Succession: how to extract cash from a business in the most tax-efficient way

When it comes to succession, people talk about exits and one big payday, but current market conditions could mean that it might not be possible to engineer an exit. In this instance, how do business owners look to extract cash profits from corporate balance sheets into personal wealth, in the most tax-efficient way possible?

Exiting the business is one of the most important personal and professional decisions any entrepreneur can make, said Head of Financial Planning at Goodbody, Owen Redmond.

“But owners can be so focused on making the company a success, they rarely give any thought to succession until they’re ready to move on. Some haven’t taken steps in time to protect themselves or their families financially.”

Extracting cash payments without a sale

From a tax point of view, income is taxed very heavily – up to 52 per cent/55 per cent for higher earners. Redmond said that it is more efficient to withdraw money from the business into your personal investment pot via a pension.

A pension is a sophisticated investment vehicle that allows you to grow your personal wealth, so it’s not just a long-term savings product that will help you fund your retirement, said Redmond.

“This is particularly true for business owners. Pensions may come with the bonus of tax reliefs on accumulation, but the real opportunity for business owners is that they can transfer profits to seed a personal investment pot that also enjoys tax-free growth.”

There are other reliefs like retirement relief and entrepreneur relief that give owners access to capital on the disposal of a business, but they rely on a sale and a willing buyer to create that access.

“With the recent changes to the PRSA legislation, the potential for a business to transfer up to €2m from the company balance sheet to the retirement fund of an owner/key employee has become a reality,” said Redmond.

“Under the old system, there was a complicated method that was a construct of the number of years of paid service and the salary, where the owner/executive needed to have a meaningful income for a sustained period of time in order to make the level of contributions from the company, in order to be able to get to the €2m pension threshold by retirement age.

“Some business owners draw little or no income for many years to get the business started, so it wasn’t always possible to get the pension maxed out by the time they wished to exit. Now the interdependence of those two factors is gone, as from January 1 this year the company can transfer up to €2m into the PRSA, keeping in mind there is still a need for a genuine employment with the supporting contract and duties, etc.”

Finance Act 2022 changes

An employer contribution to a PRSA used to be a benefit-in-kind (BIK) for tax purposes, but that rule has now been removed.

“The BIK effectively counted towards the employee’s personal contribution for pension purposes, with a €115,000 earnings limit applying. In the case of an occupational pension scheme, other than a PRSA, the level of employer funding was limited by reference to rules regarding salary and service and retained benefits,” said Redmond.

Now the only limit that applies in respect of employer pension funding where such funding is to a PRSA, is the €2 million Standard Fund Threshold. While the business may not have the ability to fund that amount, it’s not curtailed by any other max funding or salary and service calculations.

“The funding can be extended to family and key staff, but my team would advocate strongly for there being a genuine employment in place with remuneration commensurate for that role and that there’s no element of salary sacrifice. If you’re forgoing remuneration in favour of an employer contribution to a PRSA, that’s not going to work. Tax is going to apply on the level of remuneration that you’ve forgone in the normal manner.”

Some businesses are not really suited to share option schemes and staff do not always wish to hold options in a company that they are also working for. Redmond said that the changes to the legislation have given employers an option to create a significant fund for their staff and build it as part of an overall reward package.

Many business owners might already have other pension schemes in place like SSASs or executive pensions. “At Goodbody, we can consolidate existing structures together and future funding can be paid into the new arrangement. After a change in legislation last year, a number of these schemes are under pressure to close anyway so the PRSA is the natural choice. Business owners just need to have the suitability of the move assessed and get an agreement on the pricing,” said Redmond.

Pensions and corporate entities

Is it better to invest by the pension structure or by the corporate entity? “The company must be wholly or mainly trading to be eligible for tax reliefs such as Entrepreneur Relief and Retirement Relief, and investment assets don’t qualify for those reliefs. Sometimes clients think an investment portfolio will give them easier access to funds than a pension fund, because a pension fund has rules around when it can be drawn down. But the difference in the tax treatment of both vehicles is something to consider.”

In the context of investments held by a corporate, there are things that can be done pre-sale to restructure so that the business is separated from the original company that holds the investments to enable the business to avail of the tax reliefs.

“Even if you’ve put the surplus cash to work and you are not drawing a salary, but you decide to take a dividend out of the company, you might have to dispose of some of your investment portfolio, which would trigger tax within the corporate in addition to the personal tax on the dividend. The review of your situation is very important before you invest the surplus,” said Redmond.

“At Goodbody, we offer end-to-end capability in advising business owners and their businesses in relation to exit and we have a pool of specialists we have available to business owners.

“Professional advice is a form of bad decision insurance, having someone to sound out on the structure of a sale, the make-up of the business ownership and how that may be altered in expectation of a transaction can lead to an optimised result for the business owner in terms of value and reducing any unnecessary tax leakage.

“Our Succession Advisory Team, made up of M&A and tax specialists and wealth planners, offers business owners a coordinated one-stop advisory service across all aspects of a potential business exit, including both personal and corporate financial readiness for business owners.”

Avail of a consultation with the team to help you get exit ready, whether your exit is around the corner or much further way at www.goodbody.ie/business-owners.

Important information

The information in this publication is based on tax law as at 31 December 2022. It is for general guidance on matters of interest only, and does not constitute professional advice. Nothing in this document constitutes investment, legal, financial, accounting or tax advice and does not confirm that a strategy is suitable or appropriate to your individual circumstances or otherwise constitutes a personal recommendation to you. Recipients should always seek independent tax and legal advice. Goodbody do not guarantee the reliability of the information provided. Goodbody, its servants or agents accept no responsibility for any loss arising from any action taken or not taken by anyone using this material.

Goodbody Stockbrokers UC, trading as Goodbody, is regulated by the Central Bank of Ireland. In the UK, Goodbody is also subject to regulation by the Financial Conduct Authority. Goodbody is a member of Euronext Dublin and the London Stock Exchange. Goodbody is a member of the group of companies headed by AIB Group plc.