Last week we spoke about some tax tips when purchasing a buy to let property. If you didn’t get a chance to read that click here. This week the inspiration for our blog is a conversation we had. It was with a potential client about passing on his business to the next generation. What struck us was that he had his mind made up that he wanted to sell the business. The reason for this was he wasn’t aware of the other options that were available to him. In this blog, we will look at some of the options around transferring shares to the next generation. We will look at how we can do this and what some of the taxes are.
The business owner was in his early 70’s and felt he should retire. All his classmates were either retired or dead and he was still working. We asked the question if he still enjoyed the work? We will come back to that later. He had a family member managing the business so he could take more free time. He also had a great staff who were hard-working and loyal. But when things go wrong, they call him, and he was still very much the head of the business. He negotiates contracts and has key relationships with customers and suppliers. He had options and there was some cash saved in the business after many years of hard work.
1. How much is my business worth?
The first thing to understand is the value of your business. It's vital to complete a proper business valuation. This is the value of the business and any excess cash in the business will increase the value by that amount. There are different ways to value a business and Ger is the in-house expert at this. One important number is future maintainable earnings. These are the earning the company would expect to make in the years ahead. You get to this figure by looking at the current and past profits of the business. A multiple is then applied to the figure arrived at. We will look at an example below for Groovy train Ltd
|Average expected profits||€200,000|
|Expected savings [owner's salary, pension etc]||€150,000|
|Less New Manager salary||(€100,000)|
|Future Maintainable Profits||€250,000|
Using a multiple of 3 then the company value is €750,000. If there is excess cash in the company, say €200,000, then the value increases to €950,000. To understand a bit more about this see Ger’s blog on this Read here
Fred, who is 65, owns 110 shares, and his son Bob has 10 shares. Each share is worth €7,917. Both work full-time in the business.
Once we know the value, the next step is to plan the transfer of the business to Bob. Also, we need to see if Fred can get some cash.
2. Sell shares to Bob
Fred is happy to transfer his shares to Bob but is unsure if he should give them all in the one go? He is also unsure of how he will get money out of the business. Could he sell the shares in the company to Bob and use the cash in the company to pay for them?
This is possible. One way to do this is for Bob to set up a new company Bob Ltd and that company would buy the shares from his father. But, Bob couldn’t use the cash in Groovy Train Ltd to fund the acquisition so he would need to get external finance. This could be difficult in the current environment. Fred doesn’t want the full €950k for the shares but would like to get €250k. Bob ltd can secure bank finance for €250k and purchases all the shares from Bob for that price. As this is a sale between connected persons the sales price is market value which is €950k. For Capital Gains Tax [CGT] Fred has a gain
|Value of Fred's shares||110 x €7,917||€870,870|
|Cost of shares||€100|
*Revenue approved discount rates apply when valuing shares - a discount applies here as Fred doesn't own all the shares.
If Fred meets all the conditions of Retirement relief, he wouldn’t pay CGT on the sale/transfer of the shares to Bob Ltd. For more information on Retirement Relief see a previous blog on this Read here
Bob, through his 100% shareholding in Bob Ltd, has received a gift of
|Value of shares||€870,870|
|Business Property Relief||90%||€558,783|
As the value of this gift is below the parent-child Group A threshold of €335,000 there would be no gift tax to pay. For more information on Business Property Relief Read here
The other main tax to consider is Stamp Duty and Bob Ltd would have to pay this. The rate is 1% so Bob Ltd would pay 1% of €870,870 which is €8,708 within 44 days of signing the transfer documents.
What next for Bob Ltd?
Now Bob Ltd owns 110 shares in Groovy Train Ltd and Bob owns the other 10 shares. Fred has passed on the company to Bob and got paid what he wanted. Bob Ltd has a bank debt of €250k but there is €200k excess cash in Groovy Train. Bob Ltd could use this money or some of this money to repay some of the bank debt. Fred and Bob need to be aware of the anti-avoidance provisions that came in from Revenue around this. The Revenue legislation is a bit wordy and cumbersome – perhaps a bit like this blog!!!
Tax legislation doesn't allow company cash to fund the sale/transfer of the business. So, Bob Ltd would have to secure third party external funding to make the initial acquisition. Yet, per Revenue guidance, he could use company funds to refinance existing borrowings.
Bob Ltd is now a holding company as it holds the shares in Groovy Train Ltd which sits underneath it. Bob Ltd can receive dividends from Groovy Train. Bob Ltd can use those funds to repay the balance owing to the bank over time.
If Bob didn’t set up a holding company then he would have to take out a personal loan to buy the shares. Any dividends paid out to him from Groovy Train would be taxable income in his hands. This wouldn't be tax-efficient.
While all the above is doable it is a bit cumbersome and may not be that straightforward. The main issues are threefold:
a) Structure is a bit more complicated now with a holding company
b) Bob had to get external finance in Bob Ltd which may not be easy
c) Fred and Bob need to be aware of the Revenue anti-avoidance rules. This is where they are using company funds, albeit indirectly, to repay the bank debt
Next week we will look at a different way of transferring shares that is less complicated. Please seek advice from a qualified advisor before passing on your business.
Not forgetting our conversation at the start. I got a call from the prospect’s accountant the next day. He said to him “do you know bloody what I still do enjoy it and would like this business to stay in the family”
Interested in finding out more about selling or transferring your business? Please call Deirdre on 051-396703 or contact us