When the Parliament of Malta enacted the Family Business Act its main objective was to facilitate succession planning, specifically targeting family owned businesses passing from one generation to another. This came as a direct consequence of EU wide proposals and encouragement by the EU to support its Member States in implementing rules regulating and facilitating such transfers. Malta was the first in Europe to implement rules in the area and plans are in place to further develop this area in the future.
Key aspect for consideration
One of the main points of consideration when transferring a business to the next generation is the taxation cost. The main tax implications arising over in a transfer of shares arises out of the Income Tax on Capital Gains and Duty on Transfers of shares.
The Income Tax Act brings to charge a transfer of shares and the term transfer is defined to include a donation. One may think that since the donation is not made for a consideration, no income tax will follow. The legislator assumes that the donation is made at market value and such valuation has to be backed up by an architects valuation. So in general, transfer of shares are taxable.
On the other hand, the Income Tax Act exempts donations of such shares to certain family members.
For succession planning purposes we have to consider Duty which is chargeable under the Duty on Documents and Transfers Act. Unlike the Income Tax Act duty is fixed to € 2 for every € 100 of the real value. This rate is further increased to € 5 for every € 100 where it is proven that at least 75% of the assets of the company consists of immovable property. Unlike the ITA the DDTA does not contemplate an exemption in the case of a donation to certain family members.
Defining a Family Business
A typical family business would usually have the form of a limited Liability Company. The Family Business Act (‘FBA’) specifically outlines that for a Family business to benefit under the FBA;
- All the Shares are held by two family members, and
- At least one of the family member is involved in the general governance, administration and management of the company, and
- Non Family members can hold not more than 5% of the aggregate value of the share capital, and
- 10% of the Share Capital may be assigned to employees
Nonetheless, the rules also apply to Public Limited Liability Companies, Certain forms of partnerships, trusts and other types of businesses.
The term family members is designed to include the family business owner, spouse, ascendants, descendants in the direct line and their relative spouses, brothers or sisters and their descendants.
Our current rules prescribe that no Single family member should hold more than 80% of the shares to qualify for registration as a Family Business. Additionally, for a business to benefit under the FBA it must be registered as a family business with the Malta Enterprise. Subsequent to the registration, the family business must submit certain compliance documents on an annual basis.
The Benefits Under the Family Business Act
The FBA includes provisions aimed at facilitating the transfer from one generation to another by reducing the cost burden associated with Duty upon a donation of shares to the next generation.
The Duty rate on the first € 500, 000 in value is reduced from €5 for every € 100 of the real value to € 3.5 for every € 100. With this reduced rate of Duty, a family business has the potential to save € 7, 500.
By mandatory elimination, we notice that there is no benefit for businesses which do not own any immovable property, meaning that the rate of € 2 for every € 100 remains the same in the case of a business who does not have at least 75% of the assets of the company consist of immovable property.
Even though the benefit is potentially limited to € 7, 500, this is a step in the right direction as it paves the way towards further development in the area and creates the infrastructure for professionals and family businesses to continue discussing improvements in the system. Many times tax hinders the successful transfer of a business from one generation to another and these provisions encourage parents to transfer ownership to their children inter vivos.
This tends to improve communication and help encourage descendants to continue on the original founder’s legacy. With the right structure in place, children may be trained to administer, manage and operate the business while at the same time providing added peace of mind to the original founders that their children are adequately motivated to pursue growth of the family business. Reward brakes the barrier between wanting to continue the family business but at the same time not have anything to show for it.
Recent developments suggest that the legislator has already looked at further improving the existing law by reducing the Duty rate benefit provided in the FBA. In a press release issued by the Ministry for Finance and the Ministry for the Economy, Investment and Small Businesses, the Ministers outlined that transfers that will take place from 1 April 2017 to 1 April 2018 will be taxed at € 1.5 for every € 100 (with no capping).
The Local business community and our economy at large comprises of a large number of family businesses, accounting for some 80% of the jobs in the local market, it is within everyone’s interest to continue developing these organisations and facilitating succession ensures that one of the economic pillars continues to flourish.