We have seen an increased number of transactions and trade sales now that the economy is on the road to recovery, with several opportunities for business owners to “cash-in”, retire from the business or refocus on succession planning rather than wealth protection into the future. The sale of a business and business assets is within the scope of capital gains tax treatment. There are no tax reliefs on the sale of business assets, including goodwill, by a company, but there are several opportunities for a prospective seller to change the corporate structure to best place it to avail of tax reliefs on a disposal of the business.

This article is intended as a general overview of the practical issues associated with selling a business, along with opportunities and pitfalls in the context of doing so in a more tax efficient way.

1. John & Mary jointly own a company (Company A) that has been trading for a number of years. The company carries on three different trades. They have recently been approached by a competitor to take over one of their product lines valued at €1million.

Tax payable on sale or transfer of business assets and shares

There are three distinct and separate trades currently being undertaken within one company, although the likelihood is that only one of those trades will be sold. A sale of the business assets of that trade (the “target business” below), including goodwill, by the company would be subject to 33 percent corporation tax on chargeable gains. In most cases, base costs would be minimal, especially where goodwill is grown organically rather than externally acquired, so almost the entire sales proceeds would likely be within the scope of tax. A potential double charge to tax arises if the net proceeds are to be extracted out of the company to shareholders at a future point.

From the purchaser’s perspective, stamp duty at the rate of 6 percent will arise on the acquisition of assets such as goodwill or business premises.

The corporate structure could be reorganised in a tax neutral manner by moving the target business out of Company A and into a Newco, using share for share and share for undertaking provisions. The nature of the reorganisation will depend on whether the shareholders receive the sales proceeds directly (which could be a tax efficient cash extraction opportunity) or whether they are paid into Company A (for example, company creditors or investors may require this).

Option 1 – proceeds paid into Company A

If John and Mary do not have an immediate need for the sales proceeds, they could reorganise the company into a group of separate companies. This involves a reorganisation whereby a new holding company (‘Holdco’) is interposed between the current shareholders and Company A. A newly incorporated subsidiary of Holdco is also created, to which the assets/business being sold are transferred. Holdco then sells Newco; this can be done tax free under the participation exemption provisions of section 626B TCA 1997 if certain conditions are met. There may also be potential to retain up to 10 percent of Newco’s shares in John and Mary’s hands so that they have an opportunity to participate in the sale, particularly if retirement or entrepreneur relief could apply.

This option results in the sales proceeds being paid into Holdco tax free. Holdco can lend the funds to Company A for future product development and to repay debts if required.

Option 2 – sales proceeds directly to shareholders

If the shareholders require the sales proceeds to be paid directly to them rather than into Company A, an alternative is to transfer the target business into a newly incorporated company owned by John and Mary in exchange for shares in Newco to be issued to them. John and Mary sell Newco, availing of CGT retirement/entrepreneur relief if they meet the necessary criteria.

The potential tax savings are illustrated below:

Without tax planning:	€
Sale proceeds to Company A	1,000,000
Corporation tax @ 33%	(330,000)
Net sale proceeds	670,000
Income tax on dividend/salary to John & Mary	(348,400)
Net proceeds	321,600
Total tax on sale	678,400
Effective tax rate	67.84%

Option 1:	€
Sale proceeds to Holdco	1,000,000
No corporation tax if s.626B applies	0
Sale proceeds to John and Mary (up to 10%)	100,000
Capital gains tax @ 33%*	(33,000)
Net sale proceeds	67,000
Effective tax rate	3.67%
* Potential CGT of 0%–10% if retirement/entrepreneur relief available

Option 2:	€
Sale proceeds to John and Mary	1,000,000
CGT @ 33%	330,000
CGT exemption – retirement relief	NIL
CGT – entrepreneur relief (10%)	100,000

Additional benefits of the above two options are:

• The purchaser pays less stamp duty with a reduction from 6 percent to 1 percent on the acquisition of shares.
• Potentially reduced due diligence costs, disclosures, warranties and indemnities to be provided by the vendors as the shares being purchased are in a new company with little, if any, historical issues.

2. Pat & Patricia (both 62) jointly own and work in a company for the last 20 years. A purchaser has made an offer to acquire the company for €800,000, net of cash in bank of €500,000. The company value is therefore €1.3m. The purchasers are also going to acquire ownership of the business premises wholly owned by Patricia for €200,000. The premises has been used for the purposes of the company’s trade since the trade commenced.

A sale of the shares should qualify for retirement relief, allowing the couple to receive up to €1.5m tax free. A sale of the property by Patricia at the same time to the same person should also qualify for the relief. The €1.5m (€750,000 per person) is a lifetime limit up to the age of 65.

If the purchaser cannot or will not reflect the cash value in their purchase price, it will have to be extracted out into Pat and Patricia’s hands. Income tax of 52 percent could apply to this payment if it takes the form of salary or dividends. The company could pay each of them a tax-free ex-gratia termination lump sum given that they will be ceasing to be employed by the business. There are three methods by which to calculate how much can be taken tax free in this way.

In addition, especially if retirement relief is available, the company could repurchase the shares from Pat and Patricia. If certain conditions are satisfied, a share buyback is treated as a capital gains tax event rather than within the scope of income tax. It would in turn then qualify for retirement relief or entrepreneur relief, as the case may be.

A word of caution: there are strict conditions which must be met in order for capital gains tax treatment to apply, along with detailed company law provisions to be adhered to. Carried out incorrectly, it could result in the buyback being treated as a distribution, with income tax rates applied to the receipt.

The sequencing of steps is of extreme importance. The shareholders must “significantly reduce” their interest in the company after the redemption – in practice, this usually means they must divest themselves fully of their shares (with an allowance for small sentimental holdings) and retire fully from the business. In our example, they must first sell a number of shares and the building to the purchaser for €800,000, with the balance subsequently repurchased by the company. The company must also have sufficient accumulated distributable reserves on the date of the buyback for the repurchase to be legal. Accountants have a key role to play in this context.

Practitioners familiar with share buybacks will recall that the company must demonstrate that the transaction is for the benefit of the trade: it has to benefit the company, rather than the exiting shareholders. Revenue’s recently published TDM 06-09-01 sets out the current position and supersedes previous Tax Briefings on the subject. In future, an application to Revenue in relation to a buyback satisfying the trade benefit test should only be made in exceptional cases if for some reason there is doubt as to why it might not. The TDM also includes helpful examples of when Revenue will accept the trade benefit test is passed. In our case, with Pat and Patricia exiting and making way for new management, the test should be met without the necessity to get a ruling from Revenue to that effect.

Conclusion

A sale of business assets by a company attracts tax rates of up to 33 percent but, with careful restructuring, there are opportunities to do so more tax efficiently from both the company’s and the shareholders’ perspectives. This requires reliance on several tax reliefs and company law provisions, all the conditions of which must be met to achieve the required tax outcome. There is also an overriding provison that any restructuring and claim to tax relief must be done for bona fide commercial purposes and not tax avoidance.

Neasa is a Tax Manager with Laura Lynch & Associates. She is a Chartered Accountant and Chartered Tax Advisor.

Laura is Managing Director of Laura Lynch and Associates. She is a Fellow of Chartered Accountants Ireland and a Fellow of the Irish Tax Institute.

About the firm

Laura Lynch & Associates is a strategic tax consultancy firm, providing SMEs and accountancy practices with specialist tax advice across all tax heads.