The chancellor's pre-budget report proposed a new single capital gains tax rate of 18 per cent. What impact will this have on mergers and acquisitions in the FM sector?
by Chris Clark
16 November 2007
Still a relatively young industry, FM is constantly evolving to meet the demands associated with new developments in international and UK economies.
The market in which FM companies operate is driven by the outsourcing trend of non-core operations and the fact that as operations increase in their technical complexity, organisations look to specialist companies to take on the burden of compliance and regulation.
The growth this has driven in the sector has seen the FM market subject to considerable amounts of merger and acquisition activity and investment from private equity backers who recognise the favourable dynamics the sector offers.
high degree of contractual revenue
active with blue chip clients
ability to leverage position with clients to provide additional services
longevity of relationships making it difficult to switch to new providers
Management teams, along with their investors, have sought to grow their businesses either organically or through bolt-on acquisitions, ultimately realising their own investment through a sale to another investor or trade acquirer. The substantial gains that could be made from such a strategy are treated as capital rather than income and the favourable UK tax environment means that their gains would be only taxed at 10 per cent. This is now set to change.
It had been mooted for a while that the chancellor was looking to reduce the benefit private equity investors gain from this tax regime but the surprise was his broad brush approach and an increase in capital gains tax (CGT) to 18 per cent from
6 April 2008, applicable to all.
The proposal, while simplifying the tax regime and reducing the differential between tax rates on income and capital, will obviously have implications for business owners considering a sale.
Sale of shares
Generally, under the current tax rules CGT is payable on gains made from the sale of shares in a business. The amount of the gain liable to tax is determined by the increase in value of the shares during the seller's period of ownership. The standard rate of CGT is 40 per cent (for higher rate tax payers) but is reduced by taper relief to as low as 10 per cent depending on how long the shares were owned
prior to sale.
The new proposal
Under the new rules announced by the chancellor in the pre-budget report, capital gains on disposals made on or after 6 April 2008 will be liable to be taxed at a new flat rate of 18 per cent and taper relief will not be available.
This means that for the majority of individuals selling their business, the reforms will significantly increase CGT costs.
There is now less than six months remaining to exploit the benefits of taper relief and the potentially lower tax charges on gains. To avoid the new regime, a sale must be completed or made unconditional on or before 5 April 2008.
Typical sale processes can take between three to six months, therefore potential sellers who are at the very early stages of considering a sale should take action immediately by instructing advisers and corporate financiers to assist in the identification of a buyer and the key terms.
The additional tax charge could be exploited as a negotiating tactic by buyers. Therefore planning completion on 5 April 2008 could be costly in a number of aspects.
There is a limited window of opportunity to exploit the currently favourable tax regime and it leaves little time in the disposal process for typical grooming issues to make sure the business is prepared for the scrutiny of a potential acquirer. Businesses with good controls and systems are best positioned to act now.
CGT: key points
An 8 per cent increase in tax on
capital gains due to taper relief is
being withdrawn and a new 18 per cent tax rate on capital gains will be introduced after 5 April 2008. The length of ownership of an investment will become irrelevant (previously taper relief required a minimum
two-year holding period)
Business owners considering a sale can make significant savings by completing it before 6 April 2008. Bringing forward the exit or refinancing plan may be appropriate
Where loan notes have previously been taken to defer taxable gains, there may be advantages in refinancing these to crystallise gains early to enjoy the 10 per cent rate before the 18 per cent rate hits
Christopher Clark is a corporate finance director at BDO Stoy Hayward