Taxation Aspects of transferring shares from parents to children within a Family Business
Family businesses play an important role within the economy of the country. The majority of local businesses are family owned enterprises and they employ a good percentage of the local work force.
Children often decide to follow the footsteps of their parents and take up a career within the family business. The parents would often decide to gradually transfer ownership of the business to their children so as to motivate them in achieving better results. One of the main hurdles in transferring the business to the next generation is the taxation cost. The main tax implications are tax on capital gains and duty on documents on registration of share transfer instrument.
Article 5 of the Income Tax Act (ITA) brings to charge tax gains arising on the transfer of ownership of equity shares, including donations. So much so that for capital gains purposes, a donation is considered to be a deemed sale made at the market value at the time of transfer. On the other hand article 5 of the ITA exempts donations of shares when it is made by the owner to his spouse, descendants and ascendants in the direct line and their relative spouses, or in the absence of descendants to brothers or sisters and their descendants. This implies that a share transfer to family members is only exempt if it takes the form of a donation. If the transfer takes the form of a sale of shares to family members, than tax on capital gains would be due.
Another cost on transferring shares to children is duty on documents that would have to be paid. Duty is paid on all types of transfers being outright sale of shares, donation of shares to family members or transmission causa mortis of shares. Duty is charged in terms of article 42 of the Duty on Documents and Transfers Act (DDTA).
The duty payable on the transfer of shares is of €2 for every hundred €100 of the transfer value or real value whichever is the higher. The rate of duty is increased from €2 to €5 for every €100 of value when it results that 75% or more of the assets of the company, excluding all current assets (other than immovable), consists of immovable property or rights over immovable property. The rate of €5 also applies when transferring shares in a company that directly or indirectly owns shares in company that meets the previously mentioned 75% threshold. The latter rule introduced as an anti-avoidance provision.
Last year the Government introduced the Family Business Act (FBA), which includes measures to reduce the burden of duty payable on the transfer of shares to family members. One of the main purposes of this legislation is that of encouraging the transfer of family business from one generation to the other.
Article 3 of the FBA defines a family business in the case of a public limited liability company whose shares are listed, as an entity in which the majority of shares is held by at least two family members. With respect to non-listed companies, owners of equity shares must also be held by at least two family members and non-family members can hold not more than 5% of the aggregate value of the share capital. The company may also grant shares to employees subject to specific conditions that cannot exceed 10% of the value of issued share capital. The FBA also applies to commercial partnerships and to companies whose shares are held under trust.
The FBA defines family members as the owner, his spouse, ascendants, descendants in the direct line and their relative spouses and in the absence of descendants, brothers and sisters and their descendants. One can say that, this definition is very similar to terminology used in article 5 of the ITA relating to exempt donations.
For a family business to benefit from the provisions of the FBA, such a business would need to register as a family business with the competent authority and submit an annual return on an annual basis. Such registered businesses are entitled to benefit from a reduction in duty payable on the transfer of shares to family members in terms of the DDTA.
Article 41C of the DDTA stipulates that where a family business is transferred as a going concern and the business includes immovable property that had been used in the business for at least 3 years, the rate of duty payable would be reduced on the first €500,000 in value from €5 to €3.50 for every €100 of value. This would result in a maximum saving of €7,500.
To benefit from this tax saving, a number of conditions must be satisfied. The main conditions include the following:
- If the property forming part of the family business is not retained and used in the business for at least 3 years, the duty relieved would be clawed back;
- However, if within 12 months the property is replaced, the amount clawed back would be available as a deduction from the duty payable on the new property being acquired.
The benefits contemplated under the FBA are administered by Malta Enterprise (ME). ME have also uploaded detailed guidelines of the tax benefit for family businesses on their web-site.
Although the FBA has been a step in the right direction, it has only granted a benefit to family business that are in possession of immovable property. In Malta we have a number of successful businesses that operate from rented property and are not owners of any immovable property. Such companies would include software developers, manufacturers and companies engaged in the service industry. The real value of the shares of such companies could be quite significant, however these companies do not benefit from any reduction in duty on transfer of shares to family members. As a matter of fact the duty is fixed at €2 for every €100 in value.
Finally in his budget speech for 2017, the Minister for Finance announced that the current rate of duty of 5% on the transfer of businesses (owning immovable property) to children would be reduced to 1.5%, a reduction of 3.5%. This reduction is more favourable than the rate proposed for registered family businesses. However, companies not engaged in the ownership of immovable property would be paying a higher rate of duty as the rate seems to have been left unchanged at 2%.
The reduction of duty is considered to be a very positive initiative as parents would be willing to donate shares to their children at this reduced rate of duty of 1.5%. Due to this initiative, children would be motivated to expand the family business and this in turn would create a multiplier effect. In Malta family businesses have always played an important role as they generate a lot of job opportunities.