With increased personal taxes and the introduction of the Universal Social Charge, some family businesses are considering incorporation of their trading activities. Incorporation can offer real advantages for sole traders who could potentially structure their business to pay tax at 12.5% versus 55%, where the profits are being re-invested in the business.
Incorporation can provide a real opportunity for certain entrepreneurs to plan and manage taxes efficiently however succession and business profits are the critical issues to consider particularly given potential further changes in capital gains in the next budget due to be announced on the 15th October,
A number of critical issues to consider which include:
- Anticipated business profits
- Review of personal loans and whether they can be re-structured into a company
- Salary the individual will require to cover living costs
- The availability of capital allowances
- Pension planning possibilities
- Succession plans
How to Incorporate?
The most common method of incorporation is where the individual transfer or sell certain business assets to the new company. The individual may use the opportunity to re-negotiate personal bank loans in the name of the company, offset by the assets which he is transferring to the company. The repayment of bank debt using the company is efficient from a tax and cash flow perspective. Where bank debt is not being transferred the value of the assets transferred is generally reflected as a director’s loan in the company owed to back to the individual.
Income Tax and Capital Gains Tax need careful management on incorporation but can be minimised where assets are transferred at tax written down value. Most importantly is the need to ensure that potential future tax reliefs are preserved, where an individual envisages selling or transferring the business or farm to the next generation, within 10 years of incorporating.
It can be advantageous to transfer some land to the limited company, particularly where a farmer is over 55 years of age, and can qualify for Retirement Relief from Capital Gains Tax. Sales proceeds are exempt up to €750,000 but from January 2014 the limit is reduced to €500,000 for persons aged 66 and over. The transfer of land really boosts the director’s loan and is particularly beneficial in the case of a very profitable operation, where sizeable post incorporation profits are envisaged.
“Stamp duty will arise on the transfer of land but the stamp duty rates have reduced to 2% in recent years, and is therefore no longer a prohibitive cost for many” continued Suzanne.
Benefits of Incorporation
The main advantages of farming through a company are:
- Rate of Tax – The corporation tax rate in a company is 12.5% compared with a tax rate of up to 55% (income tax and levies) for an individual. Any money paid to the individual is taxable as income in his hands at normal income tax rates. The benefits of the 12.5% corporation tax rate arise where the profits from the trade are in excess of the directors/shareholders requirements for living expenses. There is no specific profit level at which incorporation is advisable and must be evaluated on a case by case basis.
- Bank Loan Repayment – A sole trader pays income tax on profits earned no matter how these profits are used. Where the profits are being used to repay bank loans, it is much more efficient for these loans to be held within a company, with the director only paying income tax on the actual income drawn by him from the company.
The table below shows that for a farm to repay a loan of €100,000, a company must make a pre-tax profit of €114,286 while an individual (paying top rate tax) must make a pre-tax profit of €222,222.
Limited company (tax rate of 12.5%)
Sole Trader (assuming tax rate of 55%)
Gross before tax
114,286
222,222
Tax
(14,286)
(122,222)
Available for loan repayment
100,000
100,000
- Pension Planning – Pension contributions remain one of the most efficient methods of extracting funds from a company and the company gets a tax deduction for the pension contribution made.
A valuable benefit when using a limited company is a more generous tax treatment afforded to company pension plans compared with self-employed pension plans. A comparison of the level of pension contributions as a percentage of salary qualifying for tax relief is as follows:
Age today
Sole trader pension contribution
Limited company pension contribution (approx.)
30 but less than 40
20%
45%
40 but less than 50
25%
69%
50 but less than 55
30%
82%
55 but less than 60
35%
118%
60 and over
40%
237%
Directors Loan – The transfer of farming or business assets to the company may create a directors loan account as outlined above. “Typically the assets transferred to the company are stock, plant and machinery and the farmer will be able to draw this amount from the company tax free at any stage in the future. This is a once off very valuable opportunity to generate a director’s loan so planning around this is critical.
- PRSI for spouses – Wages/salary paid by a company to spouses can benefit from PRSI cover adding towards entitlement to State pension.
Disadvantages of Incorporation
There are also disadvantages associated with incorporation. Once incorporated, the farm is treated as a separate legal entity and the director is an employee of the company and pays PAYE/PRSI as an employee. However, the tax outcome with him taxed personally on salary drawn rather than profits should be less, as otherwise incorporation would not be advisable.
Most critically, when transferring assets to the next generation, the Capital Gains Tax and Capital Acquisitions Tax allowances and reliefs can be more complex than those applying to a sole trader, but are not lost with careful management.
Negotiation with banks will be required in re-negotiating loans and there may be a rate increase, depending on the circumstances. Other disadvantages may include the loss of income averaging, which some farmer avail of.
Summary
I would strongly recommend that you take the time to consider if incorporation is the right option for you and your family. In doing so you should also consider the future transfer of the business or farm to the next generation or otherwise. It is critical to plan properly so that tax is minimised at the outset and also on the subsequent transfer.
Please see our Taxation page for more information on this topic: https://www.bjdennehy.ie/taxation/business-advisory-2/