10.8.Detail the issues surrounding the transfer of assets at an undervalue
The anti-avoidance provisions which apply to the transfer of assets at undervalue are outlined below.
Company law considerations
In addition to the tax issues on transfers at under value, there are a number of company law implications. A transfer of this nature must be authorised by the company’s Constitution. The directors should also ensure that they have the full support of the shareholders and that no other stakeholders could be affected, for example creditors or employees. If the shareholder is also a director there is additional legislation governing transactions between directors and the company to comply with such as those covering restrictions on ‘substantial property transactions’ between directors and a company.
A substantial property transaction is one that involves assets with a value greater than the lower of:
■ 10% of the company’s net assets, or
Such transactions must be approved in advance by the majority of the shareholders at a general meeting.
Close company issues
When an asset is transferred to a participator at undervalue there are four main tax implications:
1. The company is treated as disposing of the asset at full market value under Section 547 TCA 1997. Therefore the company will be taxed on proceeds in excess of what it actually received.
2. The difference between the asset transfer price and market value is treated as a distribution. The company must operate dividend withholding tax (see Chapter 8) and the individual is taxed under Schedule F on the undervalue (Section 130(3)(a) TCA 1997). As the distribution is a non-cash distribution Section 172B(3) TCA 1997 would apply to the distribution as outlined in Chapter 8.
3. Section 589 TCA 1997 reduces the shareholders base cost in the shares of the close company when calculating any gain or loss on disposal in the future.
4. The participator may be subject to CAT on the gift element included in the transfer at undervalue. You will see in your studies of CAT in Capital Taxes: Application and Interaction that CAT provides for a credit for CGT arising on the same event. Note that this credit does not apply to a company suffering CT on chargeable gains on the same event.
It should be noted that 1, 2 and 4 above apply equally to open companies.
Mr. A purchased shares in A Ltd in April 2004 for €125,000. Mr. A is the only shareholder. In July 2018 the company transferred a property it had purchased in June 2005 for €75,000 to Mr. A for €100,000. The market value and the current use value of the property was €150,000 in July 2018.
Mr. A sold his shares in A Ltd for €175,000 in November 2018. Assume Mr. A repaid the initial DWT on the deemed distribution arising on the transfer of the asset at undervalue.
Compute the taxation implications of the above transactions.
1. A Ltd is treated as disposing of the property to Mr. A at market value
Regross: €75,000 × 33%/12.50% = €198,000 × 12.50% = €24,750
2. Mr. A is treated as receiving a distribution of €50,000 (€150,000 – €100,000) as he repaid the initial DWT. A Ltd must pay over Dividend Withholding Tax to the Collector General as follows:
€50,000 × 20% = €10,000.
Mr. A is taxed under Schedule F as follows:
3. Mr. A’s base cost in the shares of A Ltd is reduced by the undervalue when disposing of the shares:
The transfer at undervalue effectively cost Mr. A an additional €20,000 in income tax (ignoring PRSI and the USC) and €16,500 in CGT (i.e. the reduction in base cost of €50,000 × 33%) – a total of €36,500 in taxes. It also resulted in a corporation tax liability for the company of €24,750 as a result of the chargeable gain arising on the transfer of the property to Mr. A.
Outline the tax consequences if Mr. A paid full market value for the property.
Take the same facts as the Example 10.9 above, except that A Ltd. has three shareholders; Mr. A, Mr. B and Mr. C, who own 25%, 35% and 40% of the share capital respectively.
The transfer of the property to Mr. A for €100,000 will have the same income tax implications for Mr. A and give rise to the same deemed chargeable gains for A Ltd. However, in the event of the subsequent disposal of the shares in A Ltd. by Mr. A, Mr. B and Mr. C., in accordance with Section 589 TCA 1997, each of the shareholders will have their respective base costs (before indexation) reduced by a proportion of the undervalue of the transfer to Mr. A apportioned according to their shareholding at the time of the transfer i.e. their base costs would be reduced by €12,500, €17,500 and €20,000 respectively.
In addition, Section 589(3) TCA 1997 provides that where one of the shareholders is itself a close company, the amount of the undervalue apportioned to the shares held by that close company are further apportioned to the holders of the shares in that close company.