Irish playwright, George Bernard Shaw, famously described Britain and America as “two nations divided by a common language”. The sentence summed up the difficulties that arise when Britons and Americans assume that each understands the other fully, when the exact opposite is true in reality. A Londoner going to work without his pants may feel a tad uncomfortable (although a Glaswegian may feel different!), but the New Yorker commuting without his pants is likely to get arrested!
As with language, so with tax. The USA was born out of a revolt against British taxes so it should be no surprise that there are major differences between our respective tax systems. However, the number and material nature of those differences almost always amazes UK entrepreneurs when they first interact with US buyers or investors.
A typical transaction may involve the acquisition of a British business (Britco) by an American counterpart (USco). USco will likely assume that the transaction can be structured as a trade and asset deal, since the tax differences between a trade and asset deal and a share deal for most equivalent US sellers will be negligible because of the tax transparent nature of the majority of owner managed US companies. Doing so will enable USco to “step up” the base cost of the goodwill and intellectual property to their market value for tax purposes, allowing it to claim tax relief for their amortisation. Unfortunately, a trade and asset sale will be a tax disaster for 99.9% of UK sellers, as tax will arise at the corporate level when the assets are sold and then at the personal level when proceeds are extracted.
Fortunately, there is a solution which squares this circle, which is a US tax election that allows USco to pretend it had bought trade and assets whilst actually having acquired the Britco shares. Anyone who has sold a company to a US buyer is likely to have been asked to make this election. This is generally meaningless from a UK perspective, so it can generally be made without risk.
The USA is, of course, the great bastion of shareholder capitalism and it should come as no surprise to the sellers of Britco that USco may want to offer them shares (or “stock”) as part of the consideration. What may surprise is that the UK generally has more favourable rates of capital gains tax once state taxes and other adjustments are considered. This won’t impact a British resident seller, since they should only pay UK tax when the USco shares received are eventually sold. However, the sellers will need to consider what sort of shares they receive. Common stock in USco should be taxed in the same way as UK shares but many US companies, particularly those with private equity backing, offer Restricted Stock Units (“RSU”) instead, since they avoid dilution of existing shareholders. Unfortunately, RSUs are unapproved share options for UK tax purposes, meaning that the UK holders of them will suffer a combined National Insurance and income tax rate of up to 47% on sale.
Even if USco offers the correct sort of equity, there can be other traps for the unwary British seller. As I’ve already noted, many US Limited Liability Companies (LLCs) are tax transparent, meaning that shareholders pay tax on profits as they arise. This generally results in a UK shareholder being taxed on their share of the profit in the USA as it arises, before then suffering UK income tax or capital gains tax on cash extracted by way of dividend or received on a sale. Generally, the US tax cannot be offset against the UK tax because they are different types of income (company profits rather than personal income or gains). The Treasury is currently consulting on changes to the taxation of income from US LLCs which should remove this anomaly, but it can be a major impediment to agreeing a structure for a US acquisition.
Of course, language and tax systems are not the only areas in which the UK and US have diverged over the last 250 years. Sadly, from a UK perspective, economic performance is even more divergent now, meaning that UK assets are cheap for US buyers but, also, that the opportunity for a UK entrepreneur to benefit from a version of the American dream is becoming ever more enticing. Despite the tax and language issues, US investors are likely to be keen buyers of UK assets, and British entrepreneurs are likely to be keen sellers to those buyers, for many years to come.
Iain Wright is a founder and Partner of Claritas Tax.
Iain us a Chartered Accountant and Chartered Tax Adviser with over 25 years’ experience in the tax profession. Having worked at Big Four and mid-tier firms in the past, he established Claritas in 2012 to provide big firm experience and expertise to mid-market privately owned and private equity backed businesses and their owners.