29 October 2022
As we approach the tax return filing deadline, individuals who sold shares in their business during the 2021/22 tax year will be reporting the disposal on their tax return and settling the associated tax. These transactions are likely to be unusual items on the individuals’ tax returns, which, combined with the approach HMRC revealed it is adopting earlier this year, increases the risk of enquiry.
In May 2022, HMRC shared a briefing confirming that it was undertaking a project to look at share sales declared on the capital gains tax (CGT) pages of personal tax returns, and comparing the proceeds declared by the sellers to details disclosed by purchasing companies. This project initially relates to 2019/20 tax returns and involves a ‘nudge’ letter being sent by HMRC to individual vendors whose tax returns report a different sales value from that reported by the purchasing company.
Taxpayers are being asked to check their return and, if they find an error, to make a disclosure via HMRC’s Digital Disclosure Facility. Crucially, if the taxpayer believes their return to be correct, HMRC’s letter provides an email address for them to respond to confirm this.
HMRC may then issue discovery assessments in cases where no response or disclosure is received.
Clearly, there are many reasons why the sale proceeds reported by vendors and purchasers may differ – if they were declared in a foreign currency then there may be a difference in exchange rates used by the purchaser and seller; there may be adjustments and valuations used for tax purposes on an individual vendor’s tax return that do not directly correlate with amounts reported by the purchasing company. When allocating costs within their accounts, companies may also include their related costs of acquisition, which are not relevant for the vendor; or there may be accounting differences in the treatment of elements of deferred consideration in the purchaser's accounts compared with the tax treatment reflected by the vendor.
When reporting a share sale on a tax return there are various aspects that taxpayers and their advisers need to ensure that they are comfortable with.
- Was all the consideration received in cash – if not, do the share for share exchange rules apply, and if so, is there a benefit to the taxpayer of electing to disapply these rules, thus crystalising the tax up front?
- Have all the proceeds been correctly taken into account, including any funds held in escrow?
- Is there an element of deferred consideration? If so, is this ascertainable or unascertainable, and if unascertainable what is the value of the right to receive this?
- Are there professional fees that can be deducted in calculating the gain or loss on disposal?
- Is there a risk that any element of the consideration would be taxable as income?
- Is it appropriate to claim business asset disposal relief (BADR) – are all the conditions met for the required time period and on the date of disposal?
- Are any claims and elections to apply more advantageous tax treatments being made within the statutory time period to do so? For example, taxpayers could easily lose their entitlement to claim BADR if the claim is not made in time.
It is also important to consider what additional information it may be appropriate to disclose in the white space of the tax return, to provide HMRC with sufficient information to enable it to review the position, as well as to protect the taxpayer against the risk of penalties and, in some cases, an HMRC enquiry outside of the standard one-year enquiry window.
Record keeping is also key both in terms of the client providing the relevant information to enable the return to be prepared, and also to be retained as this may be required in the event of an enquiry by HMRC.
If an enquiry notice is received, HMRC is likely to ask for various documents – these include the bank statements showing the receipt of proceeds, the sale and purchase agreement, copies of any valuations obtained, supporting documents for costs of acquisition and disposal, and calculations relating to any earnout consideration payable based on future performance of the business.
If a claim for BADR has been made, HMRC will generally also request documents to demonstrate that the conditions have been met – these could include the company’s Articles of Association, to demonstrate the voting rights attaching to each share, as well as documents from Companies House evidencing directorships. Care should be taken to ensure that the qualifying conditions have been met until the date of disposal as well as for the two years prior to the date the business ceases to be carried on by the vendor.
HMRC may also look at linked transactions, for example if shares have been transferred into a trust before sale. As well as looking at the CGT position on both individual and trust vendors, the individual’s inheritance tax position will usually also be checked.
While it is not possible to prevent HMRC raising an enquiry, individuals who usually prepare their tax returns themselves may wish to consider appointing an adviser experienced in the reporting of complex transactions to complete their return. This should help to ensure that supportable tax treatments and appropriate disclosures are adopted, but should also provide comfort that, in the event of an enquiry, taxpayers have someone who is familiar with the tax issues related to their transaction to liaise with HMRC, which is likely to lead to a smoother enquiry process and a better outcome.
In view of the higher risk of enquiry in periods in which such significant transactions take place, taxpayers may also wish to consider taking out any optional fee protection offered by their adviser to provide peace of mind over professional costs in the event of enquiry by HMRC.
For more information, please get in touch with Helen Relf or your usual RSM contact.