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I am considering selling my business or passing on to the next generation or some form of exit strategy from my business – What tax issues do I need to bear in mind?
I am a business man in my 50’s. I have owned my business for many years and am now considering my options. Will I pass some or all the business to my next of kin? Will I sell the business to a 3rd party if there is an interested party offering the right price? Do I want to retire now, or do I wish to retain some involvement or some control over the business?
There are many non-tax factors to consider in situations like this; such as family relationships, availability of funding if children want to buy the business, business values in recessional times versus Celtic tiger-like times etc. But for now, we will focus on the tax issues. The main theme of this piece is how to proceed with whatever course of action, in a tax efficient manner.
My initial thought is passing the business to my children, with as little tax payable as possible
My first tax problem here is capital gains tax (CGT). Regardless if I pass the business on without the children paying anything to me, or if they pay some monies towards the purchase, I could still be hit with a CGT liability. The basic principle is that the CGT liability would be 33% of the gain, which could result in a sizable tax liability. Fortunately, there are CGT reliefs to cushion the blow:
What is Retirement Relief?
If I qualify for retirement relief, I could possibly reduce the capital gains tax to nil. As with all tax reliefs, there are a number of conditions to satisfy. One of the key points about retirement relief is that, notwithstanding the connotations that the name might generate, I do not actually have to retire. I can still continue on in the business. If I am aged 55 or over but not yet reached 66, I may be able to pass on the business to the kids, and it does not matter what value the business is – the full gain may be exempt from CGT and there would be no CGT payable. If I am 66 or over, there is a cap of €3 million on the value allowable for retirement relief. There is marginal relief for amounts up to a certain level that exceed the €3 million limit. The other main conditions are as follows:-
- I must own the shares for a minimum period before the transfer to the children – generally 10 years.
- I must own a minimum amount of voting rights of the company – which is generally in the form of ordinary share capital. The minimum amounts are 25% if just looking at my shareholding; or if I don’t have the 25% minimum amount, then the quantum needs to be 75% when taking my shareholding along with my family’s shareholdings. In the latter 75% scenario, I must personally have a minimum shareholding of 10%.
- I would need to have been a working director in the company for a minimum of 10 years up to the date of transfer to the children, 5 years of which are on a full-time basis. To qualify as a fulltime working director, I would be required to devote substantially the whole of my time to the service of the company in a managerial or technical capacity.
- My children would need to hold on to the shares for a minimum of 6 years. Otherwise, there could be a clawback of the relief, which would be payable by them.
It is obvious from the above conditions that the relief is not just something a business owner should consider with a short-term focus. Careful planning should be put in place at an early stage to ensure that all conditions are satisfied. If Revenue were to review the transaction, there could be a sizable tax cost if all the correct building blocks are not in place.
What if I do not qualify for Retirement Relief?
If I have not yet reached 55, or do not meet the other conditions for retirement relief, entrepreneur relief might be another option. The basic premise is that the first €1 million of a gain is taxed at the lower rate of 10%, and the gain over €1 million is taxed at the standard 33%. There are different conditions than those in place for retirement relief:-
- There is no minimum age limit.
- I must own the shares or business assets for at least 3 years in the 5 years prior to passing to the children.
- I must own at least 5% of the ordinary shares in the company, or 5% of the ordinary shares in a holding company in a group situation.
- I must be a director or employee, required to spend not less than 50% of my time in a managerial or technical capacity for a continuous period of 3 years in the 5 years immediately prior to disposal.
If structured correctly, retirement relief and entrepreneur relief can be very effective reliefs to reduce the CGT burden. A couple of other points:
- I have referred to the passing on of company shares in the above scenario. However, retirement relief may also apply to businesses that are not incorporated as a company e.g. sole traders.
- The monetary limits referred to for retirement relief and entrepreneur relief are lifetime limits – not on a “per transaction” basis.
- Retirement relief may even apply to assets that a business owner owns personally. For example, if I own property in my own name which I rent to my company, I may be able to avail of retirement relief if I dispose of my property at the same time and to the same person as I dispose of my company shares to. However, this opportunity does not apply to entrepreneur relief.
Would my children have tax issues to be concerned about?
The main tax that they would need to consider would be capital acquisition tax (CAT) – also referred to as gift tax or inheritance tax. If they pay me full market value for the business, they are not receiving a gift, therefore CAT should not be an issue. However, if I pass on my business to my children without them paying me anything, or paying an amount less than market value, they could be deemed to be receiving a gift and therefore pay tax on that gift.
The basic tax rate is 33% of the taxable benefit value. Fortunately, there is a relief called business property relief available to mitigate the gift tax for my children. If they qualify for the relief, the taxable benefit could possibly be reduced to 10% of the actual benefit received, and they may then be able to benefit from the tax-free lifetime threshold that a child can receive from a parent – currently €320,000. For example, I have a business worth €9 million. I decide that now is the right time to pass it to my 3 children – in equal shares, so that they receive €3 million each. If all the conditions are satisfied for the business property relief, the taxable value for each child is reduced from €3 million down to €300,000. And if the child has not received any gifts or inheritances falling within the Class A tax-free threshold (which is generally from parents), then there is no tax payable by any of the children.
As with the other tax reliefs, there are various conditions that need to be satisfied for the business property relief to qualify – minimal shareholdings; the relief applies to trading companies as opposed to investment companies etc. There are other criteria to consider, but you can discuss these issues with our tax team.
What if I wish to sell to an interested 3rd party buyer?
If I am temped to sell to a 3rd party buyer instead of passing the business down to my children, I may still be able to avail of retirement relief or entrepreneur relief. Similar conditions apply as referred to above. However, the limits on which I may be able to claim the relief for are reduced. If I am aged between 55 and 66, the lifetime sales proceeds upon which I can claim relief on is €750,000. However, if I am 66 or older, this limit is reduced to €500,000. Again, there may be marginal relief available if exceeding these limits. If my business is well in excess of the €750,000 limit, it is unlikely that retirement relief will be of any benefit. Therefore, I turn to entrepreneur relief – whereby the first €1 million of the capital gain is taxed at 10% and the remainder is taxed at 33%. With careful planning, I may even be able to avail of both by piecemealing a potential sale.
What if I want to exit from the business, but I do not want to sell it?
In a scenario like this, it could be the case that I have a certain shareholding in the business, and family members along with an unrelated long-serving manager may hold the remainder. At this point, I want to let go of the reins, but the remaining individuals do not have the cash personally to buy my shares. Without any tax reliefs in place, a payment to me for my shares may be subject to higher income tax rates. However, if the transaction qualifies as a share buy-back, I may be able to avail of the lower CGT rate on the sale of the shares to the company. Again, there are various conditions, but the availability of CGT treatment is largely dependent on what we term “the trade benefit test” – the purchase by the company of my shares must be wholly or mainly for the benefit of the trade. This would be the fundamental issue that Revenue would examine on inspection.
Other miscellaneous points to bear in mind
- If we have a situation whereby all the shares are in one spouse’s name, it may be worthwhile considering transferring a certain portion over to the other spouse – so that both may be able to avail of the tax reliefs available.
- Retirement relief and entrepreneur relief may be available in situations whereby a company is liquidated and the cash is distributed to the shareholders.
- In some situations, it may be useful to have a holding company structure, whereby the trading company is owned by the holding company, which in turn is owned by the individual shareholders. The individual shareholders do not directly own the trading company. Subject to a range of conditions, if the holding company sells the trading company, the gain it makes may escape CGT, and the full sales monies may be reinvested back into some form of business investment.
- Other ideas that may be possible are taking a tax-free termination payment when parting from the company and possibly topping up the pension fund with employer pension payments.
Conclusion
As can be seen there is a lot to consider from a tax perspective. The important point to take away from this is the need to implement careful tax planning in a timely basis. The reliefs cannot be satisfied at short notice. And if it goes wrong, it can be quite costly.