What a great week of weather before the schools go back. The very old [should be in a museum] writer of this hit 49 yesterday. He’s delighted to be still in his 40’s. There will be no mention of birthdays this time next year.
A flock of quarrelsome crows was my alarm clock this morning. It seemed like thousands had gathered to give me a shout. When I looked out the window there were only 50 or so on the wires across the road, all singing away. And I thought outside live entertainment wasn’t allowed. I was ok with my vaccinations and EU covid cert but don’t think they had a licence.
Last week we looked at electric vehicles and asked the question if your next company car should be electric. In case you missed it see here
This week we are going to look at excess cash in companies on a business transfer. We completed 3 business transfers this month and the excess cash question was a factor in two of them. The main points we will cover are
- What is excess cash
- The Tax implications
- Some tips
- Summary
What is excess cash?
Any business will have a normal working capital need. This is the amount of money they will need to run their business every month. Liz Phelan owns a company called Eze Phelan Ltd that runs a chain of hair salons.
| Current Assets | €1,200,000 | |
| Current Liabilities | €1,000,000 | |
| Net working capital | €200,000 |
They have €1,500,000 in cash so, based on this, the excess amount is €1,300,000. This is the amount of cash they have over and above their normal working capital needs. When talking to Liz she doesn’t agree. She says they need €75,000 to buy specialist equipment for the salons. And one salon needs a complete revamp that will cost €125,000.
Tax Implications
In the normal course of business, it’s fantastic that a business has a very healthy cash balance. This can lead to more buying power, better credit terms which all help to create a strong vibrant company. Can it be an issue? Yes, it can. When it comes to passing on the business, the excess cash amount can cause a problem. Liz is 60 and is keen to take a step back and wants to pass on the business to her daughter Chloe, who is managing a salon. They do a google search and they find out about Reg, the company valuation master. They meet him and agree on an engagement. Reg values the company at €2.5 million as follows
| Future maintainable earnings | €300,000 | |
| Multiple | 4 | |
| Value of Business | €1,200,000 | |
| Current cash balance | €1,500,000 | |
| Less working capital need | (€200,000) | |
| Value of Business | €2,500,000 |
Liz has done well. She has built up a pension pot and has rental income outside the company.
One option they explore is passing all the shares to Chloe at the end of 2021, but Liz is open to other options. She would continue to work for a few years and take the same salary. Assume she transfers all her shares to Chloe the tax implications for Liz and Chloe are
| Gift of shares by Liz | value | €2,500,000 |
| Cost of shares | €100 | |
| Gain | €2,499,900 | |
| Capital Gains Tax | 33% | €824,967 |
| Retirement Relief | €824,967 | |
| CGT Payable | Nil |
Stamp Duty for Chloe
| Value of Shares | €2,500,000 | |
| Stamp Duty | 1% | €25,000 |
Gift Tax for Chloe
| Value of Company Business assets | €1,200,000 | |
| Less Stamp Duty | €12,000 | |
| Net Value | €1,188,000 | |
| Business Property Relief | 90% | €1,069,200 |
| Taxable Value | €118,800 | |
| Less small gift exemption | €3,000 | |
| Net Value | €115,800 | |
| Parent-child CAT Threshold | €335,000 | |
| Balance of threshold available | €199,200 |
| Value of Excess Cash | €1,300,000 | |
| Less Stamp Duty | €13,000 | |
| Net Value | €1,287,000 | |
| Balance of parent-child threshold | €199,200 | |
| Taxable amount | €1,087,800 | |
| Tax Payable | 33% | €358,974 |
Liz doesn’t like what she’s hearing. Chloe less so. She longs for a Monkey 47 and not only the one. They need to reconsider this exit plan
What can they do?
Before transferring any shares to Chloe, they need to look at options. Some of these include
- Bonus payment for Liz and Chloe
- Pension top-up for Liz & set up a pension for Chloe
- Purchase specialist equipment
- Complete salon revamp
- Purchase an EV for Chloe
Liz owes €75,000 on her home mortgage. She agrees to take a bonus payment of €156,250. After tax at 52%, this will leave her with €75,000 which will clear her mortgage. They agree to a bonus for Chloe of €52,083 which will net her €25,000. This will cover stamp duty on the transfer of shares with some change under a new plan. Liz talks to her financial advisors, and they tell her she can put a top-up payment of €200,000 into her pension. They also decide to start a pension for Chloe and make an initial lump-sum contribution of €100,000. Liz will complete the salon revamp and buy the specialist equipment. They decide against the EV for now
| Bonus for Liz | €156,250 | |
| Bonus for Chloe | €52,083 | |
| Pension top-up Liz | €200,000 | |
| Pension Chloe | €100,000 | |
| Equipment | €75,000 | |
| Salon revamp | €125,000 | |
| Total | €708,333 | |
| Cash in company | €1,508,333 | |
| New cash balance | €800,000 |
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The company year-end is the 31st of March. They decide to put the bonuses through before the end of September 2021. By doing this they can backdate the bonuses into the 31st of March accounts. This will give them a more immediate Corporation Tax saving – see blog here on salary or dividends.
Reg and his tax sidekick look at a different exit plan for them. This involves getting some shares to Chloe in 2021 and then doing a share buyback in the Summer of 2022. The business rationale for this is to give Cloe some ownership now. Also, Liz will put a plan in place to devise a more senior role for Chloe. She wants to notify key suppliers, salon managers, and service providers of Chloe’s new role.
With the bank balance now at €800,000 the value of the company is €2,000,000. Liz will gift 60 out of her 100 shares to Chloe in October 2021. In the summer of 2022, Eze Phelan Ltd will buy back the remaining 40 shares that Liz has and cancel them. This will mean that next Summer Chloe will own 100% of the company as she will own all 60 shares in issue.
The value of the company in October for CGT and Stamp duty purposes is
| Value of the company | €2,000,000 | |
| Value of | 60% | €1,200,000 |
| Discount for 60% holding | 15% | (€180,000) |
| Value after discount | €1,020,000 |
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There will be no CGT for Liz on her disposal, assuming she meets all the conditions of Retirement Relief. Chloe will pay stamp duty at 1% which comes to €10,200. For now, let’s assume there will be no gift tax for Chloe either, as the excess cash is less of an issue – see below.
We roll forward to the Summer of 2022. Reg revisits the valuation for the share buyback. As the cash position has now gone up to €1,000,000 Reg values the company at €2,200,000. The value of Liz’s 40 shares is as follows
| Value of company | €2,200,000 | |
| Value of | 40% | €880,000 |
| Discount for 40% holding | 30% | (€264,000) |
| Net Value | €616,000 |
Eze Phelan Ltd redeems Liz’s 40 shares and pays her €616,000. Liz resigns as a director but will stay involved on a part-time basis until the end of 2022. She reduces her salary by 80% during this period. At the end of 2022 she comes off the payroll and the company pays her a tax-free termination payment of €34,000
When Chloe got the shares in October 2021 the cash balance was €800,000. Based on having a normal working capital need of €200,000 then you would think there was €600,000 excess cash. But the company needs funds to do the share buyback in the Summer of 2022. On the basis that it needs €650,000 to pay for the share buyback and the termination payment, then is there excess cash? The argument here is no there is not. The money is needed for trade purposes ie to exit a retiring shareholder. Revenue may not agree with this but there is certainly a strong argument to be made.
Liz would not pay any CGT on the share buyback. She can get up to €750,000 from a third party. Her company would be a third party. And she will need to be sure that she meets all the conditions of Retirement relief.
Summary
There is potential for unforeseen tax costs when passing on shares in a company. Especially if there is a very high cash balance in the company or the company has investments. For this reason, an exit strategy should be part of the company director’s thinking well before the exit date. A good plan that involves salary, bonus, benefits, and pension will help to reduce excess cash. The purpose of this is to make you are aware that there can be risks. The risk for Chloe was just short of €360,000. As always, we would urge you to get help from your advisors before embarking on any course of action.
Do you need help putting a plan in place? Call Deirdre on 051396703 or start here. Tell us about you and your business and we will see if we can help.
