RMcH states: When a client sets up a company for trading or investment purposes, one area that can sometimes be overlooked is how they will ultimately extract value from the company or, where appropriate, exit from the structure.
We have provided a summary below of some of the main ways in which your clients can personally obtain value from their company and key tax considerations to note concerning each option. While there may be others, we have not explored these in this email.
i) Dividend payments:
In general, for Irish resident individuals, dividend payments will be subject to income tax at marginal rates. Where your client has other income which fully utilizes their available personal tax credits and rate bands, the rate of tax on dividend payments could up to circa. 52.2%. It is important to note that dividend payments are not tax deductible for corporation tax purposes and therefore will not benefit your client’s company by reducing any corporation tax liability in this manner.
Where your client’s company has non-trading income – such dividends can be used to reduce or fully eliminate any close company surcharge from arising and as such can benefit your client’s company by reducing a tax liability in this respect.
Another regularly overlooked aspect of making dividend payments is the requirement to assess the Divided Withholding Tax (“DWT”) obligations. For dividend payments to Irish resident individuals, DWT at 25% should be deducted by the company and paid over to Revenue. The individual claims a credit for this upon completion of their income tax return.
ii) Salary Payments:
Similar to the above, salary payments will be subject to income tax at your client’s marginal rate (which could go to circa 52.2%). There is a responsibility for the company to operate payroll and ensure its reporting requirements are met in respect of the salary payments. Where the company is trading and where the salary payments reflect duties for the trading activity – it should be possible to obtain a corporation tax deduction for the company to provide relief from corporation tax at 12.5%. For most, this option is more beneficial than the dividend route.
Your clients will often have family members working in their businesses. Revenue has in the past focused on this area where there are children (or spouses) receiving salary payments from a family company to utilize personal credits and the standard rate band, but where they are not real employees providing real services. In such cases, there is a risk that the salary payments should be assessed on the parents (and potentially subject to higher tax rates). We would recommend that your clients review any such family arrangements that are currently in place. Where family members are employed, paying family wages at market rates can make sense as, for example, the children can utilize their own personal tax credits.
iii) Pension Contributions:
Pensions are often an overlooked means of obtaining benefits from a company. By paying an amount into a pension scheme your clients can extract 25% of the value of the pension fund on retirement tax-free subject to the maximum limits. For trading companies, the company should also be able to get a deduction for the pension contributions in its corporation tax return. This can be a particularly beneficial option where your clients are coming close to retirement age and as such will not have to wait a long time to draw down their lump sum. With the New PRSA rules that have come in recently, pension contributions should give a tax deduction in the year of payment up to 100% of the individual’s remuneration (where exceed this level there would be BIK implications). We would caution pension payments to a PRSA of an employee (family member) that would be in excess of what that person would get for the role they provide, if this was a third party making the payment.
iv) Small Benefits and Expenses:
Utilization of the small benefits of €1,500 each to directors and true family members working in the Company. Putting personal expenses through payroll as a prerequisite/BIK may sometimes be a tax-effective route when the Company and the person are seen as one person. Claiming all relevant subsistence rates. There are traps in these cases, so it is imperative that the rules of each are followed so that unexpected taxes do not arise.
v) Salling the Company:
In circumstances where your clients are looking to exit from their company – a sale of the company shares can be the most beneficial exit option. Subject to relevant anti-avoidance legislation (for example Section 135(3A) TCA 1997 and Section 817 TCA 1997 and specific anti-avoidance provision in the reliefs available) a sale of shares by an individual should come within the remit of the Capital Gains Tax (CGT”) treatment. The prevailing rate of CGT is 33% which is far less than the marginal rate of income tax at circa. 52.2%. In addition, certain reliefs from CGT such as Retirement Relief and Revised Entrepreneur Relief could apply to reduce the CGT rate to 10% or provide full relief from a tax liability dependent on the circumstances. Anti-avoidance provisions however need to be considered in detail and there must be a bona fide exit or basis for the disposal. As part of this on incorporation of a company, it may make sense to structure shares to make the best use of reliefs at a future date of disposal.
vi) Liquidation:
In circumstances where there is no market to sell their shares and exit, your clients could decide to liquidate their company instead. Depending on certain conditions, there are similar tax implications on a liquidation as there is for a share sale for the individual shareholders. CGT treatment can apply to the proceeds received on a liquidation by the shareholders and the reliefs above can also apply in certain circumstances due to Revenue concessions. A person cannot accumulate cash and then start another company doing the very same thing however, as there are anti-avoidance provisions to prevent this.
Planning Ahead
The most appropriate method of extracting value from a company will depend on the circumstances of the business, the shareholders and their longer-term objectives.
The tax treatment can vary considerably between dividends, salary, pension contributions, benefits, share sales and liquidation. As a result, business owners should consider their options well in advance rather than waiting until they need to extract funds or exit the company.
Ideally, this plan should begin when the company structure is first being considered. Understanding the potential exit routes and the associated tax consequences can help ensure that the company is structured appropriately from the outset.
If you or your client would like to discuss the most appropriate options for extracting value from a company or planning for a future exit, please get in touch with us. We would be happy to review the circumstances and discuss the available options.
The information in this article is intended as general guidance only and should not be regarded as specific tax advice. Tax legislation and Revenue practice can change, and individual circumstances should be considered before taking any action.
courtesy of OmniPro