Mazars tax partner Alan Murray (pictured) details the issues that can arise when it comes to passing on the family business

There will inevitably come a time when a business owner will have to decide if they are ready to let go of the reins. Equally important, the owner will need to decide if the successor/s are ready to take over that responsibility. The various issues that may be relevant in passing on the business are outlined below. Of course, this is not a case of one size fits all. Families have varying dynamics and certain issues which may be relevant to one family situation may not be relevant to another.

There are financial issues, legal issues, tax issues and general business issues to be considered. If consideration is not given to any one of these headings, the succession plan could falter. The following outline provides guidance on the tax issues involved, along with some other considerations to keep in mind.

Why Should You Plan For The Future?

One of the most significant adverse consequences of failing to plan is the increased tax costs in passing the business from generation to generation.

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Succession planning is an important part of business planning if the continuity of the business is to be assured, if the most suitable successor or successors are chosen, if financial independence in retirement is achieved and — last but not least — if family unity is to be maintained.

What Are The Main Taxes That Arise?

The two main taxes that need to be addressed when transferring assets to the next generation are: Capital Gains Tax (CGT) at 33% for the ‘giver’ of the business and Capital Acquisitions Tax (CAT) i.e. gift/inheritance tax at 33% for the ‘receiver’. There may also be stamp duty (1%/2%) for an individual acquiring the business and VAT considerations should be taken into account.

Is There Anything You Can Do To Mitigate CGT?

• Retirement Relief

If the transfer of your business is structured carefully, retirement relief can provide for a total exemption from CGT. One of the key points is that you could get the relief but not actually be required to retire (despite the connotations in the name). In general terms, once you are aged 55 or over, and various conditions are adhered to, you may be able to pass on your business to your children without paying any CGT. It is imperative that you do the groundwork on this at an early stage, as some of the conditions are time sensitive e.g. the requirement to be a working director for 10 years.

Once you reach the age of 66, the value of the business that can be transferred free from CGT is capped at €3m. Therefore, from a tax point of view, it may be more efficient to consider transferring the business sooner rather than later. However, other circumstances may dictate whether or not this is possible.

• Entrepreneur Relief

The Finance Act 2015 introduced a reduced rate of CGT of 20% which could apply in respect of capital gains on the sale of certain business assets made on or after 1 January 2016 up to a lifetime limit of €1m. This could result in maximum potential relief from CGT of up to €130,000 in your lifetime, if it applies. If you are considering passing on your business, you would need to review the various conditions to see if you would be entitled to the relief.

What Reliefs Are Available To Reduce CAT?

• Business Property Relief/Agricultural Relief

The current tax free threshold for gifts/inheritances between a parent and child stands at €280,000, and anything in excess of this is potentially liable to 33% tax. Business property relief provides for a deduction of 90% of the taxable value of a gift or inheritance, thereby potentially reducing the tax rate from 33% to approximately 3%. Similar to retirement relief, there are a range of conditions to be complied with in order to be in a position to claim this relief, and which should be looked at from an early stage.

Agricultural relief is a similar relief except it relates to the transfer of a farm.

What If Both CGT and CAT Are Payable?

If you plan to gift certain assets during your lifetime, you may be liable to CGT on the transfer of the asset and your child may be subject to CAT on the same event. A credit for the CGT paid can be claimed against the CAT liability on this same event. A clawback of this credit may arise if the asset is sold by your child within two years.

The following two scenarios are similar transactions, but have different tax outcomes.

If a parent sells the shares in their business, they may pay CGT on any gain that they make. If they subsequently gift the cash that they receive from the sale of the business to their children, the children may have a CAT liability, and there is no offset of one tax against the other, as the transactions are not from the same event.

However, if instead of initially selling the shares, the parent just gifts the shares to the children, the parent would still have a CGT liability, and the children would still have their CAT liability. In this case, though, the liabilities arise from the same event. Therefore, when the children are computing their CAT liabilities, they may deduct the CGT paid by the parent from their own liability. The children can go ahead and sell the shares (once two years have elapsed) if they wish to generate cash for themselves.

Say  Michael sells shares for €1,000,000, on which he pays CGT of €330,000. He then gifts the remaining cash from the sale (€670,000) to his child, Mary. Ignoring any reliefs, exemptions and tax free thresholds, Mary would have a CAT liability of €221,100 (33% of €670,000). The total tax payable would be €551,100 (€330,000 plus €221,100).

Rather than selling the shares first, if Michael were to just gift the shares valued at €1,000,000 to Mary, his CGT liability would still be €330,000. Mary would now have a CAT liability of €330,000 (€1m x 33%). But the CGT paid can be offset against this – resulting in no CAT being due. Mary could sell the shares after two years at no gain — therefore no CGT liability. The total tax in this case would be €330,000 versus €551,100 from the first example.

How are you going to fund retirement?

If you do decide to pass on the business to children, you will need to consider what you are going to do for financial survival through retirement. Early succession planning allows for time to put thought and planning into potential retirement funds. The following would be your typical income sources on retirement.

• State Pension

The State Pension (Contributory) is paid to people from the age of 66 (increasing to 68 by 2028) who have made enough social insurance payments. You can review your historic contributions to ensure you have a sufficient level of contributions in place.

• Pension schemes

You may have a pension fund from previous employment or personal pension fund (self-employed).
It may be possible to receive a tax-free amount up to €200,000 at retirement age. Other options available include the purchase of an annuity or investing in an Approved Retirement Fund (ARF). Your financial circumstances in retirement will dictate what is most suitable for you.

• Personal assets and investments

You should determine what income you will be able to derive from these assets in retirement, and if you do decide to sell any such investment, what are the tax consequences?

If you are not satisfied that these income sources will produce sufficient income to fund your lifestyle in retirement, you may also consider the following options:

The business could pay you an ex gratia payment on retirement. Depending on the circumstances, there is the potential to deliver €200,000 to the retiring owner tax free.

Company buy-back of shares is a method of passing on your business whereby the company buys back your shareholding and you could avail of the lower capital gains tax rate on the money received, rather than the potentially higher income tax rate. This is subject to various conditions.

Of course, if all of the above options are exhausted, there is still the possibility that, rather than gifting the business outright, the child will pay some amount as a price for the business. This will obviously reduce the taxable amount of the gift that the child is deemed to take.

How Can You Reduce Potential Conflict Among Your Successors?

Conflict between your children could make you apprehensive about passing on the business, and identifying who to pass it on to. Whilst many postpone in the hope that a resolution will be found, there are alternative options that can be looked into.

• Create A Shareholders Agreement

This is basically to put some rules in place in relation to key decisions for the company.

• Enduring Power Of Attorney

If you feel that you may not be fully mentally capable of making decisions yourself at some point in the future, you can appoint somebody now, that you consider will make those decisions on your behalf – thereby acting as a sort of proxy for you.

• Reorganisation of class of shares

Where a number of family members are shareholders but their level of participation in running the business varies, their interests can be accommodated by way of the creation of different classes of shares to reflect the different rights and entitlements of the different family members involved.

These points would be more legal in nature, and you should seek legal advice if you are considering adopting any aspect of these.

How Can You Protect The Future Of The Business?

Although you may have decided to pass on your business, you may still be concerned about its future. After all, you have worked hard to get the business to where it is today. You might consider taking out Keyman insurance to financially protect against the prolonged illness or death of a staff member who you consider is central to the business.

As you can see, there are many factors that must be considered when passing your business to your children. To ensure that the transfer is conducted as smoothly as possible and that the business will be in good hands, you should give these points careful thought. One of the main points is that you review this at an early stage to ensure that whatever planning needs to be done, in particular from a tax perspective, can be done in a timely manner.