Tax considerations on transfer of a business to the next generation

Succession planning is a process that involves careful consideration of all the issues when an owner decides to pass on their family business.

For the succession planning to be effective, it is important that all parties in the transfer are involved, and that both tax and legal advice is sought as part of the planning process.

There are many factors to consider such as the financial independence of the current owner post-transfer; tax implications on the transfer; and the financial position of the business post transfer.

The purpose of this article is to provide a brief insight into some of the tax issues and reliefs that will be considered as part of that succession planning process. There are three capital taxes to consider when implementing a succession plan, Capital Gains Tax, Capital Acquisitions Tax and Stamp Duty.

Undoubtedly each tax head and associated tax relief mentioned below could merit an article in its own right, hence the reason for a brief rather than an in-depth discussion of each.

Capital Gains Tax (Tax on transferor/owner)

Capital Gains Tax (CGT) is the tax an owner pays on the gain arising on the disposal of a business (i.e. company shares, goodwill or property such as land/buildings) during their lifetime. Regardless of whether consideration is received, CGT may be payable on the appreciation of the market value from the date the owner acquired the business (or business assets) to the date of disposal.

This gain can be substantial where an owner has built up a business from scratch or the business assets have simply appreciated substantially in value over a period of time. The CGT rate of tax on this gain is currently 33%. It is worth noting, however, that CGT does not apply on the transfer of assets on death and in some succession planning scenarios where CGT is substantial and can’t be relieved, the transfer of the business may be carried out by Will (inheritance). However, this form of transfer (Will) may not be in the best interest of the business in the subsequent years ahead. There are a few reliefs available that may reduce or fully relieve a CGT liability on lifetime transfers.

These CGT reliefs are conditional on certain points being met, therefore it is imperative that in the succession planning process each relief is carefully considered to achieve the most tax efficient transfer possible based on the circumstances.

The most notable reliefs being:

• Retirement Relief;
• Revised Entrepreneurial Relief;
• Seven Year CGT Relief.

Retirement Relief

Retirement Relief is a conditional relief from CGT on the disposal of all or part of business assets such as farmland, business premises and family trading company shares. Whilst its name would suggest otherwise, it is not a condition that the owner must retire to qualify for the relief.

Where the transferor is aged 66 or over an aggregated transfer value cap of €3m is applied

When considering Retirement Relief the main conditions to note are:

• It only applies to individuals 55 years or older;
• The asset must have been owned for the previous 10 years;
• Where the asset being transferred is shares in a trading company the owner must meet certain working director criteria.

Where all conditions for Retirement Relief are satisfied, the transferor may be fully relieved from CGT on transfers to a child (incl. certain niece/nephew, foster child, or child of a deceased child).

Where the transferor is aged 66 or over an aggregated transfer value cap of €3 million is applied.

For all other non-child defined transfers that qualify, relief from Capital Gains Tax will be provided up to an aggregated disposal value cap of €750,000 (reduced to €500,000 where transferor is 66 years or older).

Revised Entrepreneurial Relief

Revised Entrepreneurial Relief (RER) reduces the rate of CGT from 33% to 10% on the first €1 million of aggregated lifetime gains on a disposal of business assets such as land and buildings, goodwill, and trading company shares.

The aggregated lifetime limit only applies to gains made on disposals on or after the 1st January 2016 when RER was first introduced. Where all the conditions are met, the relief provides for a possible tax saving of up to €230,000. Unlike, Retirement Relief the proceeds or market value isn’t taken into consideration.

Furthermore, there is no age condition applicable to the owner transferring the assets.

When considering RER, the main conditions to note are:

• The asset must be owned by the individual for three of the previous five years ending with the disposal;
• The asset must have been used as part of the qualifying business;
• Where the asset being transferred relates to shares, there are minimum shareholding ownership and working employee/director criteria to be met.

Seven-Year Exemption / Relief

This relief applies specifically to gains on disposals/transfers of land and buildings which was originally purchased during the period 7th December 2011 and 31st December 2014. Relief from CGT is given on a fractional basis, whereby relief for 7 years over the number of ownership years is provided. i.e. If the property was owned for 10 years then 7/10ths of the gain on disposal is relived from being assessed for CGT.

Capital Acquisitions Tax (Tax on beneficiary / successor)

Capital Acquisitions Tax (CAT) is the tax a beneficiary pays on the gift/inheritance of assets. Where a successor receives a business without paying full market value for the business they are deemed to receive a gift.

Depending on the relationship between the owner and the deemed successor, a portion of the gift/inheritance value may be received tax-free with the balance liable to CAT at a rate of 33%.

For example, a child can receive tax-free lifetime gifts/inheritances from parents up to the value of €335,000, whereas gifts from siblings, aunts, uncles, and grandparents is €32,500. Gifts from all other parties are liable to CAT above a lifetime tax-free threshold of €16,250.

Note these tax-free thresholds are aggregated for gifts/inheritances received on or after the 5th Dec 1991, so once the threshold is exceeded the beneficiary will begin to pay CAT at 33% on the excess amount.

As with CGT there are also reliefs available against CAT to further facilitate succession of businesses without tax being a significant burden. The two most notable CAT reliefs being Agricultural Relief and Business Property Relief.

Agricultural Relief/Business Property Relief

Agricultural Relief and Business Property Relief both have their own conditions to be met to qualify for the relevant relief. Depending on the circumstances a beneficiary may in fact qualify for one or both of the reliefs at the same time. Regardless of which relief the beneficiary qualifies for, both reliefs provide the same tax relieving measure. The tax relief is provided by reducing the assessable asset value by 90% on a gift/inheritance.

For example, a beneficiary receives a gift of a trading premises worth €2,000,000. If they qualify for Business Property Relief the assessable gift value of that property is only €200,000. Assuming there is no available tax-free threshold remaining the relief will provide a tax saving of €594,000 (€1.8m*33%).

Note both reliefs also have clawback measures whereby their respective relief are withdrawn if certain conditions are not met post-transfer.

Same Event Relief

In a lifetime transfer where reliefs do not fully relieve both CGT and CAT on the same transfer, there is a relief available called Same Event Relief. This relief effectively allows the beneficiary to take a credit for the CGT paid (by the transferor) against the CAT arising on the beneficiary. There is however a clawback of the relief where the asset is sold within two years of the relief being claimed.

Stamp Duty (Tax on successor)

Stamp Duty is a tax on certain instruments (written documents). In relation to a transfer of business assets such as land & buildings, or trading company shares, stamp duty is payable on the market value of these assets. The current rate of stamp duty is as follows:

• Commercial property: 7.5%
• Residential Property: 1% (2% on excess over €1m)
• Shares: 1%

Unfortunately, there are very little reliefs available against stamp duty on the transfer of business assets, and given today’s high rate of commercial stamp duty at 7.5% it would certainly be a significant hurdle for business succession where property is being transferred. However, where the business assets transfer is in the form of trading company shares the rate applicable is 1%.

Reliefs on agricultural land & buildings transfers

There are conditional reliefs available for stamp duty on the transfer of farmland and buildings. For example, the transfer of farm property to young trained farmers may be exempt from stamp duty, and a transfer of farm property to qualifying blood relatives may reduce the stamp duty rate from 7.5% to 1%.

Conclusion

Given the high rate capital taxes involved in business transfers (CGT 33%, CAT 33%, Stamp Duty 7.5%), it is crucial that all reliefs are carefully explored to reduce the financial impact on lifetime business transfers.

While all three taxes apply on lifetime transfers, only CAT is applicable on the transfer by inheritance (Will). However, where a decision to transfer by inheritance is chosen, one must realise that current tax rates, reliefs and market values may differ at that point in time in the future.

Family businesses are not created overnight. They take many years of sacrifice and hard work to build up and even then this work ethic must continue to ensure its survival. For this reason alone, business owners and their potential successors should engage in proper succession planning to ensure the business transfer is tax-efficient and avoids any significant financial impact on businesses and their owners.

Brian Harty, BBS FCCA AITI Harty Tax Consulting, 1 Rock Street, Cloyne, Co Cork.