Advice: Prepare your exit strategy from limited companies
The tax benefits of limited companies for farms are well documented but in cases where there is no successor an orderly winding down is advisable
Most articles - and public meetings - on company formation over the past ten years have been about the advantages of incorporation.
I will put up my hands and plead guilty as being a strong advocate of company formation where the circumstances were favourable and readers will have read a number of my articles in this publication over the past few years highlighting the benefits of incorporation.
Following one such article I received a number of phone calls from farmers who wanted to know what the consequences would be of getting out of a company if their circumstances were such that the company was no longer relevant or beneficial.
Such questions need to be addressed thoroughly before committing to forming a company as the answers may well determine the farmer's final decision.
The tax saving benefits in company formation are undoubtedly the big attraction but can these benefits be regarded as permanent savings or are they simply a deferral of tax that will become payable at a future date.
The answer may lie in the farmer's circumstances in terms of how, when and if he intends to retire and whether or not he has a successor. I should stress that this article is strictly about exiting or winding down a company where there is no successor. I will deal with the subject matter by way of a theoretical case study (see right).
The tax consequences of exiting or winding down a limited company will depend on the individual's age, the value held in the company and how long the company has been trading for. All three factors will determine the extent if any of an impending tax problem.
In the overall context companies in existence for more than five years and worth less than €1m will generally fare reasonably well in that the tax cost of exiting is not very penal. I should stress that this article is strictly about people who wish to exit a limited company with no successor to take over.
If you have a successor to pass on the company to, the position is entirely different and in broad terms the tax treatment is quite similar, if not more favourable in some instances, to situations where no company exists. I will deal with such cases in a future article.
Farmers considering incorporation or those who feel they rushed into company formation without adequately teasing out the long term issues as well as the short term ones should consult an expert who is known to have a thorough knowledge of both the taxation and farm regulation issues and who can allay any concerns you may have about the longer term.
Martin O'Sullivan is the author of the ACA Farmers Handbook. He is a partner in O'Sullivan Malone and Company, accountants and registered auditors, www.som.ie
CASE STUDY: 68-YEAR-OLD FARMER WITH NO SUCCESSOR
Joe, a 68-year-old farmer, formed a company in 2008. The company has accumulated retained profits of €350,000 in the form of cash (€35,000), livestock (€130,000), farm machinery (€75,000) and 12 acres of land which it purchased at a cost of €110,000 and paid for during the period.
For the purpose of this example we will assume that the land will be sold for €130,000 and that the profit earned in the final accounting period which includes the profit earned on the disposal of the stock and machinery is €120,000.
Joe has no successor, has a serious health issue and has little choice but to retire and lease his farm from 2018.
What are his options for extracting the retained profit from his company and what becomes of the company now that it has stopped trading?
The most practical options open to Joe are to voluntarily liquidate the company or simply wind it down to the point that it has no asset value remaining. We will look at what is involved in both scenarios and also look at the cost in terms of the various taxes incurred along the way.
Joe would probably choose this route if he needs to get access to cash for let us say gifting to his children and also for the reason that the company being ten years in existence offers an attractive advantage in the form of Capital Gains Tax Retirement Relief or Entrepreneur Relief, whichever is the more beneficial. If he chooses this route Joe will need to appoint a liquidator who will oversee the orderly winding down of the company whereby all assets are disposed of and all debts paid.
Any profit made on the disposal of the livestock and machinery will be subject to Corporation Tax at 12.5pc.
Any gain made on disposing of the 12 acres will be subject to Capital Gains Tax at 33pc.
The gain will be determined by the difference between what the company paid for the land and what it gets when it sells it. Joe can buy back the land from the company but it will have to be bought at current market value.
Following the sale of all the assets and discharging of all debts and taxes, the company will have a pot of cash which will represent the value of Joe’s shares in the company.
As the shares will generally have no base cost their entire value would normally be subject to Capital gains Tax at 33pc but for the availability of Entrepreneur Relief which in this case is more attractive than Retirement relief.
Table A shows a pot of cash present after disposing of the various assets amounting to €458,400 after Corporation Tax, Company Capital Gains Tax and liquidation costs.
Were it not for the availability of Entrepreneur Relief Joe would have a liability to Capital Gains Tax of €151,272 but the availability of the relief will have saved him approximately €105,432 leaving him with a liability of €45,840 which works out at €4,584 per year on an average additional tax.
Overall the amount of tax that he will have paid by forming the company I calculate to be less than half of what he would have paid if had remained as a sole trader.
It is important to note that Entrepreneur Relief is capped at €1m of chargeable gains Shareholders of companies with a value significantly in excess of this limit can expect to encounter a hefty Capital Gains Tax liability in the event that they decide to liquidate the company. If the company has little or no value they have little to worry about.
Running down company reserves
Joe might have chosen this option if the company had not been trading for very long prior to liquidation whereby he would not have been entitled to Capital Gains Tax entrepreneur relief or retirement relief.
In this scenario the company disposes of the stock and machinery and effectively ceases trading. The land does not have to be sold and can be retained if preferred and rented out by the company. It should be noted that the company will not qualify for the land lease exemption and will be subject to tax at 25pc on net rents earned.
The company can pay Joe a salary of an amount appropriate to his needs and tax profile thereby running down the cash reserves in the company.
He could also consider the option of investing some of the funds in a company pension (which I will deal with in a future article).
If Joe is happy to confine his total income to the lower tax band (€33,800 single or €67,600 married) he will confine his effective income tax rate and universal social charge cost to 25pc. Alternatively, if Joe and his wife can live on a total annual income of €36,000 or less they will pay no income tax.
In the event that Joe should die while the company still holds cash reserves, the beneficiaries under his will should not incur any liability to tax assuming they liquidate the shares and that their value falls under that beneficiary’s inheritance tax threshold.
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