Meet John
A restaurant owner in Castlebar, John has been running his restaurant successfully for several years and is now looking towards retirement. He plans to exit the business in ten years and wants to maximise his financial benefits. By leveraging tax deferral on retained profits and strategically planning for liquidation, John can optimise his cash flow and reduce his tax burden at retirement.
John's Strategy: Retaining Profits and Planning for Liquidation
Current Financial Situation
Annual Profit: €50,000
Corporation Tax Rate: 12.5%
Current Personal Income Tax Rate: Up to 52%
Step 1: Retaining Profits
John decides to retain a portion of his annual profits within the company rather than distributing them as dividends or additional salary. This approach allows him to benefit from the lower corporation tax rate and reinvest the retained earnings back into his restaurant.
Financial Breakdown
Annual Profit: €50,000
Corporation Tax Paid: €6,250 (12.5% of €50,000)
Retained Earnings: €43,750
John reinvests these retained earnings to improve his restaurant, including upgrading equipment, enhancing marketing efforts, and expanding his menu. This reinvestment aims to increase the restaurant's profitability over the next ten years.
Step 2: Compound Growth Through Reinvestment
By reinvesting €43,750 annually, John can leverage compound growth. Assuming an annual growth rate of 5% due to these reinvestments, the restaurant's value and profitability will increase significantly over ten years.
Compound Growth Projection
| Year | Annual Retained Earnings (€) | Cumulative Growth (€) |
|---|---|---|
| 1 | 43,750 | 45,938 |
| 2 | 45,938 | 48,234 |
| 3 | 48,234 | 50,646 |
| 4 | 50,646 | 53,179 |
| 5 | 53,179 | 55,838 |
| 6 | 55,838 | 58,630 |
| 7 | 58,630 | 61,561 |
| 8 | 61,561 | 64,639 |
| 9 | 64,639 | 67,871 |
| 10 | 67,871 | 71,264 |
By the end of ten years, the cumulative retained earnings with growth will be €71,264 per year, significantly enhancing the restaurant's overall value.
Step 3: Planning for Liquidation
In ten years, John plans to liquidate his restaurant through a Members’ Voluntary Liquidation (MVL). This process allows him to distribute the accumulated retained earnings and other assets to himself as the sole shareholder.
Liquidation Financials
Assuming the total retained earnings and growth over ten years are €712,640 (cumulative growth of €71,264 per year for ten years), John will benefit from the favourable Capital Gains Tax (CGT) rates at liquidation.
Total Retained Earnings Over 10 Years: €712,640
CGT Rate: 33%
Entrepreneur Relief CGT Rate: 10% (up to €1 million)
CGT Retirement Relief: Full relief for individuals over 55 on gains up to €750,000
Tax Calculations
1. Without Relief:
CGT Paid: €235,171 (33% of €712,640)
Net Distribution: €477,469
2. With Entrepreneur Relief (on €712,640):
CGT Paid: €71,264 (10% of €712,640)
Net Distribution: €641,376
3. With CGT Retirement Relief:
CGT Paid: €0 (assuming full relief on gains up to €750,000)
Net Distribution: €712,640
Net Distribution Comparison
| Scenario | Net Distribution (€) |
|---|---|
| Without Relief | 477,469 |
| With Entrepreneur Relief | 641,376 |
| With CGT Retirement Relief | 712,640 |
Conclusion
By strategically retaining profits and leveraging tax deferral, John maximises his cash flow for reinvestment, enhancing the restaurant's growth. Upon liquidation, he benefits from lower capital gains tax rates, especially through Entrepreneur Relief and CGT Retirement Relief, significantly increasing his net distribution. This well-planned approach ensures a financially secure retirement for John, making the most of Irish company law and tax rules.
By implementing this strategy, restaurant owners like John can optimise their exit plans, ensuring maximum financial benefits and a smooth transition into retirement.
