Management buyout tax implications in the UK

An MBO has two tax positions running at once, and they are not the same problem. You are disposing of shares. Your team are acquiring them because of their employment, which drops them into a regime most of them have never heard of.

The seller’s position

Broadly the same as any other share sale. You have a capital gain and the question is what rate applies.

The complication specific to MBOs is the loan note. A large part of your price arrives over several years, so the treatment of deferred consideration matters, and whether your loan notes are qualifying corporate bonds or not changes when the tax falls due. That is a question for your accountant before heads of terms are signed, because the answer can depend on how the notes are drafted.

The management team’s position

This is where MBOs catch people out, and it is worth the team understanding it before they sign anything.

Shares acquired because of employment fall within the employment related securities rules. The regime applies to employees and to officeholders, including non executive directors, and it cannot be sidestepped by putting the shares in a spouse’s name or a personal company.

If the team pay less than the shares are worth, the difference is employment income, taxed at their marginal rate rather than as a capital gain.

Restricted shares, and why it gets worse

MBO shares almost always carry restrictions: they cannot be transferred without consent, they may be forfeited if someone leaves, voting or dividend rights may be limited. Those restrictions reduce what the shares are worth.

That creates two values. Actual market value, what the shares are really worth with the restrictions attached. And unrestricted market value, what they would be worth without them.

Without an election, the gap between those two values sits untaxed at acquisition, and a proportion of all future growth is later taxed as income rather than capital, at up to 45 per cent, at the point the restrictions lift or the shares are sold.

The fourteen day window

A section 431 election cannot be made late and cannot be made retrospectively.

The section 431 election

A joint election signed by employee and employer that treats the shares as acquired at unrestricted market value. Income tax is paid on the discount now, and all future growth is then taxed as capital rather than income.

Three things about it that matter:

• Fourteen days. It must be made within fourteen days of acquisition and cannot be made retrospectively. Miss it and the option is gone
• It is not filed with HMRC. Both parties keep a copy, and the company reports whether an election was made in its annual employment related securities return, due by 6 July following the tax year
• It is a bet. If the shares rise it saves a great deal. If they fall, tax was paid that need not have been

For a management team buying a business they expect to grow, an election is usually the right answer. It is still a decision that needs their own adviser rather than yours.

Why the seller should care

You might reasonably think the team’s tax position is their problem. Two reasons it is not.

A team who discover a large unexpected income tax bill during the process may need more cash, which comes out of your price. And a team who discover it afterwards will feel it was something you should have raised, which matters when a large part of your money is still sitting in a loan note they control the repayment of.

The valuation question underneath it

Both tax positions rest on what the shares are actually worth. A valuation that cannot be supported creates exposure on both sides: yours if the consideration is challenged, theirs if the discount to market value turns out to be larger than claimed.

Which is why the valuation needs to be independent and documented rather than agreed around a table. The valuation calculator is a starting point, not that document.

How we handle it

We do not give tax advice. We work alongside a legal practice and an accountancy firm so the structure, the loan notes and both tax positions are dealt with together, and so the fourteen day window is diarised rather than discovered. More on the route on the management buyout overview, and on the structure on the funding page.