The Revenue Law Commission has established that indirectly owned shares in a dormant company containing capital due to sale of the family business (“set-aside company”) are not affected by the 3:12 rules when a related party takes over the running of the business after a generational succession. The Tax Evasion Act is not applicable. This makes it possible to pass a family business on to the next generation on the same tax terms as in an external sale.
A and his partner B owned 45 per cent each of a Swedish Limited Liability Company, A Ltd. The remaining 10 per cent of the company was owned by a foreign investor. A and B were “active to a significant degree” in the company and were, therefore, covered by the “3:12” rules (which provide for a tax rate of up to 57 per cent on capital gains and dividends). In connection with a change of ownership in 2010, the intention was that A’s son would purchase all of the shares in the company at market value.
In connection with the succession, A acquired a new limited liability company, B Ltd, which, in turn, acquired a wholly owned subsidiary, C Ltd. A sold his shares to C Ltd, who, then, sold the company’s shares to A’s son.
At the beginning of the tax year 2016, A will have been “passive” in the B Ltd group over the past five years. The two partners have remained employees within A Ltd. while the son has been, and remains, the sole actively engaged shareholder of the company. A now intends to sell his indirectly owned shares in set-aside companies in 2016 at market value to an external party.
The issues addressed in the case were whether:
- A’s shareholding in B Ltd (with the subsidiary C Ltd) should be regarded as “qualified shares” and, therefore, be subject to the 3:12 rules as of the tax year 2016.
- Would the Tax Evasion Act be applicable to the procedure?
The heart of the matter was, thus, whether A’s capital gain from his indirectly owned set-aside company, established through a generational succession, should be taxed under the 3:12 rules or at a rate of 25 per cent.
The Revenue Law Commission
The Revenue Law Commission made the assessment that both the text of the law and the existing case law supported the view that A’s shares were no longer covered by the 3:12 rules at the beginning of the tax year 2016. Elaborating on the issue of the necessary conditions under the Tax Evasion Act, the Commission stated that A no longer had any remaining shareholding in the close company. As the generational succession had been completed and as the procedure of establishing a set-aside company cannot be repeated, the Commission also found that the Tax Evasion Act was not applicable.
The Revenue Law Commission’s ruling is very welcome news for participators of close companies that are preparing to pass the business on from one generation to the next.
Paradoxically, previous legal precedents from 2010 onwards have had the effect that the tax rules discourage a generational succession within the family. This is because it has been possible to create a set-aside company for tax purposes when selling to an external party, resulting in a flat tax rate of 25 per cent for the owner after five years. However, it has not been possible to use the same procedure when a related party (such as a son or daughter) wished to take over the business. In this case the previous owner has been deemed to remain subject to the 3:12 rules for as long as the family continues to run the business. The asymmetry in the income tax law is illogical and has for a number of years created obstacles for participators of family companies to hand the business over to the next generation. It is partly against this background that the tax rules on generational succession is one of the issues that is being reviewed in the “Commission to review the 3:12regulation with special regards to generational succession”. However, the committee conducting the inquiry will not be submitting its proposal until 1 September 2016.
As the Revenue Law Commission’s ruling may be appealed by the Tax Agency to the Supreme Administrative Court, the legal situation is still uncertain. Even so, the ruling is good news for business owners, as there are now indications that it is possible to hand over a business to the next generation on the same tax terms that apply in a sale to an external party.
If you are thinking about handing your business over to the next generation or are already an owner of a set-aside company, you are welcome to contact PwC for more information.
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