To continue on with our theme of doing various blogs around business succession I thought it would be useful to look at the main tax head on a disposal or transfer of a business, which is Capital Gains Tax [CGT]. The current rate of CGT is 33% which means that you hand over 1/3 of your gains to Revenue if you can’t avail of the reliefs that are available. As one of our UK clients said to us before “Her Majesty is a significant shareholder in my business without doing any of the work” We are going to look at one of the two main CGT reliefs being Entrepreneurs Relief [ER]. The message that we want you to get from this blog is that you are aware of these reliefs and can understand some of the basics around them. You don’t need to know all the ins and outs as that is what we or your advisor is there for.
If you can qualify for this relief then the CGT rate you will pay is 10% on a gain of up to €1,000,000. So you would pay €100,000 CGT rather than pay €330,000. So quite a significant saving to pique your interest! Once the gain goes above the €1,000,000 mark you are back to the 33% rate. The relief applies to a gain arising on the disposal by a “relevant individual” of the whole or part of their “chargeable business assets”
A “relevant individual” is a person who has beneficially owned the chargeable business assets for a continuous period of 3 years in the 5 year period, immediately before the disposal. It should be noted that periods of ownership of spouses cannot be added to meet the 3 year continuous ownership test nor can periods of asset ownership before and after a business is transferred into a company. This is where assets are owned by a person carrying on a business as a sole trader or a partnership and they subsequently set up a company to carry on the same business. When selling the company shares the period before the company was set-up doesn’t qualify so you would have to own the company shares for the 3 year continuous period.
The “relevant individual” also has to be a director or employee of the company or companies in a group situation who is or was required to spend 50% or more of their working time in the service of the company in a managerial or technical capacity and has done so for the continuous period of 3 out of 5 years prior to the disposal of the business assets.
In a group scenario you need to be careful that all the subsidiary companies, where the holding company must own at least 51% of the subsidiary, are qualifying trading companies that carry on a qualifying business. If there is one subsidiary company in the group that is not carrying on a qualifying business then no ER relief would apply.
A qualifying business is a business other than the holding of securities or other assets as investments, the holding of development land, or the development or letting of land.
“Chargeable business assets” include
a)An asset , including goodwill, used for the purpose of a qualifying business carried on by an individual
b)Ordinary shares in a company carrying on a qualifying business or ordinary shares in a holding company of a qualifying group, provided that the individual holding the shares owns 5% or more of the ordinary share capital in the company being sold and is a relevant individual as per the points above.
Jurgen and Divock run a successful trading company Lads Franchise clothing Ltd for the last 8 years. They own the shares 60:40 respectively and they worked full time in the business from the outset with Jurgen, aged 45, being the Managing director and Divock, aged 28, the Operations manager. They receive an offer of €3.5 million for their shares in the business from Luis Messi Ltd, a Spanish competitor. This was a really unexpected result for them so they decide to sell. Their shares had a nil base cost. Their capital gains tax liabilities are calculated as follows:
|Sales Proceeds - Jurgen||2,100,000|
|Total CGT Payable||463,000|
|Sales Proceeds - Divock||1,400,000|
|Total CGT Payable||232,000|
If Entrepreneurs relief didn’t apply all the gains of Jurgen and Divock would have been taxed at 33% so Jurgen’s liability would have been €693,000 and Divock’s would have been €462,000 so they each have saved €230,000. A good week for them!
Key learning points about ER
A spouse could also qualify for this relief provided the spouse also meets the qualifying conditions which could mean up to €2 million of gains being taxed at 10%
Where there is a company reorganisation the period before and after the reorganisation could qualify toward the ownership and working time conditions. For example if you wanted to transfer the trade into a new company prior to sale, as the purchaser could request this so that what was being acquired was a “clean” company, then the period of ownership and working time of both companies could be amalgamated
The transfer of goodwill from a sole trade or partnership to a company wouldn’t qualify for ER relief except in bona-fide commercial cases
The relief can apply to the interest of an individual in the assets of a partnership in which the individual is a partner provided the individual was active in the running of the partnership and the assets were being used for the purposes of a qualifying business
The relief doesn’t apply to assets owned personally outside a company even where those assets are used by the company. For example many farmers are now setting up companies to carry on the trade but the farmland would usually be held outside the company, but used by the company, so ER would not apply if selling that farmland
Beware of dormant or investment companies in a group scenario as this could disqualify you from the relief on the disposal of share in a trading company of a group
The relief can apply where a share buyback is being carried out and that is within the charge to CGT
Relief can apply where a company is liquidated provided the company was carrying on a qualifying trade up to the date the liquidator was appointed and the liquidation is carried out within a reasonable time period which Revenue have confirmed is 2 years from the date of the appointment of the liquidator
Every article that is ever written about ER, and we are not about to buck the trend, mentions that the UK rate of 10% applies to gains of up to £10million while ours is at €1million. The minister for finance is well aware of this and there is lobbying to increase the threshold above €1 million. In his speech at the Institute of Taxation dinner earlier this year he stated “I’m pleased to say that it is my intention to undertake a review of the CGT Entrepreneur Relief in the coming months with a view to assessing the relevance, cost, impact and efficiency of this relief” So watch this space!!
In light of the above exit planning is key and needs to be done many years prior to a potential sale or transfer so that these types of reliefs can be maximised.
Next week we will have a look at the other main CGT relief called Retirement Relief. See links below to the other blogs we have done on the topic of Business succession