Bryan Farrell explains a number of important tax issues arising from the disposal of a business, and gives an overview of the reliefs available to the owners of a firm including on retirement.
While most engineering practices, regardless of the discipline, are set up as a limited company, many still operate as sole traders or in a partnership.
There are some differences in the conditions attaching to the various tax reliefs depending on whether the business owner is selling shares in a company or an interest in a partnership.
To examine the tax issues arising on a business disposal, we will consider the fictional case of Baggot Engineers Limited (BEL). BEL is owned by three business partners with equal shareholdings.
The business, which was set up over 15 years ago, has traded profitably in recent years and is currently valued at €2 million. The three owners are looking to sell up and are keen to understand their potential tax liabilities.
With a sale figure of €2 million, and in the absence of any tax planning, the owners would be liable for circa €660,000 in tax (€2 million/three = €667,000 x 33 per cent = €222,000 each). We will look at some of the tax reliefs potentially available to the shareholders.
Tax reliefs for business owners
Capital Gains Tax (CGT) applies to a disposal of an individual’s interest in an engineering business (be that shares in a company or an interest in a partnership). The current rate of CGT is 33 per cent.
However, there are two main reliefs that may apply to reduce the level of CGT arising or, in some cases, alleviate the tax altogether.
Retirement relief
Retirement relief provides relief from CGT on the disposal of qualifying business assets (that is, shares in a company or partnership) by business owners.
Although commonly referred to as retirement relief, an individual does not have to actually retire in the normal sense of the word in order to avail of the relief.
The main conditions of the relief are:
1.) The individual must be older than 55 years of age
2.) He/she must have held the shares/partnership interest for more than 10 years at the date of disposal.
In respect of shares in a company, there are two additional conditions:
3.) He/she must have been a working director for more than 10 years ending with the disposal and have been a full-time working director for at least five of those years.
4.) A minimum shareholding in the company of 25 per cent is required.
Where the conditions are met, the full amount of a gain may be relieved from CGT subject to a maximum lifetime limit of €750,000 applying to qualifying disposals.
Where the proceeds exceed this, marginal relief may apply to limit the CGT to half of the consideration of more than €750,000.
If we look at our case of BEL and assume that all three owners are older than 55 years of age, then it should be possible for them to sell their business and claim retirement relief. Each owner would receive circa €667,000 tax free.
It is important to watch out for non-qualifying assets (for example, investment property, excess cash and so on) in a company which may restrict the retirement relief available.
Entrepreneurs' relief
For younger business owners or cases where the conditions of retirement relief are not met (for example, the business is less than 10 years old), entrepreneurial relief may provide significant relief from CGT.
This relief provides for a 10 per cent CGT rate (as compared to the standard 33 per cent rate) on the disposal of qualifying shares or partnership interests.
To qualify for the relief, the following conditions must be satisfied:
1.) There is a disposal of shares in a trading company or interest in a partnership.
2.) Shares/partnership interest must be owned for at least three years.
3.) Individual must own not less than five per cent of the company/partnership.
4.) Individual must have worked in the business for more than 50 per cent of their working time for at least three years prior to disposal.
If we pick up on our previous example but assume that the three owners are only 50 years of age, then retirement relief cannot apply. However, provided the above conditions are met, entrepreneurial relief would give them each a 10 per cent CGT rate.
Each partner would pay CGT of circa €67,000 on the sale of the business resulting in a tax saving of €153,000 each. Each shareholder would receive circa €600,000 after tax.
Time for the health warning – as with all tax reliefs careful consideration must be taken to ensure all the conditions of the relief are understood and met. Failing to plan correctly could result in the relief being later denied by the Revenue Commissioners and an exposure to tax, interest and penalties for the company and/or the business owners.
Termination payments
Our business owners should consider the availability of termination payments from the company. Within certain limits an exiting employee/director can receive a tax-free termination payment (that is, golden handshake) from their company.
The maximum allowable payment is related to the individual’s years of service, salary level and pension provision. There is a lifetime limit on such payments of €200,000. Typically, this relief will benefit most those directors/employees with higher salaries and more than 15 years of service.
With 15 years of service, the BEL owners could each receive a termination payment from the company of circa €21,500. This may be increased substantially depending on their pension arrangements.
Pension planning
Aside from the above tax reliefs business owners should also consider pension planning as part of any disposal. With existing cash reserves in the business or as part of the exit each should endeavour to maximise their pension provision.
This is particularly relevant with company funded pension schemes. Upon retirement individuals can typically receive a tax-free lump sum of up to 25 per cent of the value of their pension fund with the balance being transferred to an ARF (Approved Retirement Fund) where it can continue to grow.
Pension contributions made by a company are tax deductible in the company and should not give rise to a benefit in kind charge for the shareholder director.
If we assume that each of our BEL owners had company related pension funds worth €800,000 on retirement each could receive a tax-free lump sum of €200,000 with the balance of €600,000 to be transferred into an ARF. An annual income could then be drawn from the ARF as required.
In summary, if we look at the position of the BEL shareholders overall, we see in the table below that on a sale of their business they could realise in excess of circa €1 million each tax free by effectively availing of the various tax reliefs available to them.
Clearly careful planning is required to ensure that the reliefs are available to provide the owners with the best return. Given the ever-changing tax landscape in Ireland exit plans must be developed in line with the needs of the individuals and their companies and monitored to ensure the relevant conditions are met.
Disposal of family businesses
The above tax reliefs can also be valuable tools when considering the sale of a family business or passing on the business to family members. Recent changes to tax legislation, however, have added restrictions to the above reliefs in family succession scenarios.
In addition, non-tax issues must also be considered in family succession scenarios. These will typically revolve around control matters such as:
• Who will become the next managing director?
• Should all beneficiaries be equal shareholders?
• Who will take the major decisions affecting the future of the business?
• The timeline for the handover of the business
Accordingly, family business successions will usually involve detailed discussions among the family members and their legal/tax advisers.
Caveat: Please note that this article, prepared in February 2019, comprises general commentary on tax issues, incentives and reliefs and does not amount to tax advice. No action should be taken based on the comments in this document. Any use made of this document is entirely at your own risk and neither the firm (Walsh O’Brien Harnett) nor its employees will be held responsible for any errors or omissions.
Author: Bryan Farrell, tax director, Walsh O’Brien Harnett, Chartered Accountants and Registered Auditors, 104 Lower Baggot Street, Dublin 2. Telephone: 01-6688677. Email: bfarrell@wobh.ie