What do we mean by succession planning?
We mean making a plan to minimise your tax liability when disposing of, or passing on, your assets. This could include passing on a business or farm to the next generation, or selling your business to a non-family member. You must carefully consider the tax implications, especially when it comes to Capital Acquisitions Tax (CAT) and Capital Gains Tax (CGT).
Capital Acquisitions Tax
CAT comes into play when passing on assets at less than market value, e.g. making a gift or inheritance from one individual to another. Inheritance tax is a form of CAT and arises where a beneficiary receives an inheritance as a result of someone dying.
Capital Gains Tax
CGT applies when ownership in an asset changes by sale or otherwise.
Both CAT and CGT can arise on the same transaction and there are substantial tax reliefs available in certain circumstances.
There are many factors to consider when creating or updating your succession plan. Here are some.
The age at which you pass on business assets is one of the main determinants on how much tax you pay. New arrangements came into play in Ireland on January 1st, 2014, in this regard. Full relief after the age of 55 became full relief at 66 years of age, with marginal relief available in certain circumstances between 55 and 66. These arrangements may change again and you should contact us for the up to date situation.
The sequence you pass on certain types of assets is also important. The key steps are:
- Pass on assets that do not attract CGT first, e.g. cash denominated in Euro.
- Then pass on investment assets, e.g. rental property.
- Lastly, pass on business assets, e.g. shares in the family trading company.
Revenue is interested in the current market value of an asset. The value of certain assets such as land and shares will fluctuate over time so, again, timing the disposal is very important.
Relationship to the disponer
The disponer is the person disposing of the asset.
Different thresholds apply depending on whether or not you are transferring assets to a family member or a non-family member. In some cases the threshold may be €3,000,000 for a child and just €500,000 for a non-family member.
If the asset is owned jointly by yourself and your spouse for many years, you may each be entitled to your own threshold thereby doubling the effective benefit.
In certain circumstances relief from CAT is available for business property acquired by gift or inheritance.
Business property includes land, buildings, and machinery owned or used for the purposes of a trade.
It can also include shares in a trading company. If you qualify, the effective rate of CAT applicable to business property is 2%.
CAT / CGT Offset
In certain circumstances, the CGT paid by the parent can be taken as a credit to reduce the CAT liability payable by the son or daughter. This can sometimes reduce the child’s CAT liability to nil.
Section 60 / 72 insurance
In Ireland it is possible to take out a life assurance policy to fund for Inheritance tax. A Section 72 policy is an inheritance tax planning tool. It allows for an inheritance tax liability to be provided for in a highly tax efficient manner hence easing the burden of transferring wealth from one generation to the next.
A recent case - succession planning and retirement
An elderly client who had grown a very successful market research company, wanted to retire and pass the company onto his two sons. The father wanted to continue to have some control over the strategic decision making process in the company. Each son had different backgrounds and their ideas on developing the company were conflicting in certain areas. One son was very marketing oriented and had a lot of project management experience in the IT industry, whilst the other was an economist and prudent in the risks and investments he was willing to take.
Having met with the family together and individually, we got a sense of how they wanted the business to prosper.
We recommended a joint venture limited liability structure, with a golden share for the father. Using retirement relief and pension tax relief we were able to extract a large tax free lump sum from the company for the father’s shares so that he had more than enough to live on, whilst allowing him to have the final say in decisions where an agreement between the sons was not possible.
The sons’ joint venture ownership allowed each to have equal rights in terms of ownership control and financially, which made working together towards the goal of a successful company easier.
Two separate trades held by a third party limited liability joint venture company, can mean that two businesses operate separately but with shared resources, profits and control. The contributions and profits will be shared equally and neither party has full control of the JVC. The JVC provides the protection of limited liability, which a partnership cannot provide. Tax deductions for losses in the JVC can be surrendered to either company A or B with joint agreement.
If the JCV cannot pay its debts, the creditors can claim only against company A and B to the value of its shareholding and not against the owners of the companies. To protect against claims from creditors, Subsidiary companies A and B can be inserted, so that creditors of JVC can claim against Sub A and B but not company A and B, as these are separate legal entities.
Passing on ownership of assets tax-effectively to Children
A client wanted to pass on the ownership of business assets tax-effectively to children but also wanted to maintain control of these assets until the timing was more appropriate. We advised that this could be achieved by:
a. Family partnerships
b. Share freezes
c. Golden Share Structures
The Family Partnership structure enables parents to exercise a degree of control over any investments or assets they wish to share with their children during their lifetime. A family partnership is a useful vehicle for holding investments. The partners in a family partnership will generally be parents and their children. The benefit of a family partnership is that it allows parents to transfer assets to their children at today’s value and pay tax at today’s value while still retaining control of the assets. Alternatively, the family partnership can be used to purchase new assets. In both cases, any increase in value in the assets is attributable to the partners, including the children.
The initial gift to the children would be liable to CAT at 33% subject to the tax-free threshold of €225,000 and the small gift exemption of €6,000 ( €3,000 from each parent).
From a taxation perspective, there will be an ongoing liability to income tax and CGT by the partnership. The children (once over the age of 18) would be able to use their tax free credits and allowances which would result in a lower rate of tax than if the assets were in the hands of their parents.
Share freezing is essentially a succession-planning tool used in a family business to pass future growth in the company to the next generation. The benefits of share freezing are it caps or freezes assets of the company at today’s value. The current shareholders retain control until they wish to exit the business while at the same time saving on future inheritance tax for the ultimate recipients of the shares.
For example: If we take a family business run by the parents, who have two children, both of whom are interested in working in the company, share capping might work as follows:
1. The existing shareholding within the company is split into three separate categories of shares, usually A, B and C shares, each with different rights and privileges
2. ‘A’ shares are usually issued to the parents and will have a value on the break-up of the company equal to the company’s current value (e.g. €1,000,000);
3. ‘B’ shares are issued to the children (or a Trust) and they will be entitled to the value of the company in excess of €1,000,000 on a break-up of the company;
4. ‘C’ shares are not entitled to share in the assets of the company on a winding-up or to participate in dividends paid by the company; therefore they would not have a great value.
However, the importance of this class of share is that most of the voting control of the company is vested in them.
Effectively, holding A shares caps the value of the shares retained by the parents, which freezes the company at its current value. This allows any increase in value to pass on to the holders of the B shares, i.e. the children, but because they do not own the A shares, they do not incur any inheritance tax liability on their parent’s death. They merely receive the profits. The parents still retain control by holding all of the C shares. However, on death, they will pass to the children along with the ultimate control of the business in the form of the A shares and the inheritance tax liability incurred will be a fixed amount.
A company shall not make a loan or a quasi-loan to a director of the company or of its holding company or to a person connected with such a director. The effect of this section means that loans between companies which are independently held but who have common directors or who are connected with the company’s directors cannot lend funds. This can cause issues where one company has surplus cash and the other requires funds. There is an exception where the loan does not exceed:
10% of the net asset value of the receiving company, per the latest set of filed financial statements.
A person is connected with a director of a company if the person is that director’s spouse, parent, brother, sister or child.
A director of a company shall be deemed to control a body corporate if, but only if, he is, alone or together with any other director or directors of the company, or any person connected with the director or such other director or directors, interested in one-half or more of the equity share capital of that body or entitled to exercise or control the exercise of one-half or more of the voting power at any general meeting of that body.
If section 31 is breached the loan is considered to be an illegal loan and a breach of Company law. A breach of Company law results in the directors being reported to the Office of the Director of Corporate Enforcement and it is an indictable offence.
A golden share structure can circumvent the restrictions of inter-company lending imposed by section 31. This is facilitated by Section 155(1)(a)(i) of the Companies Act 1963 Act which states that a company is a subsidiary company of another if that other is a member of it and controls the composition of its board of directors.
Relying on this definition we create a group structure by creating a new class of shares in Company A, and the only right of this new class of shares will be the right to control the composition of the board of directors of Company A. The winding up value of the new class of shares would be capped at its par value in the Articles of Association. We would then issue this class of share to Company B. By issuing the share to Company B, Company B becomes the parent of Company A and remains the parent for so long as it holds the relevant share.
However, creating a group means that a company can not avail of audit exemption and may need group accounts depending on the size. Creating a group, via the golden share structure, would avoid the loan issue under section 31 of the 1990 Act since the companies would have formed a group and will come under the heading of one of the exemptions under sections 32 to 37 of the 1990 Act. Note a group is created for company law purposes only and these companies would not be considered to be a group for tax purposes.
CASE STUDY APPLICATION
Mary has excess cash resources in XYZ Limited. She is connected to MO Limited as a result of section 26 Companies Act 1990. A loan of €500,000 from XYZ Limited, would exceed the net asset value of MO Ltd, and be deemed an illegal loan for company law purposes. Mary could alternatively, extract the cash from XYZ Ltd Limited via dividend or salary but this would be liable to income tax at her marginal rate and be inefficient from a tax perspective, leaving a balance available to lend after tax of €240,000, assuming a 52% income tax rate.
Therefore, the putting in place of a golden share structure between XYZ Limited and MO Limited would facilitate the inter-company lending without a breach of section 31 Companies Act 1990.