Once a start-up business has successfully manoeuvred its way through the early phases, established the customer base and secured a reasonable financial footing, thoughts will turn to the next phase of expansion.

Business Structure

An expanding SME may need to consider some or all of the following issues;

• Moving the business into a corporate environment by incorporating an existing sole trade or partnership business
• Creating a group structure involving a holding company and one/more subsidiaries
• Introducing key employees as shareholders

Incorporation of the Business

The CGT and stamp duty implications arising on the incorporation of a sole trade business or partnership should be given careful consideration. In effect there are two methods of carrying out this transaction; the transfer of the business into a new company in exchange for the issue of shares in the company to the original business owner(s), or the sale of the business to the company. A specific deferral of CGT may be available on the ‘transfer in exchange’ method; one of the key requirements here is that the ownership of the new company must mirror the ownership of the sole trade/partnership business. This mirrored ownership is not required on a straightforward sale of the business to the company. Although a CGT liability at 33% may arise on the sale, it will generate a lump sum payment to the original owner(s) representing the market value of the business. This payment can comprise existing business cash reserves and/or a loan balance to be repaid in the future. Any CGT liability arising may be reduced/eliminated if the disposing business owner(s) can rely on either CGT entrepreneur relief or CGT retirement relief. Note that these transactions may trigger other tax implications also.

Creation of a Group Structure

There a wide variety of commercial reasons why business owners would want to operate through more than one company and to use a group structure. These include the need for or future plan to;

• Separate companies for different business activities or locations
• Develop a part of the business for future sale
• Protection of valuable assets used in the business from the trading risks
• Give a key employee a share in a part of the business
• Have flexibility to move loans/assets/losses across the group companies

Where the transaction to create a group structure is effected by way of a share-for-share exchange and certain conditions are met, specific reliefs may be claimed to avoid triggering CGT and stamp duty liabilities. Again, other tax implications may also arise.

Introduction of a Key Employee as Shareholder

As with the majority of benefits provided by an employer to an employee, the issue of shares to an employee will be subject to payroll taxes (with the exception of employer’s PRSI) on the benefit-in-kind. The shares must be valued at the time of issue which means of course, that if an employee is receiving shares in a company with an established business, then a tax bill will be triggered. The taxable value of the shares will be reduced by a ‘minority discount’ to recognise the fact that private company shares do not have a ready market. It may be possible to further reduce the taxable value of the shares if a so-called ‘share clog’ scheme is used, which means that the shares are held in trust for the employee for a set period of time and during that time, the employee cannot deal with them. Another possible method of justifying a reduced taxable value for employee shares is to issue a different class of shares, with restricted rights.

Other ways of giving shares to employees include share option schemes, which are tax-inefficient as payroll taxes typically arise on the exercise of the option, or Revenue-approved schemes that are used mainly by semi-State agencies and multinationals. In addition to being expensive to create, these Revenue-approved schemes do not allow companies to selectively target key employees. The government has recognised the commercial benefits for Irish businesses if they could avail of a tax–efficient share incentive scheme that would allow employers to attract and retain key talent. A public consultation on the issue was carried out in the summer of 2016 and the then Minister for Finance Michael Noonan said that a new SME-focussed scheme would be announced in Budget 2018, assuming EU State Aid approval is secured.

Financing the Business

Most SME businesses requiring external finance will secure this from a combination of sources, including bank financing, invoice discounting, leasing, external investors (often family/friends) and government/EU agency grants. As the business expands, the ‘right’ combination for that business will evolve; often an expanding business will need to introduce new external investors. This could be exactly the time to introduce an Employment and Investment Incentive Scheme (EIIS), which is a type of equity investment that generates income tax relief for the investors. EU requirements, incorporated into Ireland’s EIIS in Finance Acts 2014 and 2015, specifically steer the EIIS towards entirely new or expanding SME companies. This is because a company that creates its first EIIS must meet one of the following conditions;

• Has not been operating in any market (i.e. it is a start-up company),
• Has been operating in a market for less than 7 years following its first commercial sale, or
• Requires initial risk finance which, based on a business plan prepared with a view to entering a new product/geographical market, is greater than 50% average turnover for the last 5 years.

In broad terms, an EIIS involves the issue of eligible EIIS shares to a qualifying investor in a qualifying company that is carrying on relevant trading activities (note that all of the phrases in italics are defined in the relevant legislation and require certain conditions to be met). The eligible EIIS shares must be held for at least 4 years and, during this time, the company must increase either, its employee numbers and salary costs, or its R&D spend. Assuming this is the case, then income tax relief is available in 2 tranches; 30% at the time of investment and 10% in the tax year after the 4-year holding period has expired. The EIIS investor exits their investment by having their EIIS shares bought back after the 4-year holding period has expired for a buyback price per share that (hopefully!) exceeds the price per share on investment. Of course, if the company does not progress as planned, the EIIS investor may make a loss on their investment and could lose their entire investment.

Internationalising the Business

While some Irish SMEs will have international customers right from the beginning, many will only look to foreign markets after becoming established at home. Expanding SMEs may, therefore, be exposed to the complications of having foreign customers for the first time. While internationalising the business is a complex area, which cannot be properly aired in a few short sentences, below are some general helpful comments.

• When an Irish business sends employees to explore a foreign market and assess business opportunities, it is important to be clear on what the company employees are doing/are authorised to do in that location. This is because the activities of even one company employee could be sufficient to trigger a ‘permanent establishment’ (or taxable presence) of the company in that foreign location, which could generate foreign tax on the Irish business’ trading profits.
• Alternatively, the Irish SME may decide at the outset to register a taxable presence in a foreign country. This could take a number of forms, for example a branch, company or representative office. Detailed Irish and foreign tax advice should be secured to ensure that the tax implications of items such as the use of trading losses and repatriation of profits are managed, as well as the exposure to foreign taxes on trading profits.
• The Irish payroll and social security implications of sending an Irish employee abroad should be assessed; in certain instances, tax reliefs such as the foreign earnings deduction and split-year resident relief, and the payment of tax-exempt expenses can be relied upon.
• The Irish VAT and foreign VAT/sales tax implications of sales from Ireland to foreign customers must also be assessed. These will differ depending on the type of product or service being sold, whether the customers are business/private customers and whether they are based within the EU or outside of it. Not only does the Irish SME need to understand whether/where VAT must be charged on its supplies to foreign customers; also the additional reporting obligations triggered by these supplies must be satisfied.

The above was an overview of some of the significant business issues faced by expanding SMEs. The tax implications of these issues, along with many other tax topics relevant to Irish start-up and expanding SMEs, are reviewed in Kerri O’Connell’s book, Small and Expanding Businesses: Getting the Tax Right, published by Chartered Accountants Ireland.

Kerri O’Connell Tax Adviser & Principal at Obvio Tax Service

Email: kerri.oconnell@obviotax.ie