy a minority stake in one of the two service lines that my IT services company operates. I don’t want to let down the clientele that the company has built up over its six years, but the investor’s cash offer is very substantial and should let me reduce how much time I spend in the business. What are my options?

Expert’s Answer: There are generally two avenues to go down if you wish to realise a tax-efficient cash payment from the investor. Your first option would be to demerge your company into two businesses and sell shares in one of them. 

Your second, easier option is to sell some of your shares in the current company to the investor. By doing this, Entrepreneurs’ Relief should be available so the tax rate you’d pay on any capital gain would be only 10 per cent. Although this would give the investor an interest in both of your company’s service lines, you could continue to run them both.

Alternatively, you could take the de-merger route. But this is more complicated, so should only be attempted if it is vital that your current business is split into two separate entities. Demerging is also more costly, so a significant amount should be at stake if you proceed.

In addition, because you intend to sell some shares subsequently, you would require what’s known as a Section 110 liquidation demerger. With this, you shouldn’t attract a hefty tax charge on the reorganisation. After this stage, the investor can acquire an interest in the relevant business.

Lastly, I recommend that, before you take action, establish between you how any shared costs will be allocated, and how your time will be divided to run both businesses. You might consider a joint venture, but a cash return from the investor appears to be more what you want.

The expert was Jon Dawson, partner at Kingston Smith LLP.

Wednesday 20th August 2014