How to manage your debt
Crona Brady, tax manager at Grant Thornton, advises how retailers or other small companies can put tax structures in place to help them manage the repayment of their personal debt
Print19 October 2012
Property, debt, negative equity, interest rates; these are terms that are frequently spoken about in this country. With increasing interest rate rises, government taxes and even petrol and diesel price hikes, the reality is that many individuals and families are currently struggling to meet their debt repayment obligations. Many are exhausting their salaries on other household bills and are dipping into their savings each month to help pay their mortgages.
The Budget for 2012 introduced some measures to help stimulate the property market, for example by reducing the rate of stamp duty on commercial property from 6% to 2%, increasing the rate of mortgage interest relief to 30% for individuals who purchased homes between 2004 and 2008, and extending the window for first time buyers to start claiming interest relief for the first time to 31 December 2012.
While some of these measures may help struggling first time buyers repay their mortgages, the measures are unlikely to help the thousands of individuals who have purchased investment properties and are now struggling with their debt repayments and in severe negative equity.
Many find themselves in increasingly difficult cash flow positions which can often result in falling behind with debt repayments. With thousands of family owned companies in Ireland, it is now the reality that many directors are drawing down large salaries or dividends from their companies to fund their debt repayments. These salaries and dividends are suffering income tax at rates of up to 55% which means that for every €100 withdrawn from the company, only €45 is left for debt repayment and other personal expenditure. More and more directors are also taking loans from companies, and in times of fluctuating trading conditions may find themselves in breach of company law as a result of falling asset values in companies.
The reality is that this position is unsustainable. Individuals cannot continue to drain cash from their companies to repay personal debt. In order to manage this situation, consideration could be given to the family company purchasing the underwater property and debt repayments being made by the company rather than the individual.
How does this work?
Take the example of Joe and Laura who purchased a commercial investment property in 2008 for €400,000. The level of debt attaching to the property is currently €250,000 and the property is rented out. Unfortunately the rental income received is not sufficient to service the debt. Joe and Laura estimate that the current value of the property is €250,000. They are unable to sell the property and have fallen behind with their mortgage repayments.
Joe and Laura together hold all of the shares in a company (X Ltd) which is involved in the food and beverage industry and the company is realising a modest profit. In order to repay the debt, Joe and Laura are drawing down large salaries and suffering marginal rates of income tax and this is adding to their cash flow difficulties.
To repay the debt in a more efficient manner, it is proposed that Joe and Laura incorporate a new Irish company (NewCo) and NewCo purchases the property from Joe and Laura for its current market value of €250,000. The consideration for the purchase could be the assumption of their existing debt, the drawdown of new facilities by NewCo or could be funded by any available cash reserves in X Ltd. The repayment of debt could be funded by X Ltd by putting in place a golden share between NewCo and X Ltd to allow cross company financing. The funds in X Ltd used to service the debt would have therefore only suffered corporation tax of 12.5% (or 25% at its maximum) and therefore increased funds are available for debt repayment.
If X Ltd had €250,000 to purchase the property from Jim and Laura, they could use the cash proceeds to repay their debt immediately. It is important to note that if the debt attaching to the property were to exceed the value of the property, the differential would be liable to income tax at marginal rates in the hands of Joe and Laura. Consideration could therefore be given to reducing the level of debt transferring.
The tax cost of such a structure would be stamp duty of €5,000 (€250,000 x 2%) for NewCo. No capital gains tax would arise for Joe and Laura as the property is valued at much less than it was originally purchased. NewCo would receive the rental income going forward which would suffer tax at 25% (subject to close company provisions) which is less than the current rate of 52% in the hands of Joe and Laura.
In conclusion, the above could be considered a simple solution to aid the debt burden on many individuals which could result in improved cash flows and less hardship.
This article is only a general discussion and does not deal with all the issues and tax savings available. When implementing any of these savings, it is important to do so carefully and to obtain professional advice.
Crona Brady ACA AITI – Tax Manager at Grant Thornton, 24-26 City Quay, Dublin 2, 01 680 5773, crona.brady@ie.gt.com
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