C
T
S
C
T
S
CTS

Holding companies – are they still the best thing since sliced bread??

Picture the scene… A client has a profitable trading company, they have learned from the mistakes of the past and come to you for advice as to how they can protect the accumulated profits from trading risks. Your first thought is to follow the age-old solution of inserting a holding company and distributing any cash reserves or investment assets to the holding company. However, recent changes to tax legislation mean that this is no longer a suitable structure in all circumstances.

Traditionally, the pros and cons of a holding company were as follows:

Advantages

  • Dividends paid by the subsidiary to the holding company should be exempt from taxes (subject to certain administrative requirements). Therefore, inserting a holding company allows accumulated profits to be protected from trading risks without giving rise to any taxes.
  • Once a holding company is in place, sister companies could be formed to separate investment and trading assets or to protect the existing trade from risks associated with new business ventures.
  • If a subsidiary is subject to company surcharges, a holding company structure could be used to minimise any surcharges arising.
  • A sale of a trading subsidiary by the holding company may be tax exempt by virtue of the Participation Exemption.

Disadvantages

  • Extra administration burden and compliance costs.

For individuals that were happy to build up wealth in their corporate structure, the advantages clearly far outweighed the disadvantages. So, what has changed?

Entrepreneur Relief

Entrepreneur Relief was introduced in 2016 but was not perceived to be a “game changer” until the relief was amended in 2017. The standard rate of Capital Gains Tax is 33%. Since 2017, Entrepreneur Relief reduces the rate of CGT to 10% in respect of qualifying gains of up to €1 million (a potential CGT saving of €230,000). Further information on Entrepreneur Relief can be found here.

Anyone looking to exit from a company (whether by share sale or liquidation) and who doesn’t qualify for Retirement Relief should target Entrepreneur Relief. However, the presence of a holding company can preclude a claim for Entrepreneur Relief. A sale or liquidation of the trading company followed by a liquidation of the holding company will not qualify for the relief.

For the relief to apply where a holding company exists, the following options would therefore need to be considered:

  • Sell the holding company rather than the trading subsidiary to the prospective purchaser. This, of course, requires the co-operation of the purchaser. The recent amendments to Section 135(3A) TCA would also need to be considered in this scenario as they may give rise to an unanticipated income tax liability. A discussion of Section 135 is outside the scope of this article.
  • Implement a pre-sale restructure or liquidation.

The options above would need to be considered on a case by case basis. They would add complexity, delays and additional tax risks to what may otherwise be a straightforward share sale.

What does all of this mean for us when advising clients?

It means that holding companies should no longer be suggested as a matter of course. Advisers must now dig further into their clients’ intentions and backgrounds in order to conclude on whether the benefits of the holding company structure outweigh any potential threat to Entrepreneur Relief. Some of the relevant questions will be:

  • What age is the client?
  • What is their plan for accumulated profits (e.g. invest in new businesses, hold in cash etc)?
  • Do they have any intention to exit from the trading company in the short term? If yes, what will they do with the proceeds (personal use or business investments)?
  • What is the value of the trading company?
  • Would they qualify for retirement relief on a sale or liquidation of the company?

If a holding company is not suitable, it may be possible to put other structures in place which would allow for asset protection while still protecting entitlement to Entrepreneur Relief.

Conclusion

The intention of this article is not to dissuade against the use of holding companies. There is no doubt that they are still a very important tool, both commercially and from a tax perspective.

However, when compared to the pros and cons traditionally associated with the holding company structure (as described above), there is now a significant potential disadvantage to the use of a company. The table now looks as follows:

Advantages

  • Dividends paid by the subsidiary to the holding company should be exempt from taxes (subject to certain administrative requirements). Therefore, inserting a holding company allows accumulated profits to be protected from trading risks without giving rise to any taxes.
  • Allows for the formation of sister companies which could, for example, protect the existing trade from risks associated with new business ventures.
  • If a subsidiary is subject to the professional service company surcharge, a holding company structure could be used to minimise any surcharge arising.
  • A sale of a trading subsidiary by the holding company may be tax exempt by virtue of the Participation Exemption.

Disadvantages

  • Extra administration burden and compliance costs.
  • Risk that ER might not apply to a future sale, which could preclude a client from claiming tax relief of up to €230,000 when they exit from the company.

On a final note, the Department of Finance is actively reviewing the operation of Entrepreneur Relief. The Irish Tax Institute made various recommendations with regard to improving the relief. The recommendations included reducing the restrictions that apply to disposals of shares in holding companies. However, for now these are purely recommendations and therefore the commentary above still applies.

Ascertain your clients intentions for the future before advising on the use of a holding company.

Published July 2019

Subscribe to our newsletter