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Losing one&#39s balance

James Brown has run his limited company for five years and now wishes to sell it and enjoy retirement. While there are a number of potential buyers, his professional advisers have warned that there are some financial planning issues he needs to address before the sale goes ahead.

Specifically, Brown needs to plan the possible extraction of a cash balance of around £200,000 as this could be potentially offputting for purchasers If only Brown could hold on a little longer, the solution to his problem would be simple.

Following legislative changes in April 2006, the £200,000 would be able to be paid as a pension contribution. Tax relief would be gained and he could make use of a more flexible approach to taking the benefits. However, his home in the sun can wait no longer. Hence, his financial planner needs to be more creative.

The smart answer may be to plan to do nothing. If a purchaser could be persuaded to buy the cash, it could then be left in the company.

As Brown will qualify for business taper relief on the sale proceeds, the effective rate of tax to pay on the extra £200,000 is only 10 per cent (relief of 75 per cent of the gain is given and the remaining 25 per cent is taxable at 40 per cent).

Brown needs another plan, however, as his mergers and acquisition broker thinks it is unlikely that a purchaser will want the capital balance.

A pension payment could be his first move. Unfortunately, Brown does not own his business premises. His pension fund could then have purchased it with a view to renting it to future purchasers, securing an income for his pension.

A straightforward single-premium payment could be a solution but even here there are drawbacks. Like many business owners, Brown has opted for a low salary, high dividend approach to his remuneration. Since pension contributions are based on his salary, this limits the amount he can pay. His financial planner may consider maximum funding in an executive pension plan but, with only five years service, there is little scope for significant contributions.

An investment in a venture capital trust should be seriously considered but this will necessitate Brown taking the money out of the company either as salary or dividend. As the money has remained on the balance sheet to avoid this, at first glance, this advice may seem flawed. Further examination is required.

The tax to pay on extracting £200,000 is frightening. Payment by dividend means a whopping tax bill of £110,000 (dividend tax = £50,000 while corporation tax = £60,000).

A better solution is to take the cash as a salary bonus. Employer&#39s National Insurance is £25,600, with personal tax and NI totalling £82,000.

However, a VCT investment of £200,000 will give tax relief of £80,000 if held for three years. Repayment of tax could be almost immediate by asking the tax office to change the PAYE tax code.

VCTs have other tax advantages as dividends and growth are tax-free. But the investment decision should not be made on taxation issues alone.

VCTs are investment trusts listed on the London Stock Exchange which offer investors the ability to invest in small unquoted, Ofexor Aim-listed companies. They are therefore for those investors looking for a higher-risk investment. That said, there are many fund managers in this market with significant experience.

A generalist VCT (as opposed to an AIM or sector-specific VCT) run by a well known VCT manager (notably Electra, Baronsmead, Close and Northern) is therefore less of a gamble. Good past performance figures and acceptable volatility offer some comfort.

For Brown, it should be borne in mind that the VCT will ultimately form only a small proportion of his total investments. With a sale target for the business of £3m and another £500,000 in assets, the investment will be just 5.6 per cent of his portfolio.

Now that his salary has been increased, Brown has much more scope to make a pension payment. He can do this now, when the sale proceeds are received, or later using this tax year as his basis year.

Whatever his choices, Brown is in an enviable position and his financial planner can feel satisfied that their knowledge of the tax system has provided some extremely valuable suggestions.

•Tax calculations provided by Altons Chartered Accountants


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