MJ O'Connor Solicitors

Difficult market conditions and falling property and other asset values are generally not good news, however, for some family businesses, it may well present an opportunity to re-structure the business to bring in the next generation in a tax-efficient manner.  There are many issues which should be considered by parents before deciding how and when to bring in their children as owners and it is increasingly important that proper planning for succession of the business be undertaken, if the business is to remain viable.  The issues in any individual case will of course vary widely depending on the business, family circumstances and so on, but Capital Gains Tax (CGT) will always need to be considered.

 

A transfer of ownership in a business and/or business assets to children by way of gift may trigger a CGT liability for the parents based on the current market value of the business/ assets.  In effect, there is a deemed sale at the current market value and CGT assessed accordingly.   In addition, there may also be a liability to both Stamp Duty and Capital Acquisitions Tax (CAT - otherwise known as gift/inheritance tax) again based on market value which is payable by the children.   By contrast, an inheritance of ownership arising on death will be exempt from both CGT and Stamp Duty, although CAT will apply. Looking at this in simple terms, it may be said that by passing assets as an inheritance rather than as a gift there is a saving of both CGT and Stamp Duty. A decision will often be made by parents because of the CGT cost, to defer an immediate transfer of ownership by way of gift and ultimately the assets are held by the parents to be passed on death under the terms of a Will. 

 

There may be drawbacks to deferring a transfer in this way. It is possible that the future inheritance may happen at a time when the value of the business or business assets will be significantly higher and/or at a time when CAT rates have increased or CAT reliefs are not available. Furthermore, a decision to defer, even when the reasons for doing so might be communicated clearly to the children, will inevitably give rise to ongoing uncertainties both as to the timing of change of ownership (i.e. when the parents will die) and indeed even as to whether it will happen at all (given the possibility of a change in circumstances and an amendment to the parents Will). It is likely in many cases, that such uncertainties mean the next generation do not fully commit to the business both at a personal and financial level. This may be bad news for family relationships and the business itself.

 

CGT is based on market values in the event of a transfer between family members and is levied on the deemed profit or increase in value of the assets during the period of ownership. A parent will typically have owned the company shares or business assets since start-up and so the increase in value may be significant. The rate of tax had been at a historically low rate of 20% for several years, however, it is now 22% following a change in the recent budget (effective from 14 October, 2008). In making this amendment to CGT rates, it is interesting to note that the Minister made reference in his speech to the Dail to an “imbalance” between CGT and stamp duty and also a reference to the increase in CGT reflecting the additional 2% levy on income tax.

To assess CGT, one of the first issues to consider is whether ‘retirement relief’ provisions may apply as these can offer a full exemption (Sections 598, 599 TCA 1997). These provisions only apply to those aged 55 and over and where certain other conditions, including ownership of the business assets for 10 years, are met. If these provisions apply, it is likely to be deemed tax-efficient to proceed with the transfer by way of gift.   

A further issue to consider is whether it will be possible to ‘set-off’ the CGT cost (Section 104 CATCA 2003) against a CAT liability. In a situation where the proposed transfer of ownership will trigger a CAT cost for the children (e.g. where children have no ‘tax-free threshold’ available and/or no CAT reliefs apply), then the CGT payable by the parent may be taken as a credit by the child against the child’s CAT bill. In this situation, to the extent that it is set-off, the CGT is not an additional cost and so the transfer by way of gift may also be deemed tax-efficient. 

In the absence of ‘retirement relief’ or ‘set-off’, the CGT cost becomes a significant factor.  Given present market conditions, commercial property and land values are likely to be lower than in previous years and the value of a business owning or including such assets, or a business otherwise affected by the recession may also be less. For some, it may therefore present a window of opportunity to review the value of the business or business assets now and transfer at a reduced CGT cost. It should also be noted that CGT and CAT rates are historically at low levels and it may be the case that rates will increase in the future (the recent Finance Bill has increased the CAT rate from 20% to 22% effective from 19 November, 2008).  It is generally perceived that from a financial and tax perspective, a good time to transfer an interest in a business to the next generation is before a strong increase in the value of the business. Again, if market conditions mean that there is a relatively low value in the business now but it is anticipated that the value will increase considerably in future years, it would be prudent to look at an immediate transfer. 

 

For a parent with other investment assets, there may also be the possibility of being able to set off losses arising on the disposal of those assets against a CGT gain which would arise on the disposal of a share in the business to children. Losses may have arisen for some in recent times, for example, where a parent has decided to off-load non-performing investment assets. It may also be possible to crystallise CGT losses (e.g. on shares) in other circumstances, but if this is done in such a way that the parent re-invests or re-acquires similar assets, then crystallisation of the loss will really only be a cashflow benefit and not a tax saving.

 

There are options for the parents to consider, other than a simple transfer of the entire or fixed portion of the business to the children.   In particular, for succession planning purposes, a ‘share-capping’ or ‘share-freezing’ exercise is often considered in the case of an incorporated business. It may also be possible to look at similar exercises in the context of business property held under a partnership agreement. 

A ‘share-capping’ exercise generally involves creating different classes of shareholdings in a company with different rights attaching. The parents retain the existing value of the business in one class of shares (“A shares”) to be owned by them and these shares are ‘capped’ or do not increase in value if the company value increases. They create a second class of shares (“B shares) for immediate transfer to the children to which the future growth in value of the company will accrue. The parents by Will make provision to pass the ownership of the A shares to the children but in the knowledge that this inheritance will be at a fixed value. The B shares at the time of transfer have little or no value and so the gift is tax efficient.

Such arrangements are typically also attractive to parents who wish to retain control of their business as this may be achieved by creating a further class of shares with most of the voting rights attached (i.e. the ‘Golden shares’) to be retained by parents. The Golden shares can be transferred at some future date when appropriate or ultimately passed as an inheritance by Will.

 

FOR FURTHER INFORMATION contact Cormac Mullen, M.J. O’Connor, Solicitors

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Email: cmullen@mjoc.ie