Under Section 600 Taxes Consolidation Act (TCA) 1997 where a person transfers a business as a going concern to a company, a measure of relief is given to the extent that the sales proceeds are taken by way of shares in the company. The relief, in effect, is a deferral of the tax payable on the amount of consideration taken in the form of shares in the company. If the consideration is paid in a form other than shares, (for example cash or a director’s loan) then the transaction becomes subject to capital gains tax under normal rules.
All of the following conditions must be complied with to attract this deferral:
- There must be a transfer of a business to a company from a person who is not a company.
- The business must be transferred as a going concern.
- The whole of the assets of the business or all of those assets other than cash must be transferred.
- The transfer must be wholly or partly for shares in the company.
The Revenue Commissioners have specifically stated that if all of the assets of the business (other than cash) are not transferred to the company the relief will not be available and a capital gains tax charge may arise on those assets which are transferred to the company. Therefore it is important to identify all of the assets of the business prior to incorporation.
Calculating the relief
The chargeable gains on the disposal of the business assets to the company are calculated in the normal manner. They might arise for example on the transfer of a premises and goodwill.
The overall gain is then apportioned on the basis of market value between:
- the value of shares taken in consideration of the transfer and,
- the value of other consideration (e.g. cash, assets, loan account).
The part of the gain apportioned to the other consideration is assessed and the tax is collected in the normal manner.
The part of the gain apportioned to the value of the shares taken in the company is not assessed. Instead relief is given by deducting that part of the gain from the allowable cost in calculating a gain on the ultimate disposal of the shares received in consideration of the transfer.
Where the acquiring company takes over the liabilities of the business on transfer of the business to the company the value of the liabilities taken over represents consideration other than shares for the transfer.
There is a published Revenue Precedent on this issue. It states: “Liabilities of the business included in the transfer rank as consideration for the transfer because the discharge of liabilities of the transferor by the transferee is equivalent to the payment of cash by the transferee to the transferor. In practice, however, where an individual transfers a business to a company, in exchange for shares only, and assets exceed liabilities, bona fida trade creditors taken over will not be treated as consideration.” This is a significant point.
In any situation where a sole trader takes out cash for goodwill (including the company taking over personal liabilities e.g. tax), or a director’s loan to the company, as part of the consideration then he cannot avail of this concession. Therefore any liabilities that the company takes over are also deemed to be the equivalent of cash consideration in the individual’s hands and therefore increase his CGT liability further.
Retirement relief
One of the conditions necessary for capital gains tax retirement relief on the disposal of shares in a family company is that the individual must have owned the shares being disposed of for a period of 10 years. However where the individual concerned had previously transferred his business to the company wholly or partly for shares in such a manner as to comply with the conditions for relief on the transfer of his business to the company (i.e. Section 600 TCA 1997) the period of ownership of the business transferred is taken into account as part of the period of ownership of the shares in the company. The period of ownership of the business transferred is taken into account as part of the period of ownership of shares in the company.
Example
An individual transfers all the assets of his business to a company and receives no cash (only shares). However the company takes over his trade creditors and the assets exceed the liabilities.
- No capital gains tax arises on the transfer of the assets e.g. goodwill and premises. The base cost of the shares is reduced going forward.
- If the company takes over the trade creditors of the business it is not considered to be cash consideration in the hands of the individual.
The individual gets credit for the length of ownership of his business before incorporation for retirement relief purposes when he sells the shares.
Example
An individual transfers all the assets of his business to a company for shares and a cash payment. The company takes over his trade creditors and other liabilities.
- CGT is payable on part of the chargeable gain in proportion to the cash consideration received including the amount deemed to be received because the company took over liabilities.
- The individual still gets credit for his length of ownership of business for retirement relief purposes when he sells shares.
Example
An individual sells some of his business assets to a company and the company takes over some liabilities.
- Calculate a fair market value price for the sale bearing in mind the market value of the assets transferring including goodwill and the fact that the company is taking over some liabilities which is the equivalent of consideration from company for the individual’s business.
- Only some assets are transferred. Therefore this incorporation takes place outside Section 600 TCA 1997.
- Despite the fact that CGT may now arise due to the transaction being outside the scope of Section 600 TCA 1997 there may be an opportunity to extract cash from the new company at 25%.
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Related Article: Incorporating a Business
Please call Noel Murphy today on 021-4310266 if you need further information on disposal of a business to a limited company or a consultation.