Family firms with large cash piles face tricky tax issues when passing on or selling the business, writes John Kinsella

It’s not uncommon in Ireland for long-standing family-owned businesses to build up large cash reserves over time. The business owners have been doing what they’ve been doing well for years, and the cash just piles up.

Current tax policy encourages the transfer of family businesses to the next generation at an early stage by minimising tax costs through the use of specific reliefs such as Retirement Relief for Capital Gains Tax purposes, and Business Relief for Capital Acquisitions Tax purposes.

However, according to tax experts in PwC, there are limitations and anomalies associated with these reliefs, which may lead to higher than expected tax costs. This could potentially put the business at risk and can also discourage business owners from making lifetime transfers.

Business Relief from CAT is designed to minimise the tax cost arising from the transfer of a business to a family recipient. Even when Business Relief operates in full, it only provides relief of 90% of the value of the assets. Depending on the value of the family business, there may still be a significant CAT liability for the recipient on the remaining taxable value. That liability may have to be funded out of the resources of the business itself.

PwC tax partner Ronan Furlong (pictured), who works in the firm’s entrepreneurial and private business practice, notes that tax authorities regard any of the cash that is not immediately required for the purpose of the business as being an ‘excepted asset’ for Business Relief purposes and therefore excluded from the relief.

In Association with

This can give rise to significant CAT liabilities that must be funded from after tax income. “In a worst case scenario, where the cash has grown substantially, Revenue can even take the view that the business is not a qualifying business for Business Relief purposes,” says Furlong.

“Our view is that this approach is not always appropriate, as it is simply based on a snapshot of a company’s assets at a moment in time and takes no account of the circumstances in which the cash has arisen nor the purpose for which the cash is intended.

Ahead of the autumn budget, PwC has suggested to finance minister Pascal Donohoe that where the cash has been earmarked for pre-existing contractual or planned expenditure, it should not be regarded as an ‘excepted asset’ for Business Relief purposes.

Excepted Asset

Surplus cash is also regarded as an ‘excepted asset’ for inheritance tax purposes in the UK. However, the equivalent UK legislation provides that cash assets required for the future needs of the business should not be regarded as an ‘excepted asset’.

According to Furlong: “The absence of such a provision in Irish tax legislation often restricts the amount of Business Relief available on the transfer of a family business. We recommend that an equivalent ‘future use test’ is introduced to address the issue and provide a clear legislative basis for allowing cash reserves which are required for future business commitments to be regarded as relevant business property.”

The surplus cash issue also looms large when family business owners sell the venture to the next generation or the management team. The usual form of financing for such arrangements is bank debt, which has to be secured on collateral. Where there is a large cash pool in the business being sold, a typical buyout structure will see the bank debt being repaid using the retained earnings of the newly acquired business.

Finance Act 2017 introduced an anti-avoidance measure to prevent undistributed profits of a company from being extracted in the form of capital, and therefore subject to CGT rather than income tax, by way of an ‘arrangement’ involving companies which are ‘close’ for tax purposes.

Bona Fide Test

In Furlong’s view, the problem with this new measure is that, unlike other anti-avoidance legislation, it does not contain a ‘bona fide’ test and therefore prevents the ability to carve out genuine commercial transactions.

“A well-established path to structuring a business ownership transition, such as the one described above, is no longer a viable option from a tax perspective, as it imposes an income tax charge on the business owners who are selling rather than CGT. The result is that the usual reliefs such as Retirement Relief would no longer apply,” Furlong explains.

“This means that income tax rates of up to 55% apply to sales proceeds as opposed to 10% or 33% for capital gains. This differential in tax rates is discouraging family business owners in transferring the business to the next generation, and instead may push them to consider other exit strategies not involving the family,” Furlong adds.

Furlong notes that a ‘bona fide’ test is included in similar anti-avoidance sections in legislation designed to counter capital to income schemes. “We therefore recommend that a ‘bona fide’ test is inserted to the anti-avoidance legislation brought in under Finance Act 2017 to ensure that commercial transactions such as the ownership transition structure described above can be implemented without imposing an income tax charge.

“Whilst we recognise that there is an element of subjectivity to a ‘bona fide’ test, it would allow family business owners to document their motives and rationale for a transaction which can then be produced and defended in the event of a future challenge from Revenue.”

Tax Appeals

Tax disputes over alleged avoidance are currently clogging up the tax appeals system, with 3,650 appeals outstanding in April 2019. Sean Fleming TD recently observed that if the Tax Appeals Commission is going to receive additional and more complex appeals, and it is already finding it hard to deal with legacy complaints, then the problem is going to get worse and worse.

“Ireland’s tax system needs to be transparent, fair and consistent.  A fully functioning Tax Appeals Commission is critical in achieving that,” Fleming added.

The view from PwC is that the TAC has insufficient resources to deal with the volume of the appeals being received. According to Ronan Furlong, taxpayers are often reluctant to submit an appeal for fear that they could have to pay disproportionately large interest costs should their appeal prove unsuccessful.

“The delays in hearing appeals is exacerbating this issue,” says Furlong. “Furthermore, the high legal costs associated with an appeal, which are still payable even if a taxpayer wins an appeal, act as a deterrent to taxpayers bringing an appeal for smaller cases.”

Furlong would like to see the establishment of a Small Claims division of TAC to focus on minor appeals, typically contested by individuals and family businesses. “This should have the effect of increasing the efficiency of dealing with claims, particularly as the new division gains more experience in dealing with the more routine appeals,” he adds.