Business Sale – What to do with a €230k Tax saving?
We would often talk with business owners and one of the questions we always ask is about the long term plan of the owner. Quite often, in reply, we get a glazed look as to know what we mean by that. When you are young and enthusiastic, working hard and looking to grow a business it is quite rare that the business owner will even have thought about what the long-term plan would be in terms of selling the business, passing it onto the family or a bit of both. We are of the view that knowing what your long term plan is is key to getting there. If you know where you want to go you can put the steps in place to achieve your business goals to arrive at your destination. Hopefully the fruits of your labour and knowledge will have helped you build up a business that someone would look to buy and pay you handsomely for your considerable efforts and that of your staff. The ideal scenario is that you get well rewarded and that your staff, who have worked hard alongside you, also get some benefit in the event of a sale. This can be implemented by means of setting up a share scheme and we are to expect some new share scheme options later this year for smaller businesses.
One of the very useful, and quite new, tax reliefs on the sale of a business is called Entrepreneurs Relief [ER]. This is a Capital Gains Tax [CGT] relief on the sale of business assets provided certain conditions are met which we will look into below.
Our Neighbours – The grass is greener
I have yet to find an article written by an Irish commentator on this who hasn’t compared Irish ER to UK ER and I am not about to buck that trend.This brings to mind the 10th commandment “Thou shalt not covet your neighbour’s wife or anything belonging to your neighbour” In tax terms you could change this to “thou shalt not covet your neighbour’s Entrepreneurs Relief!” In the UK the current CGT rate is 20% but for clients who can avail of ER the rate reduces to 10% on lifetime gains of up to £10 million, so the relief over there can be worth up to £1 million. Here the relief is worth up to €230,000. As in the UK the Irish ER rate is 10% but it applies on lifetime gains of up to €1 million and our normal CGT rate is 33%. So on a €1 million gain that qualifies for ER here, rather than paying €330,000 to Minister Noonan he will get €100,000 from your lifetime achievements. On gains above the €1 million mark the normal rate of 33% applies. Up to 31 December 2016 the ER rate was 20% and it has reduced to 10% for qualifying disposals from 1 January 2017.
As they say the devil is in the detail but the main problem with this piece of tax law is that there isn’t much detail as of yet. The piece of legislation is quite short and a lot more detail will come out as to what will and will not qualify. The relief applies to a disposal of a qualifying business by an individual.
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. The relief applies to individuals only. So basically all types of businesses qualify other than those mentioned above.
The qualifying business assets must have been owned by that individual for a continuous period of 3 years in the 5 years immediately prior to the disposal of those assets. In relation to this,
- periods of ownership by spouses cannot be aggregated for the purpose of the 3-year continuous ownership condition
- Neither can periods of ownership of assets before and after incorporation of a business (e.g. periods of ownership of assets of a business carried on by a sole trader or partners in a partnership and shares in a company that carries on the business previously carried on by the sole trader or partnership).
The relief does not apply to the disposal of the following assets:
- shares, securities or other assets held as investments
- development land
- assets on the disposal of which no chargeable gain would arise
- assets owned personally outside a company, even where such assets are used by the company.
If an individual is selling shares in his/her trading company they will need to be aware of the following points;
- The individual must own, not less than 5% of the ordinary shares in a qualifying company or 5% of the ordinary shares in a holding company of a trading group.
- The individual must have been a director or employee of the company and
- was required to spend not less than 50% of his or her time in the service of the company in a managerial or technical capacity
- The individual has served in that capacity for a continuous period of 3 years in the 5 years immediately prior to the disposal of the chargeable business assets.
Revenue has gone on to clarify a number of different situations to which the relief will apply.
Where a director or employee of a company is serving in a managerial or technical capacity for the necessary periods of time, mentioned above, and if there is a company reorganisation, then the period working for the old entity and the new entity can qualify, provided the share reorganisation is not regarded as a disposal for CGT. An example of this would be – Des and Karen are directors of a dance academy business [Company A] who each own 50% of the shares in the company and have been working for 2.5 years in this company. This company also own a number of residential properties. There is a potential offer coming down the line for the company but Des and Karen want to hold onto the investment properties. To this end they set up Company B and transfer the trade from Company A to Company B. As before, they own Company B 50:50 and once they trade for 6 month or more in Company B they will have owned the shares for more than 3 years between both companies and can benefit from ER on the sale of the shares in Company B.
Revenue have also confirmed that ER can apply when a share buyback is within the charge to CGT. We will look at a share buyback in a future blog post.
ER can also apply in a company liquidation situation where the company in question would have been carrying on a qualifying business up to the date the liquidator was appointed and the liquidation was completed in a reasonable period of time which Revenue have clarified as being 2 years from the date of appointment of the liquidator.
Similarly ER can apply to a partner in a partnership set-up, where those assets were used for the purposes of a qualifying business carried on by the partnership and the individual was actively involved in the business.
If you have a new BMW 5 series or whatever luxury car tickles your fancy in your driveway you will be pretty happy with yourself. Then your neighbour across the road parks up his brand new Maserati and the green eyed monster kicks in. It’s natural to compare but we must remember that we never had a valuable ER relief like this working in Ireland before. Our government leaders are well aware of the differences in the Irish and the UK rate and obviously both countries compete for inward investment and have to try and foster a tax system that enable entrepreneurs to set up businesses and small family businesses are the cornerstone of most country’s economies. I believe the current ER in Ireland will improve in terms of the lifetime limit and can see that increasing in successive budgets so watch this space and keep an eye and ear out for what the Minister has to say next October. Don’t be worried about the finer details, sure isn’t that what you pay your accountant for! All you need to know is that ER exists and hopefully one day you will be in a position to benefit from it.
For more information and future blogs check out our resources page.