There is a situation where you might be advised to make an election to pay tax. It arises if you sell your company and accept payment in the form of shares (or certain types of loan notes) from the buying company.
Let’s say that you own all of the shares in your company X Ltd and the original cost of the shares five years ago was £1,000.
You are approached by Z Ltd who offers to purchase your shares for £1m and offers you shares in Z Ltd as consideration for the transaction.
What are the tax consequences?
Basically, the share swap is not a chargeable event for Capital Gains Tax purposes. Your holding in Z Ltd will be deemed to have a base cost of £1,000 (the original cost of the X Ltd shares). This tax treatment is automatic. No election needs to be made. No tax is payable.
Why might you want to elect to pay tax now?
The issue that might encourage you to elect to pay Capital Gains Tax when the share swap is completed is Entrepreneurs’ relief (ER). To qualify for ER certain criteria need to be met. For example:
- You will need to be a director or employee
- Hold at least 5% of the ordinary share capital and voting rights
- Have held the shares for at least a year, and
- The company must be a trading company or the holding company of a trading group
The possible benefit arises if you are uncertain that your new holding in Z ltd will qualify for ER when you dispose of the shares at some future date. Any gains that qualify for ER, either now or in the future, would be taxable at 10%; gains that do not qualify would be subject to tax at 28% (based on present rules).
In order to work out the best way forward you should consider your options before completing the sale.
