We will look at the tax considerations of transferring your business to a company. The main points we will cover are
- Goodwill. Is there any?
- Sell your business for shares
- Sell your business for cash
- Potential Tax reliefs
- Other considerations
- Summary
Goodwill. Is there any?
Goodwill. You sell your business to a third party and the amount you get for it could include Goodwill. The value of the assets is €50,000 but you expect to get €500,000 on a sale. The excess value over the asset value is Goodwill.
But why would someone give you more than the asset value? The business could have a brand. It generates profits every year of €100,000 plus. A buyer expects that trend to continue and wants that future profit stream. Factors that would show goodwill include
- Client and Customer lists
- Contracts with customers for future income
- Recognisable Brand, website
- Quality employees
- Business processes
- Intellectual property – e.g. patents and copyrights
Revenue’s view is that a sole trader, where one person carries out all the work, doesn’t have Goodwill. This is on the basis that the business cannot function without that person.
They challenged this successfully in cases where medical consultants set up a company. Some consultants put a value on their goodwill. When they sell their goodwill asset to a company the company owes them money for the asset.
Selling an asset is a disposal for Capital Gains Tax so one sells and pays tax at 33%. But with reliefs like Retirement Relief or Entrepreneurs Relief, the CGT hit could be none or 10%. The company owes the seller for the asset and pays that money tax-free.
Sell your business for shares
Instead of selling the business for cash, the vendor sells the business for shares. He/she gets more shares in the company. The capital gain on the sale rolls over into the shares when setting the company up.
Best to show an example of how this works. Betty Black runs a very good hairdressing business and wants to transfer it to a company Wild Child Ltd. She is 52 years old. Her business assets have the following values.
| Stock | €10,000 |
| Goodwill | €90,000 |
| Equipment | €20,000 |
| Trade creditors | (€15,000) |
| Net Value of assets incorporated | €105,000 |
| Consideration | |
| Shares 105,000 €1 shares | €105,000 |
The gains on the assets are
| Stock | Not chargeable |
| Goodwill | €90,000 |
| Equipment | €0 |
| Total Capital Gains | €90,000 |
| Base cost of shares | €105,000 |
| Less Deferred Gain | €90,000 |
| Base costs of shares in future | €15,000 |
This CGT relief is subject to some conditions
- It must be a business transferring as a going concern
- The consideration for the transfer must be wholly or partly in exchange for shares in the company
- The whole of the assets of the business (other than cash) must transfer
- Setting up the company must be for bona fide commercial reasons and not for the avoidance of tax
Sell your business for cash
Betty wants to consider her options. She understands that if she sells the business for cash, she will have a CGT liability on the sale. Her worst-case scenario is a CGT liability of €29,281.
| Goodwill Sales Proceeds | €90,000 |
| Less Cost | nil |
| Gain | €90,000 |
| Less Personal Exemption | €1,270 |
| Taxable Gain | €88,730 |
| Tax Payable 33% | €29,281 |
But the flip side is Wild Child Ltd will owe her €105,000. The company has €50,000 in cash so she decides to take €30,000 and use that to pay the tax. The company now owes her €75,000.
Betty wants to leave €20,000 in there to run the business. Over the following 6 months, the bank balance grows to €50,000. As a result, Betty takes €10,000 as wild child Mary is starting university.
Potential Tax Reliefs
On a disposal of business assets, Retirement Relief and Entrepreneurs Relief are relevant. For Betty Retirement Relief [RR] is not an option as she isn’t over 55.
Would Entrepreneurs Relief [ER] work for her? Betty started the business in 2015 and has spent the last 7 years building it up. Her advisor lets her know of one possible hitch. Revenue won’t allow an ER claim when disposing of Goodwill to a company you are connected with
There is an out though. If the transfer is for bona fide commercial reasons and not to avoid tax, then it is ok. Betty is happy that the transfer is for commercial reasons. She wants to open a new salon and will need to borrow from her bank to finance the fit-out cost. Her bank recommended that it would be easier to make the repayments when trading in a company.
Considering this she will claim ER on the goodwill disposal. Her CGT liability now reduces to €8,873
| Goodwill Sales proceeds | €90,000 |
| Less cost | nil |
| Gain | €90,000 |
| Less Personal exemption | €1,270 |
| Taxable Gain | €88,730 |
| Tax Payable 10% | €8,873 |
Betty is over the moon with this news as she only needs €9,000 to pay the tax now and can hold onto the balance of €21,000. She doesn’t tell Mary though.
Other considerations
Looking at the above options for Betty, selling the assets to Wild Child for cash is a no brainer. So, you would think? But there can be downsides too. The main point is that once you move your trade into a company from a sole trader or partnership you are starting again
What we mean by that is in Revenue’s eyes commencing the business in a company has a defined start date. That is significant for reliefs such as
- Retirement Relief – 10 years
- Entrepreneurs Relief – 3 years
- Business Asset relief – 5 years
- Share buyback relief – 5 years
Betty couldn’t get Retirement Relief until she was 62 as she would have to own the shares for 10 years.
Flair Hair Ltd makes an offer to buy Betty’s shares in Wild Child Ltd for €750,000 in 2025. This is three and a half years after starting the trade in the company. On the sale she can’t get Retirement Relief but could get Entrepreneurs Relief. She will either pay 33% on the gain or 10% if she qualifies for ER.
However, when setting up the company, if Betty sold her business for shares, she could qualify for Retirement Relief. The reason for that is that the sole trader period of 7 years, in that case, isn’t lost. The pre-incorporation and post-incorporation periods are added together. As a result, she would meet the 10-year holding period for Retirement Relief and there would be no CGT on the sale. This is on the basis that Betty met the other qualifying conditions.
Summary
Transferring your business to a company can make sense for many reasons. For instance, Betty wanted to expand, and a company was more efficient to borrow money. We will leave you with two questions. Does your business have goodwill or is the goodwill personal to you? And what is the long-term plan for your business?
The answers to these questions will impact how you transfer the business to a company. It is also possible to have a combination of both shares and cash.
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