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The Next Generation – What about the family business?

By Cormac Kelleher

By Cormac Kelleher

Cormac Kelleher looks at succession planning and relevant tax considerations for family businesses in Ireland

Introduction

Benjamin Franklin was of the belief that the only certainties in life were death and taxes. Irish research undertaken suggests that the majority of Irish businesses do not have succession plans in place. This is particularly worrying when one considers that family owned businesses make up approximately 90% of the Irish indigenous business sector. It has been established that only one third of family businesses survive into the second generation, while a further one third only survive into the third generation.

The reason for failure to retain the business within family ownership can typically be attributed to:

  • There being no qualified successor; or
  • Business failure / sale to third parties

What about the Kids?

The owners of Irish family businesses, having devoted a substantial amount of time in developing and growing the business, may look on the business with a feeling of pride. Surveys have determined that 80% of respondents wished for a family member to succeed them in the family business. While this may be the hope which parents harbour, the goals and objectives of the children may not be in keeping. It can be difficult for, a parent to objectively assess a child's interest in the business and their commercial abilities. Alternatively, potential successors may be overlooked by reason of differing business perspectives.

While it may be th e desire for a family member to be the successor, it may not be a viable possibility. As an advisor it is necessary to address with clients two fundamental questions, namely:

  • Are my children interested in the business? and
  • Are my children capable of managing the business?

It may be difficult for children to openly express that they do not share the same passion or enthusiasm for the business as their parents. In this regard it may be necessary for the professional advisor to act as mediator.

Retirement Funding

As part of the succession planning process, consideration needs to be given to funding retirement. It is important to create and extract sufficient retirement income from the business to ensure independence from the fortunes of the business. In order to build up a sufficient pool of resources it is necessary to plan in advance in order to maximise the potential tax free pool of income which can be extracted. In this regard, consideration needs to be given to factors such as:

  • employer pension schemes
  • buy back of shares
  • termination payments

A review of the level of directors salaries may need to be undertaken in order to facilitate the maximisation of tax free termination payment amounts. This can also tie in with the level of company pension contributions being made. When considering the level of income required to fund retirement consideration should also be given to other assets held personally (e.g. rental properties, deposits, shares etc). These assets could be retained by the taxpayer until death. At that point in time they could be transferred to a child who has indicated that they do not have an interest in the business.

Tax Considerations

Having identified which children are interested in the business, a tax efficient structure must be devised to facilitate the transfer. The valuation placed on the business will be intrinsic to the structure opted for. Depending on the nature of the business in question, obtaining a valuation can be a lengthy process. It is vital that a robust valuation be obtained in order to avoid a possible exposure to interest and penalties which are provided for in Stamp Duty and Capital Acquisition Tax (“CAT”) legislation.

In endeavouring to maximise tax free income, consideration should be given at an early stage to the possibility of employer pension contributions, termination payments etc. These instruments can ultimately have an impact on the value to be placed on the business.

In having a succession plan in place, it is possible to work to minimise the amount of tax payable by the successor. The composition of the assets to be transferred to the successor can be structured so that the benefit of business property relief / agricultural relief can be availed of. This is particularly the case if the farmer test is to be satisfied and agricultural relief is to be claimed. Prior to any transfer of wealth to the child, it is recommended that the current asset portfolio of the intended beneficiary be reviewed.

The Extended Family

A significant number of family businesses do not survive the second generation. While the demise of the business may in certain instances be attributable to commercial factors, in other instances it may be due to the breakdown in family relations.

At the original time of the transfer of the family business to the children, idealistically the belief may be that the business will continue to operate smoothly. However, it is possible that the business could end up being under the control of two or more siblings. It is recommended that a shareholders agreement be put in place at the time of the business transfer. This agreement would protect stakeholders’ interests and address a buyout mechanism. In the event that there is no such agreement in place and, say, one of the stakeholders should suddenly die, difficulties could arise with the surviving spouse as to the buyback of the interest in the business, the consideration to be paid etc. The agreement could also be used to establish a “family council” whereby ongoing family and ownership issues could be addressed.

The Time is Nigh

Under current tax legislation, in certain instances the availability of a suite of tax reliefs can result in a valuable business being transferred to the next generation whereby stamp duty will be the only tax cost. The November 2010 National Recovery Plan indicated that the Capital Gains Tax (CGT) and CAT tax base will be broadened. In addition, the Plan indicated that in 2012 the system will be changed whereby there will be different rates for different levels of gains. A similar system will also be introduced for CAT. It was also indicated that various CGT, CAT and Stamp Duty reliefs and exemptions will be abolished or restricted. While this Plan was drafted by a different Government, it is believed by many tax professionals that the CGT retirement relief and CAT business property relief / agricultural reliefs will be overhauled in the near future. Nothing has been indicated by the current Government to suggest that a different approach will be adopted.

Aside from the current attractiveness of various tax reliefs, now may also be an appropriate time to consider business transfers. Depending on the nature of the family business in question, the business may have witnessed a depression in market value. This, coupled with the reliefs, may facilitate the business being transferred at a low tax cost.

Cormac Kelleher is Tax Manager at Moore Stephens Nathans

Tel +353 1 8881004

Fax +353 1 8881005

Email Cormac.Kelleher@moorestephensnathans.com

Website http://www.moorestephensnathans.com