Two weeks ago, we looked at a Tax Strategy for a growing business. In case you missed it see here
This week we are looking at a Tax strategy for the Directors who want to exit their business. The main points are
- Exit Plan
- Meet Reg
- Look at gifting shares to Megan
- Paulaid Ltd buying back shares from Paul and Sinead
- Termination payments
It’s now 2040 and it’s hot out there. It was 25 degrees last night at midnight. Paulaid Ltd has traded very well in the last 18 years. Paul and Sinead’s daughter Megan is working in the business and is showing good potential. There is €1 million in cash in the company. They visit Bob, one of the owners of Tax Magic Ltd to discuss their exit from the business. They are unsure about
- What to do with the cash in the company. Is there a way of getting some of that?
- Explore the company purchasing two investment properties with the cash
- Passing on the business to Megan. Can they do this and how?
- What is the tax cost and what will they end up with?
Bob has a super conversation with both. Paul wants to get out of the business. He is very keen to improve his golf game. He’s sick of O’Reilly slagging him off in the bar after telling everyone how he’s good at finding the trees. He also wants to spend more time in their holiday home in Iceland. Sinead would like to continue to work part-time as she doesn’t want to be stuck at home when Paul is golfing. She loves the garden and enjoys spending time with Javier their new gardener. Megan is very interested in taking more responsibility in the business. She gets on well with staff and is getting to meet some suppliers and customers. She likes the sales side of the business and is introducing changes to make it a better place to work. Bob comes up with a potential exit plan
- Paul and Sinead transfer some shares in the business to Megan now in 2040.
- In the next 6 to 9 months, they put a plan in place to introduce Megan to key customers, suppliers, the bank, and others.
- In 2041 the company will buy back Paul and Sinead’s remaining shares
- Paul will no longer be a director and will cease employment at the end of 2041.
- Sinead will no longer be a director from the time of the share buyback but will continue to work part-time
- They will need to get a company valuation
Reg is the man when it comes to company valuations. He has done hundreds of them, and Revenue never has an issue with the numbers. He has been part of many business sales and transfers, and all have gone well. Reg knows the key to a quality valuation is that it is based on quality numbers from the accounts. In his report, he needs to understand the business and the prospects for the future. He knows what will reduce the value of the business and is very aware of the factors that add value. He outlines the importance of a valuation to Paul & Sinead
- Revenue would expect a valuation to be in place
- A transaction between a company and its shareholders is between connected parties. This means that all transactions must be at market value. You find out what market value is by doing a valuation report
- Paul and Sinead need to know what the company is worth so that any monies they get are what they should get
- Market value will determine the taxes for Capital Gains Tax, Gift Tax, and stamp duty.
Paul and Sinead agree on an engagement with Reg, and he promises to have a draft valuation report in place in a month. Reg gets to work, and he presents his valuation report. He has valued the company at €1.6 million which includes the value of the cash on the balance sheet.
For more information on company valuations click here
Gifting Shares to Megan
Paul and Sinead own 50 shares each in the company. Bob recommends that they each gift Megan 10 shares. After the gift, Megan will own 20% of the company and they will own 80%.
For Capital Gains Tax [CGT] and Stamp Duty, you use a minority discount factor to value the shares. The discount factor for single percentage holding is up to 90%. As they are both transferring 10% of the company, we will use a discount factor of 80%
|Value of Company||€1,600,000|
|No of shares in issue||100|
|Value per share||€16,000|
|Value of Paul’s 10 shares||€160,000|
|Value for CGT and Stamp Duty||€32,000|
The gift of 10 shares from Sinead to Megan will have the same value as Paul. So, Megan will pay stamp duty of €640 on the two lots of shares transferred to her.
For CGT Megan will get 10 shares from Paul at a value of €32,000 and the same from Sinead. So, her base cost going forward for these 20 shares will be €64,000
Paul and Sinead are both over 55 and meet all the conditions for Retirement relief. This is a disposal within the family so there is no cap on the amount of proceeds. Remember there is a cap of €3 million when you are 66 or over. Paul and Sinead have no CGT cost on the gift to Sinead. Sinead must hold onto the shares for 6 years. If she doesn’t, she will have to pay her CGT on the gain and will also have to pay the CGT that Paul and Sinead didn’t pay.
The other tax here is Gift tax. For Gift tax purposes there is no discount applied. Business Property Relief will come into play. The gift from Sinead is as follows;
|Value of Gift||€160,000|
|Less Stamp Duty||€320|
|Net value of gift||€159,680|
|Business Property Relief||90%||€143,712|
|Value of gift after BPR||€15,968|
|Small Gift Exemption||€3,000|
If Megan got any prior gifts from her parents, then the value of those would be taken into account. The current parent/child gift tax threshold is €335,000. The net value of both gifts is €25,936 will leave a balance of parent/child threshold of €309,064. There is also a clawback period with Business Property Relief of 6 years.
Paulaid Ltd buying back shares
It is now 2041 and 9 months since the initial gift of shares to Megan. The company has continued to trade well, and Megan is thriving in her new managerial role. Paul is spending less time at work and his golf handicap has fallen from +24 to plus +20. Sinead is enjoying the garden and Javier is helping her with a beginner’s Spanish course. All customers and suppliers know that Paul is stepping back and that Megan is taking over. They are both happy that Megan is ready to take full control. They get onto Reg and he advises them that the company valuation should be up to date for the share buyback. He updates the valuation to take account of the
- 2041 accounts
- current cash position in the summer of 2041
The current valuation is €1.8 million and the current cash position is €1.2 million. Paul and Sinead’s shares have a value as follows;
|Value of company||€1,800,000|
|No of shares in issue||100|
|Value per share||€18,000|
|No of shares Paul owns||40|
|Value of Paul’s shares||€720,000|
|Discount for minority holding||30%||€216,000|
|Net value of Paul’s shares||€504,000|
The market value of Paul’s and Sinead’s shares is €1,008,000. The company acquires Paul and Sinead’s shares for this amount and issues a bank transfer to each of €504,000. Provided Paul and Sinead meet the conditions of Retirement relief they will have no CGT to pay. They are selling their shares to a third party, their company. There is a lifetime cap of €750,000 each so they are both below that number.
When a company makes a payment to a shareholder that payment is usually liable to Income Tax. The key point for Paul and Sinead is to have the payment liable to Capital Gains Tax. Once the payment is for the benefit of the trade then it will be liable to CGT. Per Revenue when an older shareholder is exiting to make way for new management that is a benefit of the trade. For more information on share buybacks see here
Provided the paperwork is correct there is no stamp duty for the company when buying the shares. The company acquires the shares and cancels them. The only shares now in issue are the 20 shares that Megan owns. As such, she owns 100% of the company.
As Paul is ceasing his employment with the company he can get a termination payment. This is tax-free and the basic exemption is €10,160 plus €765 for each year of service. His payment is as follows;
|No of complete year’s service||20|
|Amount per complete year of service||€765|
As Sinead will continue to work, she doesn’t take a termination payment yet. She can do so when she exits the company.
O’Reilly is sick when Paul rocks up to the golf club with his new Tiger Woods golf clubs and trousers. Paul lets it slip that he bought two investment properties with the cash he got from the company. He will get €200,000 tax-free from his company pension next year when he is 60 and an annual pension of €30,000. O’Reilly counters with how well the garden is looking and that Sinead is flying at the Spanish.
With proper planning, you can exit your business in a tax-efficient way. This is a plan that you put in place with your advisor over time. It will change and you may need to do some restructuring to maximise reliefs. A company valuation report must be there to support the value of the transactions. Revenue will ask for this and expect you to have it. Given the value of the reliefs claimed it will be an area of scrutiny for Revenue. Proper planning will save you money. Like Hannibal from The A-Team, you too can love it when a plan comes together!
Interested in getting a plan in place? Call Deirdre on 051 396703 or start here. Tell us about you and your business and we will see if we can help.