TAX ISSUES OF BUSINESS SUCCESSION

Transcription

1 TAX ISSUES OF BUSINESS SUCCESSION Family firms are important, not only because they make an essential contribution to the economy, but also because of the long-term stability they bring, the specific commitment they show to local communities, the responsibility they feel as owners and the values they stand for. EU Commission Expert Group Report on Family Business November 2009 What is a family business? A firm, of any size, is a family business, if: 1. The majority of the votes are held by the person who established or acquired the firm, or by his/her spouse, parents, children or children s direct heirs. 2. At least one representative of the family is involved in the governance of the firm. 3. Where the company is listed, the person who established or acquired the firm, or his/her family or descendants possess 25% of the voting rights through their shares. Research data from the United States [University of Vermont Family Business Initiative] show that 90% of all US businesses are family owned or controlled. They employ over 60% of the US workforce and they are not just small businesses 35% of Fortune 500 companies are family controlled. Walmart Stores and Ford Motor companies are family controlled companies. The average life span of a family business is 24 years. While about 40% pass to the second generation, there is a significant fall to about 13% passing to the third generation and only 3% beyond that. Family businesses are estimated to make up more than 60% of all European companies. On 15 November 2012, the Department of Finance published an economic assessment of the SME sector in Ireland - using 2009 data SMEs account for over 99% of the enterprise economy in Ireland and 72% of employment in the private sector. Most SMEs are family owned. So this is not a minority sector. Family businesses have a problem that non-family businesses don t generally have succession a time when the ownership changes hands almost all at once and the family business is passed on to the next generation. There are a number of financial, legal, business and tax issues to consider and of course, the emotional and personal complications of dealing with family members and their expectations. Succession planning is an important part of business planning if the sustainability and continuity of the business is to be assured, the most suitable successor or successors chosen, financial independence in retirement achieved and last but not least family unity maintained.

2 Advance planning for succession Successful retirement from the business and succession cannot be planned overnight. The necessary steps have to be taken well in advance so that the building blocks are in place when the time is right. Most probably the owner will need to have some financial independence outside the business. If the owner intends to remain dependent on the business for income when he/she is no longer in control, he/she may be limiting his/her successor who will need to ensure that the business can support such payments and prosper. Why financial independence is important? People are generally living longer in retirement and need a secure future income independent of the business The business should not be burdened with having to provide for the retiree and his/her spouse as well as the successor and his/her family. Financial independence will mean that there are other assets to leave to children who are not in the business. How can financial independence be created? Traditionally there were three pillars for funding for retirement: 1) From the State to provide a standardised basic income, 2) From a private funded pension scheme and 3) From personal assets and investments made during a working life. Private Pension Schemes A pension fund sets aside money in a separate arrangement over a number of years to provide funds on retirement. There are essentially 2 types of pension scheme an occupational pension scheme, such as a trust established by the company to which the employer and employee make contributions and personal pensions that may be small self- administered funds or personal retirement savings accounts set up by an individual to provide for his/her own retirement and to which he/she and possibly his/her employer will make contributions. Personal contributions are tax relieved based on a scale of 15% to 40% depending on the age of the contributor and on income capped at 115,000. Employer contributions to an occupational pension scheme are also restricted but not to the same extent as those by an individual. Employer contributions to a PRSA are treated as benefit in kind and the personal contribution cap applies. During the continuity of the pension scheme, there is exemption from income tax and capital gains tax on income and gains in the scheme.

3 At retirement, there is the possibility of a tax free lump sum capped at 200,000 and the remainder of the funds can be used to purchase an annuity or invested in an Approved Retirement Fund. All in all, provision for pension should not be ignored and should begin sooner rather than later. More restrictions on tax relief will come in Personal assets and investments These will include a combination of assets built up over a lifetime and will usually be no more than a collection of separate assets acquired as funds allow such as Family home Holiday home Deposits, bonds and other cash savings Directly held investments in stocks and shares Investment property, either residential or commercial (often rented to company in family business) Life policies Inheritances from relatives Other assets collections of art, coins, wines etc Prepare for Succession In a Survey carried out by University of Limerick [see Irish Tax Review September 2008] 93% of respondents agree that planning for succession was important, but the responses indicate that succession is an issue that is often avoided with focus remaining on the day to day running of the business and a lack of appreciation that adequate succession planning may take a number of years. There may also be a reluctance to expend money on advice in advance of action and a perception that such money would not be well spent. Review the legal structure of the business Most family businesses started by an entrepreneur are held in limited companies often with the shares held by a small number of people typically husband and wife or immediate family members. We have all seen the valuable company with 100 shares held 50:50 by husband and wife. Over time this can be restrictive and there is merit in considering if an increase in share capital with different classes of shares and rights attaching to them will give greater flexibility in the longer term. Example Joe and Mary own the shares in a company that has a successful agribusiness. There are 100 shares issued and they own them 50:50. They have 3 children to whom they wish to leave the company, but with the eldest child controlling the

4 business. They may consider increasing the share capital by a bonus issue and amending the voting rights on the shares to ensure that the eldest child has control. By doing this well in advance of any transfer and having appropriate wills, they are beginning the plan for a successful succession. Although uncommon in Ireland, occasionally a few friends get together and set up a company which they own between them a re-organisation of such a company is likely to be needed well in advance of any of the shareholder s passing on their shares, if the tax reliefs are to be available. Review the requirements for any tax reliefs As most tax reliefs come with conditions attached, it is worthwhile looking at the tax reliefs in advance and considering if the business, the basis of ownership and the owners will meet the various tests. Example To obtain CGT retirement relief on the disposal of shares in a family company, the owner has to have been a working director for 10 years and a full-time working director for 5 of those years. Financing unexpected events Pure insurance has a place in every business key person/business partner/shareholder insurance should be considered. The funds provided if the insured dies or becomes incapable could be used to buy out his/her shares, support the business or repay debt and help reduce the effects of the untimely death. Insurance to pay CAT was common in the 1980 s and 1990 s when tax rates were higher, but fell somewhat out of favour when tax rates reduced. With tax rates increasing again, this type of insurance may become more common. Handing on the business In the survey mentioned earlier, 75% of respondents hoped to pass the business onto a family member. The choice of successor is often difficult, if there is no clearly identified person who is interested in the business and able to manage it. This often leads to delay is handing on the business, even when the owner wants to retire. Assuming that the successor is chosen and willing to act, the tax issues need to be addressed. Irish tax laws currently provide favourable treatment to allow the transfer of a business on retirement, where the owner passing on the business is over 55 years of age.

5 What are the tax issues on succession? Capital gains tax (CGT) A disposal, even a transfer for no consideration to a family member (other than spouse/civil partner), may give rise to CGT currently at 33%. This can be significant especially where the now valuable business has been built up from scratch and the owner has little or no base cost. Where the business passes on death to the intended successor, no CGT is payable regardless of the value and the successor is treated as acquiring it at the market value at the deceased s date of death effectively all gains up to date of death are tax-free and there is an uplift in base to market value. This is valuable and could lead someone to defer transfer until death, which may not be the best course of action for the business. There is a specific relief from CGT on lifetime transfers of certain business assets by an individual owner. Retirement relief In the first instance, the owner does not have to retire as such he/she can continue to work in the business, subject to the usual family dynamics and the new owners, of course. Broadly, the relief from CGT is given to an individual who disposes of all or part of the qualifying business assets, provided certain conditions are met. There are 2 separate reliefs 1) on disposal to a child of the owner and 2) other disposals. Disposal to child Where the disposal of qualifying assets is to the child/certain niece/nephew/foster child of the owner, there is no limit on the proceeds/value of the disposal or the gain that may qualify for relief. In an effort to incentivise the early transfer of businesses, a cap of 3m was introduced in Finance Act 2012 on transfers by individuals aged 66 or over. This amendment will only apply to transfers on or after 1 January There is a claw-back of the CGT relief from the child if he/she does not retain the assets for a period of 6 years after the transfer. In addition to any CGT on a gain during his/her own period of ownership, the child will have to pay the CGT that the parent would have paid without the retirement relief. Example Monica has built up a successful company from scratch providing specialist breads and cakes and having reached the age of 59 decided to pass the business to her

6 son, Danny, who has been working with her in the business for a number of years. The company is valued at 2.5m. CGT retirement relief and CAT business property relief meant only a small stamp duty bill to pay. Three years later Danny got a good offer from a bigger company and decided to sell for 3m. As Monica had virtually no base cost, Danny will have to pay both the CGT that Monica would have paid and the CGT on his own gain. CAT will arise as the retention period has been breached, but the CGT that Monica would have paid should be available for offset against the CAT. Other disposals Where the disposal of qualifying assets is not to a child of the owner, the gain may be relieved from CGT provided that the total sale proceeds does not exceed 750,000. Finance Act 2012 provides that the cap will be reduced to 500,000 on disposals by individuals aged 66 or over on or after 1 January Marginal relief may be available where the total sale proceeds exceed the 750,000/ 500,000 limit. The retirement relief is available to an individual sole trader, an individual partner in a partnership, or an individual who holds business interest through a company. Conditions for the relief: The disposal must be: Made by an individual, Who is aged 55 years of age or older at the date of the disposal, A disposal of qualifying assets Owned by the individual for at least 10 years. Points to Watch: Points to watch out for in relation to the individual s age and sale proceeds limit are: 1. The test for reaching 55 is the date of disposal for CGT. Therefore, he/she must be 55 before the contract is signed if unconditional rather than before the closing date. 2. Revenue have indicated that they will consider a claim for relief where the claimant is near his/her 55 th birthday and the disposal is made due to his/her severe or chronic ill health. 3. The sale proceeds limit is a lifetime limit. If all the business is not sold in one transaction, a later transaction that exceeds the limit may claw-back the earlier relief and give rise to a significant CGT liability. Qualifying Business Assests: The qualifying assets include the following specific business assets:

7 The chargeable business assets of the individual (other than tangible moveable property) which he/she has owned for at least 10 years ending on the date of disposal and which have been his/her chargeable business assets throughout that 10 year period. Shares or securities in a company, which he/she has owned for at least 10 years ending on the date of disposal, being shares or securities in the individual s family trading or farming company, or which has been a member of a trading group, of which the holding company is the individual s family company during a period of at least 10 years ending on the date of disposal and he/she has been a working director of the relevant company for at least 10 years, of which at least 5 years he/she was a full-time working director. Land, machinery or plant which the individual owned for at least 10 years ending on the date of disposal and which was used throughout for the business of the relevant company and is transferred at the same time and to the same person as the shares in the family company. EU Single Farm Payment entitlements where they are disposed of at the same time and to the same person as the land to the extent that the land would support a claim for those payments. Land used for farming carried on by the individual which he/she has owned and used for a period of at least 10 years ending with the date of transfer for the purpose of qualifying for the early retirement scheme for farmers. Land which has been let by the individual at any time in the period of 5 years ending with the disposal where (i) immediately before the land was let for the first time in that period, it was owned and farmed by the individual for a period of at least 10 years ending at the time that it was first let and (ii) the disposal is under a CPO for road-building/widening. Land which has been let by the individual at any time in the period of 15 years ending with the disposal where (i) immediately before the land was let for the first time in that period, it was owned and farmed by the individual for a period of at least 10 years ending at the time that it was first let and (ii) the disposal is to a child. Points to watch out for in relation to the qualifying assets: The relief only applies to qualifying business assets. Where a company owns assets other than qualifying assets, the relief will be restricted. If there has been a share reorganisation involving a rights issue or additional share subscription the period of ownership test may not be met. Where a holding company is interposed or removed during the 10 years, before the transfer, by concession Revenue allow a look through approach. Where the transfer is of shares in the family company, it must have been a family company for the 10 years ending on the disposal to qualify.

8 Family company A family company is one in which the individual owns: 25% or more of the voting rights, or 10% or more of the voting rights and his/her family including the individual own 75% or more of the voting rights. The individual s family includes his/her spouse/civil partner and his/her own and civil partner s brother, sister, ancestor or lineal descendant. If a parent is transferring his/her shares piecemeal to children, care must be taken to ensure that the parent s holding does not drop below 10%. Points to watch out for in relation to the working director requirement: The working director requirements do not necessarily have to be in the 10 year period ending with the disposal. The full-time working director requirement for a period of at least 5 years does not need to be the last 5 years before the disposal. Full time working director is defined for this purpose as a director who devotes substantially the whole of his/her time to the service of the company in a managerial or technical capacity. Issues may arise where the director has other interests. The Court of Appeal in the UK in Palmer v Maloney [1999] STC 890 allowed an appeal in a situation where Mr Palmer worked 50 hours a week 42.5 hours in a managerial capacity for the company and 7.5 hours for his business as a sole trader. The CA considered that fulltime meant the amount of time that a comparable worker would have devoted to the service of the company and held that he worked fulltime in the services of the company. Capital acquisitions tax (CAT) Business property relief Business property relief may apply where a beneficiary receives a gift or inheritance of relevant business property. Where business relief applies, the taxable value of a benefit is reduced by 90%. Relevant business property is defined as any one of the following assets: (a) Property consisting of a business or an interest in a business. This means a trade carried out by a sole trader or by a partnership. It is important that the business, in addition to the assets, must pass to the beneficiary. The business must be carried on for profit.

9 (b) Unquoted shares in or securities of an incorporated company, whether incorporated in Ireland or otherwise, provided on the valuation date, after taking the benefit, the beneficiary will: Control more than 25% of the votes on all company matters, Control the company within the meaning of CATCA 2003 s27. Broadly, this means that the beneficiary, along with his/her relatives, must own more than 50% of the voting control or more than 50% of the issued share capital of the company or control the board of directors or have an entitlement to more than 50% of the dividends or interest in debentures. If the company is a private family controlled company within the meaning of CATCA 2003 s27 then any size of shareholding may qualify for relief; or Own at least 10% of the aggregate nominal value of all the issued shares and securities of the company and have worked full time in the company as an employee or officer or in another company within the same corporate group for a period of 5 years ending on the date of the gift or inheritance. In this context, full time means that the employee or officer (director/secretary) has devoted substantially the whole of his/her time to the services of that company or for a group of companies in a managerial or technical capacity. (c) Land or buildings, machinery or plant owned personally by the disponer which, immediately before the gift or inheritance was used wholly or mainly for the purposes of a business of a company controlled by the disponer or by a partnership of which the disponer was a partner. Example John is a partner in an accountancy practice and personally owns the premises out of which the practice operates. John gifts his interest in the practice, along with the premises to his son Paul. As the interest in the partnership qualifies as relevant business property and as the premises is transferred at the same time, Paul will qualify for business relief on both transfers, assuming the other conditions for the relief are met. In order for land or buildings which are used by a company to qualify for relief, the disponer must have more than 50% of the votes in the company. The relief will only apply on these assets if the assets pass to the same beneficiary at the same time as an interest in the business or partnership or shares in the company provided the shares/business also qualify as relevant business property immediately before the gift/inheritance.

10 Excluded businesses Not all businesses will qualify as relevant business property. Where the business or the business of the company consists wholly or mainly of dealing in currencies, securities, stocks, shares, land or buildings or making or holding investments, then the relief will not apply. The Revenue CAT Manual states that the term mainly means more than 50% and that the position should be looked at over a reasonable period of time prior to the gift or inheritance to allow for temporary fluctuations in activity and performance. Where it is not obvious that the business qualifies, Revenue will look at each case individually, taking the following factors, among others, into account: The ratio of asset value and profit attributable to trading and investment respectively; The ratio of turnover to investment income; The day to day activity of employees; Whether there are any reasons for low trading profits; The use to which the investments/income from the investments is put; and How the business is described in the annual accounts; Whether management expenses are being deducted for corporation tax purposes. Holding companies and groups Where a company holds shares in other companies, the shareholdings are regarded as investments and ordinarily business relief would not apply. However business relief may apply on a gift or inheritance of shares in a holding company: (a) If the business of the holding company consists wholly or mainly of holding one or more companies that are not wholly or mainly engaged in excluded businesses; or (b) If the value of the shares is wholly or mainly, directly or indirectly attributable to non-excluded businesses. The Revenue CAT Manual states that where a company is being valued on a group basis by reference to consolidated accounts, it will generally be acceptable to apply the wholly or mainly test to the total group activities without looking at each subsidiary individually. If the answer is uncertain, each company should be looked at separately.

11 When valuing the shares or securities of a holding company for the purposes of applying business relief, the value of any group companies which cannot be regarded as relevant business property should not be taken into account. Where a company within a group consists wholly or mainly of holding land or buildings wholly or mainly occupied by another member of the group which would qualify for relief (i.e. the other member of the group is a trading company), its value does not have to be excluded. Example A holding company, Lucky Limited, holds 40% of the equity share capital in Star Limited and Chance Limited and 20% of the equity share capital in Debbie Limited. Star Limited and Chance Limited are trading companies. Debbie Limited is an investment company. Lucky Limited 40% 40% 20% Star Limited Chance Limited Debbie Limited 20% of the value of Lucky Limited relates to the shares in Debbie Limited. The shares in Lucky will wholly/mainly qualify as relevant business property but the part of the value of Lucky due to the shares in Debbie Limited will not qualify for business relief. Minimum period of ownership The relief will only apply if the relevant business property has been continuously comprised in the disposition prior to the date of the benefit for a minimum period of 2 years in the case of an inheritance taken on the death of a disponer or 5 years in any other case. These holding periods are to prevent businesses being acquired solely so that business relief can be availed of. A period of ownership by a disponer, a disponer s spouse or civil partner will count for the purpose of calculating the period during which it was continuously comprised in the disposition. The minimum periods of ownership must be complied with at the date of the gift or inheritance.

12 Replacement property Where the relevant business property directly or indirectly replaced other relevant business property within the minimum period of ownership, then the relief will still apply provided the property being gifted or inherited, together with the property it replaced were both comprised in the disposition for at least 2 of the 3 years preceding the date of the inheritance taken on the death of the disponer and at least 5 of the 6 years preceding the date of the gift or inheritance in any other case. There is no limit to the amount of times relevant business property can be replaced. There is no requirement that the replacement property be of a similar nature to the property it replaced. If the value of the replacement property exceeds the value of the property it replaced, the relief will be restricted to what it would have been had the replacement not been made. Example Sam owned a hardware shop since In 2009 he sold the hardware shop for 200,000 and bought a supermarket for 400,000. In 2012 Sam gifted the property to his son, Fintan. At the time of the gift, the supermarket was worth 500,000. Business relief will be restricted to 250,000 using the following formula: 200,000 x 500, ,000 Excepted and excluded assets When valuing a gift or inheritance for the purposes of business relief, certain assets, known as excepted and excluded assets are disregarded. An excluded asset is an asset held by a company which is used for the purposes of a non-qualifying business, such as a business which has not been held for the minimum ownership period or a business which is engaged wholly or mainly in one of the non-qualifying business activities. Every business or interest in a business beneficially owned by the company or, where the company is a holding company, any company within the group, will be excluded property unless it would be relevant business property on the assumption that: (i) It was the property the subject of the gift/inheritance; and (ii) It had been comprised in the disposition for the minimum periods of ownership. Effectively this requires a look through the company to see if the actual business in the company/group would qualify for the relief if the actual business is the asset in the gift/inheritance.

13 Excepted assets are any assets held within a qualifying business that are not used wholly or mainly for the purposes of the business for the 2 year period prior to the gift or inheritance, for example an investment property or excess cash held by the business. Where an asset was acquired less than 2 years prior to the date of the gift or inheritance, then it will not be an excepted asset if has been used wholly or mainly for the purposes of the business throughout the entire period of ownership. This permits relief on new assets acquired within 2 years of the gift/inheritance, provided they are used for the business from the date of acquisition. Any asset used wholly or mainly for the personal benefit of the disponer or his/her relative will not be regarded as relevant business property. Where a company holds significant cash assets, Revenue may regard the cash as an excepted asset, on the basis that it is not used wholly or mainly for the purposes of the business, particularly if the cash is held on medium or long term deposit. It is generally accepted that cash held for liquidity/cash flow purposes will not be an excepted asset. Where the business is carried on by a company within a group, then any asset of the company which is used for the purposes of a relevant business of any group company is treated as being used for the purpose of the business of the company concerned provided the company using the assets was a member of the same group at the time of use and immediately prior to the date of the gift or inheritance. Example Monster Limited and Batty Limited are members of the same corporate group. Monster Limited holds the premises out of which Batty Limited trades. The premises held by Monster Limited will not be an excepted asset as it is used for the purposes of another company within the group. Claw-back of relief Business property relief will be clawed back where the relevant business property, or any property that replaces it; (a) ceases to qualify as relevant business property; or (b) is sold, redeemed or compulsorily acquired; within the period of 6 years commencing on the date of the gift or inheritance.

14 Ceases to qualify as relevant business property In order to consider whether a claw-back arises, one must assume a notional gift of the relevant business property at any time during the 6 year period commencing on the date of the gift or inheritance and determine whether the relief would apply to that notional gift. Where the business ceases to trade within the 6 years, the property will no longer qualify as relevant business property and any relief claimed will be clawed back. No claw-back will arise if the non-qualification is as a result of an insolvent winding up or bankruptcy. Sale, redemption or compulsory acquisition Where the relevant business property is sold, redeemed or compulsorily acquired within the 6 year period, the relief claimed will be clawed back. No claw-back will arise where the relevant business property is replaced by other relevant business property within 12 months unless the market value of the original property is greater than the market value of the replacement property, in which case the relief is proportionately clawed back. There is no requirement that the replacement property be of the same type as the original property provided it qualifies as relevant business property. Development land The claw-back period is extended from 6 years to 10 years where the relevant business property is comprised in whole or in part of development land and business relief was claimed after 2 February Points to be wary of: The Revenue CAT manual states that bonus shares are treated as having been acquired at the same time as the original shareholding was acquired for the purposes of the minimum period of ownership. Where a disponer acquires additional shares as part of a rights issue, the additional shares will only qualify for the relief once they have been held for the minimum ownership period. A sale of the property within the 6 years can give rise to a claw-back of the business relief and a CAT liability and a claw-back of the retirement relief and a CGT liability. If the sale takes place within 2 years of the gift, no CGT/CAT offset will be available. If reinvesting the sale proceeds, the time allowed is limited to one year. If reinvesting the sale proceeds to avoid a CAT liability be aware that the CGT may still be payable.

15 Stamp duty In general stamp duty will always be payable on lifetime transfers of shares and other assets. In the context of transferring business assets, other than shares, Finance Act 2012 reduced the stamp duty rates for non-residential property to 2%. The reduction for consanguinity transfers will end on 31 December 2014, so in the meantime with the relief, stamp duty is 1%. Transfers on death do not generally give rise to stamp duty. Leaving succession until death gives a stamp duty saving! Funding the tax/succession The CGT retirement relief may reduce/eliminate CGT, but if this is not available for some reason, or is limited, any CGT paid by the transferor may be available as a credit against CAT for the transferee, provided that the transferee retains the assets transferred for 2 years. Even with all the reliefs, there may be some tax to pay by the transferee 33% CAT (if the tax-free threshold has been used) and 1% stamp duty. The CAT will be higher if some of the assets or value of the shares do not qualify for business property relief. Insurance If advance planning has been undertaken, there may have been an insurance policy taken out to pay gift/inheritance tax. Share -buy back Where a company acquires its own shares, there are circumstances where CGT treatment will apply. In broad terms there are 2 purposes where this applies where the transaction benefits the trade of the company or the proceeds are used to pay inheritance tax due on those shares. The second purpose is clearly useful where the succession takes place on a death and inheritance tax has to be paid. In other situations, the trade benefit test is applied by Revenue and it has to be shown that the sole or main purpose of the buy-back is to benefit a trade carried on by the company or of one of its 51% subsidiaries. Revenue have indicated that a controlling shareholder who is retiring as a director and wishes to make way for new management would meet the trade benefit test. This should not be overlooked as a means of providing some funds to the retiring shareholder to pay the CGT or fund his/her retirement. Valuation issues for tax The valuation of the business or shares in the company on the transfer is important. Valuation is not an exact science. It is advisable to have a detailed valuation report prepared to support the values to be included in the tax returns.

16 The basis of valuation for CAT does not allow for a discount on the transfer of small holdings where the company is a family controlled company. However, a discount may be available for CGT and stamp duty purposes depending on the percentage of shares transferring. Given the different basis of valuation for CAT, there can be a difference between the value for CAT and that used for CGT and stamp duty. Income tax and VAT For completeness, income tax and VAT should be mentioned. Where an unincorporated business is transferring, the transferor will have a cessation for income tax purposes and will also cease to be registered for VAT. The transferee will have a commencement for income tax purposes and a new VAT registration. Where property is transferring, it will be important to check VAT implications. Summary Planning for succession in a family business is a complex matter, but advance planning and good professional advice can reduce the tax costs on any transfer and provide the solutions for a successful transition to the next generation without conflict. Ann Williams williamsann@eircom.net 17 December 2012