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Transmission within the family: civil law and tax aspects
The transmission of a business within the family generally occurs without the children having to pay their parents for being able to continue the family business. This is the main difference with respect to the scenario where the business is sold to a third party outside the family.
If the owner only has one child, who wishes to continue the business, the transmission is relatively straightforward. A gift of the shares is here the easy way to achieve the transmission while the parents are still alive. The gift is carried out through a gift deed in front of a notary and triggers gift tax of 1.8% computed on the estimated value of the transferred shares.
Optionally, the parents may retain the usufruct on the transferred shares and only transfer the bare ownership to their daughter or son. One would then refer to a so-called ownership dismemberment. The usufructuary retains the right to use and benefit from the shares, which means in other words that he or she retains the right to perceive the dividends the company may distribute from its profits. The bare owner on the other hand decides generally on the more structural organisation of the company. The advantage hereof is that the parents, who are no longer actively involved in the business and therefore are no longer paid any salary, keep a source of income through the dividend distributions from the company. The child who runs the business derives its income from the salary he or she receives for his or her daily work. And he or she may also decide – through the bare ownership of the shares – on the direction the business takes.
The usufruct on the shares in principle extinguishes upon the death of the usufructuary. In that moment in time, the dividend entitlement falls back to the bare owner. The latter then holds the full ownership of the shares.
From a tax perspective, a dismemberment of the property is also advantageous, because the tax basis for the gift tax only consists in a certain percentage of the total value of the business. This percentage is determined by law and depends on the age of the usufructuary at the time of the gift. The younger he or she is, the less value is on the bare ownership, since it statistically – as a result of the life expectancy of the usufructuary – takes longer for the bare owner to recover the full ownership of the shares.
Taxes are thus somehow reduced, but one should also take into account that the scope of the gift is a different one.
What if not all children wish to continue the family business?
It happens however sometimes that not all of the children wish to continue the business. There may be some who are interested in other things, e.g. studying medicine, planning to become a lawyer or an auditor. Then other questions will arise, notably trying to find a way to compensate the latter and ensure all children are treated in a fair way.
In that case, the parents generally wish to achieve two objectives.
The first one is to ensure that the child, who wishes to take over the business, may actually do so and that the transfer is legally secured.
The second objective is however generally also to avoid disadvantaging the siblings who do not wish to work within the family business.
There are a series of possibilities to reconcile these two objectives and the devil lies here – as always – in the detail. An interesting instrument, which we would like to cite here, is a so-called donation-partage. This is in fact nothing else than a gift, but with the same consequences than an anticipated apportionment of the parents’ estate or of part of the parents’ estate. The parents may thus decide to donate the shares in the company to the child who wishes to take over the business, whether in full ownership or in bear ownership, as we discussed earlier. At the same time, they may impose a charge on their child, consisting for instance in a sum of money to be paid as a compensation to his or her siblings. Or they may donate other assets to these siblings.
As for every ordinary gift, the donated assets are later imputed on the respective child’s inheritance share, in order to make sure that the compulsory parts are complied with. In contrast with the ordinary gift, in case of a donation-partage, the relevant value for that imputation is the value on the day of the donation-partage as opposed to the value on the day of the father’s or the mother’s death. By following this route, it can be assured that any increase in value for which one of the children is responsible as a result of his or her work in the family business after the gift, only benefits the relevant child.
The taxation of the donation-partage is in principle the same than in the case of an ordinary gift: 1.8% on the estimated value of the assets transferred to the children. This is however only true if the children all receive equally valued assets. If this is not the case, a higher tax rate of 3% applies to the portion the relevant child receives on top of what it would have received, had the total gifted value been apportioned equally.
Transmission to a third party: introduction and valuation aspects
If one wishes to sell to a third party, the issues are entirely different. In that case, income tax related questions arise, but also different ones, such as valuation.
In case a transfer of a business to a third party occurs, there are indeed different questions to resolve than in the first scenario. Here it is obvious that in principle the buyer has to pay a price to be allowed to take the business over. The first consideration of the current owner thus relates to the valuation of his or her business.
The valuation of a business is obviously a matter of figures. One needs to look at the accounts and there the fiduciary, the chartered accountant, auditor or even a bank is more in demand than the lawyer, who is more accompanying the client rather than performing the valuation.
Upon the sale of a business to a third party, one historically referred to an average annual profit. The annual profit results from the accounting, the net accounting result. And then, one would multiply that annual profit by a figure, between three and fifteen, or even twenty, in function of how reliably the profit is expected to be able to be realised in the future.
Nowadays, one does not reason in terms of net accounting result anymore, because the net accounting result is a figure that does not correctly reflect the economic profitability of the business, or that does not as appropriately reflect the latter than other concepts. And there, the Anglo-Saxons introduced the nowadays in practice predominant word, which is EBITDA. We do not need to go into the details. It is sufficient to know that the EBITDA is in essence the net accounting result with certain adjustments which generally increase the result in order to represent the true economic profitability of the business. And then the reasoning is the same as previously. One does not try to determine the past EBITDA, because that is the past. Here we are interested in the future. Therefore, one tries to project the future EBITDA. Once this figure is determined, one needs to determine the multiple which is a function of the company’s sector of activity. It can be a more or less high figure. A car dealer business, due to the changes in technology that we are seeing nowadays, may have a lower multiple. Supermarket retailing, where the activity is relatively stable, lasting and foreseeable, may have a higher multiple. And that results in a figure, which is the business’ value. That does however not yet answer the question how to sell. It is only the value. Then the question arises as to whether I sell my shares or the assets.
Share deal or asset deal?
Once the price of the business has been determined, one needs to find an agreement with the potential buyer with respect to the terms and conditions of the sale. There are indeed in general two possibilities. Either the buyer buys the shares in the company, this is the case of the so-called “share deal” in English. Or the buyer buys all assets and liabilities with the goodwill out of the company. This is the case of the so-called “asset deal”. Both scenarios have different legal consequences, notably regarding the taking over of ongoing agreements with clients or suppliers. In case of a share deal, the company remains in existence as a legal person, which means that any contractual counterparties remain contractually tied to the company. This is different in an “asset deal”. With the exception of employment agreements, where employment law foresees an automatic transfer to the buyer, the transfer of the agreements generally does not occur. This means that the buyer of the business needs to separately negotiate, or can separately negotiate, new agreements with the contractual counterparties – whether you see that as an advantage or disadvantage.
Due diligence, confidentiality and purchase agreement
In that context, one may refer to the next phase of the sale of the business, which is – at least in a “share deal” – more or less full-fledged: the so-called “due diligence”. This English concept stands for the careful analysis of the legal and economic situation of the business, which the buyer wishes to perform in order to make sure he does not to buy a pig in a poke. Typically, the buyer and his or her advisors are provided for a certain period of time all relevant documents and information and may also ask questions to the seller.
Due diligence, this is like completely undressing, so that the buyer actually strikes. One needs however, on the other hand, to make sure that the information provided is treated confidentially by the potential buyer and does not end up in the public domain.
It is indeed important that, in the context of the sale or at the latest during the due diligence phase, that the buyer and the seller agree on a confidentiality clause, which oblige the buyer, if the sale is not completed, to keep all information confidential, respectively to destroy all documents provided to him or her.
In case of a successful due diligence, the purchase agreement is to be drafted. This is the key document for the transfer of the business. It is not only determining what exactly is sold and for what price, but frequently, the seller provides certain guarantees to the buyer, for instance on points that attracted attention during the due diligence process. In the purchase agreement, things like the financing of the purchase price may be dealt with as well. Often, it is agreed that the price is not paid in one shot, but in different instalments. It also often happens that the previous owner agrees with the buyer to remain personally involved in the business for a transitional period. Such aspects may be decisive in order to guarantee the success of a transaction on both sides.
In the first case, meaning in case of a share deal, the seller is taxed on the capital gain on his or her shares. The capital gain is nothing else than the difference between the sale price, on the one hand, and the acquisition price of the shares, on the other hand. The applicable tax rate is however not the ordinary income tax rate at the seller’s level. The law here takes the exceptional situation into account – one does obviously not sell one’s business every day. It reduces the progression of the tax a little by limiting the tax rate to half of the average income tax rate. A tax allowance of 50.000 euros for a single seller, or of 100.000 euros if the seller is married, may also be deducted from the capital gain for the purpose of the computation of the tax basis. But only in case this allowance has not yet been used by the taxpayer in the last ten years on the occasion of a sale of real estate or shares.
In the second case, meaning in case of an asset deal, the company is taxed on the difference between the sale price, on the one hand, and the book value of the assets and liabilities, which are being taken over by the buyer, on the other hand. The tax rate here is the ordinary corporate income and municipal business tax rate, that applies to the company. Personal income tax may also apply at the shareholder’s level, if the sale price is subsequently – for instance in the context of the company’s liquidation – distributed.