In a company’s change of generation process ownership of a company will be shifted to another generation, family or relatives. Methods of making a change of generation are trade or donation.
Change of generation -related tax penalty might be avoided by tax planning.
Unlike in other acquisitions, it is possible to get tax exemptions in the change of generation as long as certain conditions will be met. The exemption could be possible for both, the vendor and the buyer, who continues running the business.
In an equity transaction, a company is sold to a successor, whereby the seller can obtain a gain on the sale. For this profit must be paid capital income tax.
For the purpose of calculating the gain on sale, from the purchase price will be deducted the undepreciated acquisition cost of the asset and the sum of the costs incurred in obtaining the profit, or the assumption of the acquisition cost.
When calculating a presumption of acquisition cost, a 20% reduction will be made in the transfer price got by a natural person if the property has been owned by him for less than 10 years or a 40% deduction when the property has been owned for at least 10 years.
If the property is received free of charge that is to say as gift, the taxable value of the inheritance and gift shall be considered as the acquisition cost.
In the case of a change of generation, however, the capital gain from a company’s shares may be completely tax-exempt if it meets the requirements of the Income Tax Act.
Each of the three conditions must be fulfilled to achieve exemption from taxes.
A prerequisite for exemption of taxes on the capital gain is that
1. at least 10% of the company’s shares will be transferred
2. he transferor or the person who has donated the shares to him, has owned the shares for more than 10 years
3. the transferee must be transferor’s close relative, that is a child or his heir, sister, brother, step-sister, step-brother, either alone or spousal when buying the business together.
When trade can be considered a gift?
In the case of change of generation, a situation may arise whereby the company’s shares will be sold to the successor under fair value, i.e. true price, if the parties of the transaction were independent of each other.
In principle, if the price does not exceed ¾ of the fair value of the company, the acquisition is considered to be partly a gift, of which the buyer has to pay the gift tax.
Exemption of gift tax
It is possible to mitigate the gift tax either in part or in full. So the gift tax can be exempted in accordance with the Inheritance and gift tax Act, if certain conditions are met.
The prospective successor does not have to be a close relative. The prerequisite is that the taxable gift includes an enterprise or part of it, and the transferee continues the business activities of the company. In addition, the amount of the gift tax, i.e. the tax to be deducted, must be over 850 €.
If the successor, i.e. the transferee, pays more than 50% of the fair value of the shares, he is entitled to full deduction of the gift tax.
The application for the deduction must be filed to the Tax Administration before the tax is imposed. Note that the buyer of a company is not allowed to transfer a majority of the shares for a period of five years, or otherwise he will forfeit the deduction. In other words, in the case of change of generation, in order to avoid the gift tax it will be sufficient, if the purchase price is at least 50% of the fair value. If, in addition, a change of generation is done by selling the business to a close relative, it may be possible to avoid both, the tax for capital gain and gift tax.
An inherited company
A change of generation can also take place in a situation where the previous entrepreneur is dead and the company will be inherited.
A partial relief of tax in change of generation can also be obtained if the conditions laid down in the inheritance tax act are met.
Planning the change of generation can bring many benefits to taxation. Starting the change of generation in good time improves the opportunities to make use of the chances offered by tax planning.