Shareholder Tax
Tax on Sale of Shares
The sale of shares by an individual is generally subject to capital gains tax. In broad terms, the gain is the difference between the acquisition cost and disposal price or value. An allowance for inflation is allowed for periods from 1975 to 2003 on the acquisition and other improvement costs.
The sale of shares may be subject to income tax, in the unusual case where the shares are held as part of the trading stock of an investment company. If the holder is an investment intermediary entity, it may be subject to the special tax arrangements for such entities.
In the case of a company, the sale is subject to capital gains tax which is part of the corporation tax liability. However, a generous holding company exemption applies which exempts many disposals from tax.
The buyer acquires the shares at their price or value (if different) for the purpose of their future capital gains tax base. Where their later disposal is subject to another tax, the acquisition price or value is also deducted in the computation.
Stamp duty is charged on the purchase of shares. The obligation to account for and pay the tax falls on the buyer. It is charged at the rate of one percent. Formerly, a stamp was impressed on the share transfer form. Stamp duty returns are now made through the ROS service, and a certificate is issued electronically. Proof of stamping is required as a condition of registration in the internal register of members, by the company secretary.
Holding Company Seller
A disposal of shares in a subsidiary company by an Irish resident holding company is exempt from Irish capital gains tax provided the following conditions are met. This is the so-called participation exemption.
The holding company must have directly or indirectly held at least 5% of the ordinary share capital (and have been beneficially entitled at least 5% of the profits available for distribution and assets available on a winding up) for a continuous 12 month period and the disposal must take place during or within 2 years after the date of meeting the aforementioned holding requirement.
The company whose shares are being disposed of must be tax resident in a country with which Ireland has concluded a DTT (or in a country with which Ireland has signed but not yet ratified a DTT) or an EU Member State. At the time of disposal, either the target company is a trading company or the holding company and each of its 5% subsidiaries, together form a trading group ( wholly or mainly of the carrying on of a trade or trades).
Most corporate shareholder receives dividends tax-free. Where the corporate seller does not qualify for the participation exemption another mechanism for tax-efficient structuring may be available where there is cash in the company. The funds may be distributed pre-completion as a dividend.
Residence Issues
Persons resident or ordinarily resident and domiciled in Ireland are subject to Irish capital gains tax on their worldwide disposal of assets If the seller is also resident in another country, he may also be taxable there. If it is a country with which Ireland has a double taxation agreement, he may obtain a credit or be exempted entirely from the charge.
An Irish resident company is subject to Irish capital gains tax on its worldwide disposals. It may be entitled to double taxation relief where it is also subject to taxation in another jurisdiction. Ireland will usually have the primary taxation rights in relation to Irish situate assets. The holding company exemption is often available.
In the case of a person, resident or ordinarily resident in Ireland but not domiciled, he is subject to Irish capital gains tax on the disposal of all Irish assets only to the extent that the proceeds are remitted into Ireland.
If the individual is neither resident nor ordinarily resident in Ireland, he is subject to Irish capital gains tax on the sale or other disposal of shares and securities in an Irish private company if they derived the greater part of their value from land (real property, buildings et cetera), mineral rights and exploration rights in Ireland.
Double taxation relief may be available. If the individual is resident in another jurisdiction, the tax may be reduced or eliminated entirely under the terms of the relevant double taxation agreement.
Nature of Consideration
The taxation consequences of the share purchase agreement will require a consideration of the share capital structure. In a straight-forward case, the consideration may comprise cash for shares. The CGT rules can be readily applied.
There may be a purchase of loan balances receivable from the target company to a group or third-party company. The assumption of liabilities is part of the consideration for capital gains tax and stamp duty purposes. Accordingly, in the calculation of each, the price is the cash (or other consideration) plus the assumed liability.
The purchased assets may comprise shares in a group holding company, intercompany debt, loan notes, debentures, the assumption of liabilities and options. The CGT treatment of debts and options differs in some respects to that of shares and each class of asset disposed of must be considered separately.
Where the buyer takes the existing debt, it will usually be at face value. Where the shareholder acquires the debt other than for its value, this may itself create a loss or gain for capital gains tax purposes.
Where in the context of a sale of shares, there is a release by the shareholder of debt in the company; it may be treated as a trading receipt for the company. Therefore, it is preferable that there be a substituted refinancing loan or the subscription of funds by the buyer into the company such as to facilitate the repayment of the company’s debt to the seller or its associate.
Contingent or Uncertain Consideration I
In some cases, there may be a contingent consideration. If the company meets certain targets within certain time frames or other criteria as defined, additional consideration may be payable. This raises practical issues in relation to capital gains tax and stamp duty liability.
An earn-out type consideration may be attractive to both parties. It may increase the ultimate price available to the seller. From the buyer’s perspective, it may incentivise the seller who remains involved in the business, to maximise value.
An earn-out clause typically measures the additional consideration with reference to certain key financial performance indicators. They are typically defined by reference to earnings before interest tax depreciation and amortisation in one or more post completion periods.
Contingent or Uncertain Consideration II
From a capital gains tax perspective, the whole of the contingent consideration in respect of the disposal is taken into account without any discount for the postponement of the right to receive part of the consideration and without regard to the risk that all or part of the consideration may become recoverable. In this event, a later adjustment of tax may be available.
The presumptive position is that capital gains tax must be paid in respect of the earn-out consideration. If it proves irrecoverable or does not materialise, an application may be made for repayment and adjustment as the circumstances require. Where the maximum earn-out consideration is capped, this is the chargeable consideration.
Where it is not capped, there is authority for the proposition that the provision does not apply. In this case, the value of the earn-out must be determined at the time of sale and added as part of the consideration. There is a separate asset namely the right to receive the further sum. Further receipts are part disposals of that asset. With multiple earn-out, the asset may need to be revalued at the time of each part disposal for the purpose of apportioning the base cost.
Working Capital Adjustment
Commonly, the share purchase agreement will provide for an adjustment of the price based on the net asset value on completion as ascertained shortly after completion. If the company is trading on an ongoing basis, its value will rise and fall in accordance with the working capital cycle involving purchases, stock-holding and sales in a simple retail trading case. The same broad principles will apply to other companies although the nature of the assets / purchases and stock may differ.
A working capital adjustment clause will typically provide for an estimated working capital figure at or near completion. The price paid is based on this figure. Part of the price may be retained from the seller until the determination of the actual completion figure which may take weeks or months after completion.
After completion, an examination is undertaken to verify the working capital figure on the date of completion. There is then an adjustment with a payment by one party to the other to reflect the correct working capital value at completion. Where the working capital value is higher than expected, the payment is made by the buyer to the seller and vice- versa, as the case may be. The share purchase agreement will make provision accordingly.
The final determination of the price with the working capital adjustment will usually take place well in advance of the obligation to filing capital taxes returns. Any additional consideration payable is added to the price for the purpose of calculating the capital gain.
Reconstructions Current and Historical
The tax and legal issues applicable to reconstructions are dealt with separately. In broad terms, there are reliefs from stamp duty and capital gains tax where the arrangement is, in essence, a reconstruction of the shareholding and indirectly the underlying assets, without a change in the underlying beneficial ownership of the company. The tax treatment of some amalgamation and mergers is similar to that for reconstructions.
Shares may be acquired in exchange for debt. The face value of the debt is included without discount in calculating the capital gains tax liabilities. If the debt is unrecoverable, an adjustment may later be made by the repayment of tax, if applicable. Before the significant reduction in capital gains tax rates at the turn of the century, there existed a share for paper(debt) relief. Roll-over relief was allowed when shares were sold in exchange for debt so that capital gains tax could be deferred until the disposal or realisation of the debt. In tandem with the reduction in general capital gains tax rates, this relief was abolished on 4th December 2002.
The reconstruction relief whereby shares may be swapped for other shares on a capital gains tax neutral basis remains subject to compliance with a number of conditions applicable to it.
A reconstruction involving a mixture of debt and shares may in principle qualify for relief from stamp duty. The reconstruction and amalgamation relief cover both shares and stock in the sense of a company’s funded debt. Funded debt is broadly long-term capital/loan stock in the nature of a security.
Stamp Duty and Uncertain Consideration
Similar issues apply in respect of stamp duty. Where the consideration cannot be valued at the time of transfer, the transfer is stamped on the basis of the fair value of the asset. The buyer will accordingly require a valuation of the shares. The valuation of shares in a private company can pose significant challenges.
The obligation to stamp arises within 30 days by which time the precise figure will not usually be known. In practical terms, it may be necessary to stamp on the basis of an approximate price as certified by the financial controller or a person with knowledge of the working capital cycle. In principle, it is possible to postpone stamping by making a payment on the basis of the estimated price. In this event Revenue may exercise its discretion not to apply a penalty or interest, provided that the procedure is undertaken bona fide and subject to specific consent in advance.
The alternative is to stamp at the approximate price, and then afterwards pay any balance or seek a reclaim to or from the Revenue Commissioners. In theory, penalties may arise on any underpaid element of the price. In principle, an overpaid stamp duty may be reclaimed where the duty has been inadvertently paid at too high a level.
Stamp Duty and Debt
The transfer of debt itself by way of an instrument may constitute a stampable conveyance on sale. There are exemptions from stamp duty which are primarily for the financial services sector, where the debt is in the nature of a security or loan capital. This is defined to mean any debenture stock or funded debt by whatever name known or any capital raised which is borrowed or has the character of borrowed money whether in the form of stock or otherwise.
It must
- not be convertible into shares or marketable securities, other than loan capital.
- not carry rights equivalent to shares;
- be redeemable within 30 years of issue;
- be issued for not less than 90 percent of its nominal value;
- not carry a right in respect of repayment of interest, which is related to a securities index.
In the context of stamp duty, it may be possible to engineer a release of debt without consideration, which does not fall within the categories of assets, which are subject to stamp duty for a transfer not at full value.
Share Options
The company may have issued options in itself. A buyer who wishes to acquire the entire interest in a company must obtain all outstanding share options. Commonly options are granted to senior managers by way of performance incentive. There have been and continue to be tax-based incentives for more general share options schemes.
A buyer who wishes to acquire share options may do so in a number of ways. It may negotiate their release by way of cash consideration or for the exchange of new options in the buyer or its group entity. It may agree to the acceleration of the option and sale of the option shares. The position will be determined by circumstances and the nature of the option rights.
Where arm’s length commercial options in the company exist, the grant of the option and its exercise are treated as a single event for capital gains tax purpose. The base is the sum paid for the option plus the exercise price.
Employee Share Options
Employee Share option arrangements are best structured under a trust which facilitates collective dealing and the rearrangement of rights. This may not, however, be the case in the circumstances. The particular terms of the option agreements must be carefully considered.
The acceleration and exercise of a share option may trigger an income tax liability that would not otherwise arise if the options were held for a longer period. Presumptively income tax arises on the difference between the value of the shares at the date of the exercise less the option price paid by the employee.
If the scheme shares were issued under an approved scheme, capital gains tax treatment may be available rather than income tax treatment, after the requisite holding period has expired. Income tax treatment effectively deems the shares to be a taxable benefit of the employment, taxable at the employee’s marginal rate.
In principle, any instrument transferring or releasing a right to a share, such as share option may itself be stampable and subject to stamp duty. In principle, an exchange of rights is also subject to stamp duty subject to potential exemptions.
The share employee option scheme may itself contemplate the substitution of options subject to approval. This may facilitate the acquisition of the rights in a stamp duty efficient fashion.
CGT v Income Tax Treatment Re Options
Capital gains tax treatment is generally more favourable (being at a relatively lower rate; 33 percent). If no relief is available, the capital gain arises on the basis of the value of the shares at the date of exercise of the option less their acquisition cost. Thereafter, if the shares are sold, there may be no further capital gains tax liability, provided that the price is not above that value. The base cost is the value of the shares as at the date of exercise.
Where the share options are released or cancelled for cash, this generally creates an income taxable receipt for the employee. This is so even though the sum does not directly emanate from the employer. They are accordingly subject to the general PAYE, PRSI and USC obligations from the employer’s perspective.
Exchange of Options for New Options
Where the share options are released in exchange for cash or liquid consideration, there is a disposal for capital gains tax purpose. Where arm’s length share options granted to third-parties are released or cancelled in exchange for shares, they may qualify for share for share relief. Where they are exchanged for any debt instrument or cash, there is an immediate capital gains charge, and no deferral relief is available.
Where employee share options are exchanged for options in the buyer company, the special charging provision, which charges benefits in kind to employee income tax provides for a roll-over relief. This is effectively a deferral of liability until the ultimate disposal of the substituted option rights. Equally, a share option for share option exchange may qualify for general capital gains tax relief on an exchange.
The cancellation of a share option in return for shares or debt in the buyer presumptively triggers income tax liability for the employee. The relieving provisions contemplate an exchange of rights for rights rather than rights for shares.
Real Property / Resources Company
Where more than 50 percent of the value of the shares derive from Irish situate real property (land and buildings, fixtures, minerals, mining and equivalent right, or exploration rights on the Irish Continental Shelf,) then the disposal of the shares in the company is subject to Irish capital gains tax irrespective of the seller’s residence. There is a capital gains tax clearance procedure which is designed to ensure that tax is paid by non-residents in such cases.
Where the consideration exceeds, [], a clearance certificate is required from the Revenue Commissioners. If the clearance certificate is not produced, the buyer is obliged to pay 15 percent of the consideration to the Revenue. This applies both to liquid consideration and to any consideration in kind.
The obligation to pay the withholding tax in the absence of a CGT clearance certificate rests on the buyer. If the buyer pays the full consideration without so doing, the obligation still remains. There is no mechanism for obtaining the CGT clearance retrospectively. Logistically, the certificate where required must be applied for at least a week before completion.
Practical Issues with Cert I
The certificate must be obtained in advance. In practice, the transaction can rarely complete without it, because most sellers are unprepared to suffer the immediate payment of 15% of the consideration to the Revenue.
It may be difficult in some cases to ascertain whether the majority in value is so derived. A valuation may be required of the company’s assets. They are usually shown in the balance sheet at historic cost, which may be low or high relative to present value.
Debt will reduce the net value of the company. Secured debt is commonly charged specifically against the property. However, Revenue may argue that it is charged against the general assets. In case of difficulty, the matter should be pre-agreed with Revenue given that the onus is on the buyer to withhold and pay Revenue the relevant monies.
Practical Issues with Cert II
In principle, the Revenue will issue a capital gains tax clearance certificate if it is satisfied that the seller is resident in Ireland or if non-resident, that no capital gains tax arises, or if it does, that the capital gains tax is paid in advance. In some cases, Revenue requires as a condition of issue of the certificate that a certain proportion of the CGT liability be paid.
The CGT clearance requirement applies to non-monetary consideration. In this case, the application is made on the basis of the value passing.
Where the transaction qualifies for share for share relief for capital gains tax purposes, then theoretically there is no disposal. However, the acquired asset may be itself deemed property subject to the obligation, so that the obligation arises on the redemption or repurchase of the shares by the company.
Clawback of Previous Relief
There are several instances in tax legislation where particular relief is granted for a reconstruction or reorganisation provided that continuity of shareholding is maintained for a period, often many years after the particular transaction.
Transfers of assets within a group are relieved from tax, provided that they are not simply a bridge for an immediate or short-term sale. Where the sale involves the company leaving a capital gains tax group within ten years of acquiring an asset from another group member, a clawback of capital gains tax relief on the original acquisition transaction may arise.
Similarly, if relief was previously given for stamp duty in relation to a transfer of the property within a group (90 percent group), a clawback arises if it was either intended from the outset or incurs within two years.
Trading Profits Issue for Company
If there are losses carried forward and within three years before or after the sale of a company, and there is a major change in the nature and conduct of the trade, then the losses may be restricted so that they may not be offset against future gains and income. They may also be restricted where prior to the acquisition, the trade had become small or negligible.
Where fees and expenses are incurred in relation to a share acquisition, merger or reconstruction et cetera, they are not usually deductible for income / corporation tax purposes for the seller. VAT is not usually recoverable. The expenditure is not undertaken for trading purposes and is not a vatable input for the purpose of a vatable trade. They are in the nature of capital transactions.
Tax Reduction Measures for Seller
The seller may qualify for retirement relief, where he is over a certain age and has traded the business for more than a certain period. See other chapters in relation to the applicable conditions.
The company, if it has sufficient cash may make a special pension contribution over and above the standard amount for the benefit of the seller. Pension sums may be tax efficient for the seller. They may grow in the tax-free environment of the pension and will be ultimately taxable, only on payment of the pension in retirement.
Formerly, where an employee’s/seller’ s employment was terminated with the company, there were very generous termination payment allowances. Their availability has been significantly reduced in the last 10 years.
CGT / CAT Set Off
If the seller intends to distribute part of the sale proceeds to his family, it may be possible to use the capital gains tax / capital acquisition tax set off. Shares in the company are sold to a family member at a reduced price immediately prior to the sale. This qualifies for the capital gains tax / capital acquisition tax set off.
Commonly, the price is equal to the capital gains tax liability. The capital acquisitions tax liability may be structured so as to be within the beneficiary’s tax-free threshold.
The family member shares are then sold as part of the entire shareholding so that the capital acquisitions tax that would otherwise be payable is offset by the capital gains tax payable by the seller.