Economic uncertainty and changes to tax laws have altered the thinking of many tax advisors. Some structures used in the past are now defunct and new considerations have to be taken into account when advising clients, as Mark Doyle explains.
With many individuals having experienced dramatic changes in their financial situation as a result of the global financial crisis, there are new challenges for tax advisers. Some key considerations to take into account are set out below.
In succession planning, the solvency position of the successor is becoming increasingly relevant. There is little to be gained from passing assets to a successor who is insolvent since, if a creditor decides to take action against the successor, the asset transferred may well be seized and sold in an effort to recoup debts.The situation of the successor may be hopeless if their debt burden is too high. There is no perfect solution to this problem. However, parents will often wish to help the child in difficulty, particularly if their day-to-day financial position is tight. Consideration could be given to:
➤ The use of certain trusts;
➤ The possibility of making the transfer of assets revocable;
➤ Transferring assets to the spouse or children of the successor. Clearly a lifetime transfer of assets is under
the control of the parents. However, it is important to review the will of the parent to ensure that, on death, the assets do not unwittingly pass to an insolvent child. It is commonplace to find that a will is drafted without any consideration for the financial position of the beneficiary. As with lifetime transfers, the use of trusts, etc can be consid- ered as a means of warehousing assets until such time as the financial position of the beneficiary is settled. There is a big push from advisors to encourage their clients to transfer assets to their children while tax reliefs are generous. Although there are some merits to this approach, tax should not be the prime driver behind succession planning and all even- tualities must be considered.
FINANCING PRIVATELY HELD COMPANIES
It is common for the shareholders of pri- vately held companies to provide working capital finance to their company by way of loan. In most cases the loan is provided on an informal basis with little or no docu- mentation. Where the shareholder suffers a loss on this loan no tax relief is available as the loss is generally not an allowable loss for capital gains tax purposes.
It is often suggested that the loan should be converted into share capital such that when the company is liquidated the share- holder would realise an allowable loss for capital gains tax purposes. In many cases such a scheme is likely to fail by reason of section 547 (2) TCA 1997 which, in the case of an insolvent company, is likely to determine the base cost of the shares allotted on the conversion of the loan as nil. Consideration should be given to docu- menting the making of a loan and including in the terms rights that are likely to make the loan a ‘debt on security’, e.g. the loan should be convertible to shares, capable of increasing in value, marketable, etc. If a loss were realised on the loan it should be possible to offset the loss against certain capital gains. In this way the shareholder could gain some relief for their loss.
UNWINDING PATENT STRUCTURES
The abolition of tax relief on patents has generated discussion between advisors and clients. In many cases patents were licensed under long-term agreements with signif- icant royalties. The operation of a patent structure can now lead to unwanted tax costs.A common structure would have been for a patent company to license its patent to a connected manufacturing company; the difficulty is that the rate of tax applicable to the profits of the patent company may be 25% (depending on the trading status of the company) while the manufacturing com- pany would only receive relief for royalties paid at the standard rate of 12.5%. Clearly this is not attractive. For a number of reasons it may not be advisable, or possible, to simply cease charging for the use of the patent.
Some companies have chosen to unwind and migrate their patent structure to jurisdictions offering attractive patent regimes such as Luxembourg. Clearly this option will not suit most Irish businesses.
One solution would be for the patent holder to dispose of the patent to the patent user. Although there is an element of doubt about the tax treatment of a sale of a patent due to the provisions of section 757 TCA 1997, the author understands that it is the view of the Revenue Commissioners that the outright sale of a patent should be regarded as subject to capital gains tax rather than income tax under case IV. This should be confirmed on a case by case basis.
Where the patent company and manu- facturing company are members of the same capital gains tax group it should be possible to transfer the patent free from capital gains tax.Where the companies are not members of the same group, and where the sale of the patent would realise a chargeable gain, it may be advisable to firstly reconstruct the share ownership of the companies to bring them together in a group prior to transferring the patent. In cases where the patent is held by an individual, the opportunity to dispose of it to a company and extract cash at capital gains tax rates is attractive.
Section 101 SDCA 1999 should provide relief from stamp duty on the transfer of the patent.
FINANCING PERSONAL DEBT
The income tax cost of financing personal debt on property and investment assets is proving prohibitive.These investments were made during a rising property market and often without consideration as to how the debt would eventually be repaid absent a sale of the property. A sale of the property may now not be possible or desirable due to significant negative equity. Banks are now pressing borrowers for interest and capital repayments which may have to be financed by the client from their own personal income or reserves; this brings with it significant tax costs.To repay €1m of capital will require approximately €2m of income before tax.
It is worth considering whether it is possible to restructure the financial affairs of the client to reduce the tax burden associated with paying down their debt. Where the borrower has a degree of flexibility around his/her financial affairs (for example, if he or she is a shareholder or director of a privately held company) it is worth considering transferring the asset and debt into their trading company or a related company financed by the trading company. It should then be possible to finance the repayment of the debt out of income taxed at corporation tax rates (likely to be 12.5%) rather than at income tax rates (circa 50%). Clearly this represents a significant saving.
The main point to note is that the company cannot pay over the odds for the asset trans- ferred to it, i.e. the value of the property should at least equal the outstanding debt. If this is not the case and the debt exceeds the asset value, then only a portion of the debt should be transferred. The consent of the bank to the transfer is likely to be required. It would seem that the position of the bank is strengthened significantly as the borrower’s ability to repay their debt is enhanced. In practice banks are willing to facilitate a reorganisation provided that their position is not compromised. The share- holder may consider taking an option to acquire the property back from the company at some stage in the future; in this way it should be possible to ensure that future uplifts in property value accrue to the shareholder and not the company.
Where there is new money coming to the table it is possible to negotiate a debt write-down with certain banks. In one particular case involving a very weak borrower, the bank compromised their debt by almost 90% where the borrower’s father agreed to discharge a portion of his debt.The borrower also held onto the property in this case as the bank could simply not warrant the cost of appointing a receiver, holding and then selling the property.
The issues examined above are common to many Irish businesses and advisors should keep them in mind when dealing with clients. Careful planning at the outset can avoid unwanted financial and tax costs in the future. The tax analysis outlined above is high level in nature and all potential tax liabilities or opportunities may not have been identified.Tax and legal advice should be sought when advising clients on such matters.
Mark Doyle, ACA is a Director in the Capital Taxes department of Grant Thornton and is the author of the forthcoming book Capital Gains Tax: A Practitioner’s Guide to be published by Chartered Accountants Ireland.