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Passing on the family business - Now appears to be the time
AUTHOR(S): John Gill
PRACTICE AREA GROUP: Private Client, Capacity, Charities, Estate and Tax Planning, Private Client Property, Relocation Services, Trust and Estate Disputes / Will Challenges, Trust Structuring and Administration, Administration of Estates, Tax Disclosures
On 26 October 2010, the Government published the National Recovery Plan (the “Plan”) which outlined that an overall adjustment of €15 billion over the next four years was warranted in order to achieve the target deficit of 3% of GDP by 2014. Of that €15 billion, €145 million was to be raised through reform of Capital Acquisitions Tax (“CAT”) and Capital Gains Tax (“CGT”).
In a client update in November 2010, we raised the question “Passing on the Family Business – Is now definitely the time to do it?”.
Given the current economic environment and the Government’s agreement to implement the part of the Plan referable to CAT and CGT in the last quarter of 2011, we update our previous comments and say in relation to “Passing on the Family Business – Now appears to be the time”.
Estate planning is the process where wealth is transferred from one generation to the next in a tax efficient manner.
The Commission on Taxation (the “Commission”) Report (published on 7 September 2009) proposed that many existing reliefs be substantially curtailed.
The key taxes to be considered in a business transfer are CGT for the donor, and CAT and stamp duty for the beneficiary.
At present, full relief from CGT is available where an individual, aged 55 or over, gifts a qualifying business, shares in a family company or a farm to a child, regardless of the value. However, if the assets gifted to the child are sold within six years of the date of gift, the CGT becomes due.
In relation to CAT, a relief is available which treats gifts and inheritances of business assets (“business relief”) more favourably than other assets. The relief reduces the taxable value of business assets by 90% where the relevant business property has been owned by the donor for a qualifying period.
The relief is withdrawn if the property is sold within six years and is not replaced by other qualifying property or ceases to be used for business purposes.
Equivalent relief is available for agricultural property (“agricultural relief”).
At present, the entire benefit is taxable at an effective rate of 2.5%.
Taken together, the restrictions proposed by the Commission would impose an effective tax rate of 6.25% on a gift to a child of relieved assets worth €4 million. An effective tax rate of 25% would apply on any further value gifted to that child.
The following example illustrates the significant impact of the Commission’s recommendations, if the reliefs are restricted.
At present, a transfer of shares in a family company worth €10 million to a child, where the conditions for the CGT and CAT reliefs described above apply, would be taxable at an effective tax rate of 2.5%, giving rise to a tax liability of €250,000. If the Commission’s recommendations are implemented, the effective tax rate would be 17.5%, giving a tax liability of €1.75 million, assuming that CAT / CGT set off relief would be available.
The Government indicated in 2009 that the recommendations of the Commission were more likely to be introduced over the longer term, rather than the shorter term. However, in October 2010, the Government issued the Plan which agreed to reform CAT and CGT in the final quarter of this year. In addition, CAT thresholds were reduced in the Finance Act 2011 by 20% (compared with 2010 thresholds).
For these reasons, we recommend that clients take advantage of the reliefs currently available at the earliest possible date prior to the next budget. In addition, the market value of assets at the date of transfer is relevant for tax purposes, and given the current depressed state of the market, now appears to be an opportune time to make gifts of qualifying assets at a low value.
TRANSFER VALUE BUT RETAIN CONTROL
Very often, clients wish to retain control of a business after the transfer of economic value to their children. A limited partnership can prove to be a useful structure for these purposes.
A limited partnership is one where the limited partners have limited liability and are not entitled to participate in the management of the partnership. In the family context, the children could be limited partners with the family matriarch or patriarch, as the case may be, the general partner who has exclusive management and control over the partnership but has unlimited liability.
In this instance, it should be possible to pass on the economic value of a family business to the children in a tax efficient manner by availing of the above reliefs, while at the same time retaining control.
Some clients may not wish to transfer assets to particular family members at this point in time. In this instance alternative mechanisms can be put in place to minimise the tax costs of the Plan proposal and the Commission’s recommendations, if implemented, and / or ensure that any future increases in the value of shares in a family company are attributed to the next generation.
For the owners of valuable family businesses, now is an opportune time to consider passing some of the family wealth to the next generation without incurring significant tax costs.