24 June 2022

Selling companies with debt - Don’t get caught out!

Office workers shaking hands

A buyer will often insist that the company it is buying is debt-free. What should happen where there is debt owing to a bank, shareholder or indeed any other debt in the company?

Many buyers will instinctively want the seller to pay off the debt. The buyer might have bought their own house and it was for the seller to pay off its own debt. Why should buying the shares in a company be any different?

Unfortunately, the way a share sale is structured can have significantly different outcomes for the seller.

There have been a number of cases over the years where a seller has fallen into the trap of agreeing to (a) present the buyer with a debt-free company or (b) ensure commitment to pay off the debt on behalf of the company out of part of the sale proceeds. That is a tax disaster for the seller. The seller ends up paying capital gains tax (CGT) on the debt repayment.

Consider a deal to sell a company free of debt for £5million. At the time the deal is agreed the company has debt of £3million. If the seller agrees to sell their shares for £5million and use £3million of the proceeds to repay the company’s debt of £3million, then they will suffer CGT on the gain on the full £5million of proceeds. 

This is precisely the situation in which one poor seller recently found themselves. The seller in that case argued that if the deal had been documented differently, there would obviously have been less CGT to pay. The court accepted that was logical in a business sense, but unfortunately had no power to go against the tax law. It referred to the famous 1936 Duke of Westminster case (where the taxpayer won) which says:

Every man is entitled if he can to order his affairs so that the tax is less than it otherwise would be.

The taxpayer in the recent case was ordering her affairs so the tax was higher than it needed to be. What is sauce for the goose, is sauce for the gander (with a bitter aftertaste!) She had to pay tax on the full £5million of proceeds.

So, what should the seller have done? If the shares were sold for £2million with the buyer agreeing to clear the debt, the buyer is still paying £5million overall and the seller will only pay CGT on the gain on £2million of proceeds.

We will work with your existing accountants and advisers on mergers and acquisitions and other corporate transactions to help you achieve the best outcomes.

For further information on how we can help you, please contact Nasim Sharf. Alternatively, click here to view our corporate and commercial page.

Nasim Sharf, Wilkin Chapman LLP
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