After building your business for a few years, a buyer shows up for the company. You sell the business and make a nice profit on it. This profit is called cessation profit. Unfortunately, this profit is immediately subject to income tax of up to 49.5%. You have worked for years, and when you make a profit, you have to immediately pay half to the tax authorities. In this article, you will learn how to prevent this!
As mentioned, the cessation profit is taxed. To determine how much tax you have to pay on cessation profit, you first need to know what cessation profit is. Cessation profit is the difference between the book value of your business and the actual value at the time of transfer or termination of your business.
In the case of selling the business, it is relatively easy to determine the cessation profit. In that case, the cessation profit is the selling price minus the book value of the business. However, cessation profit can also arise from a conversion from a sole proprietorship to a BV structure. In this case, the cessation profit consists of a fictitious profit determined by a calculation of hidden reserves, goodwill, and often a very important factor, the old-age reserve. This is further explained in the article Convert a Sole Proprietorship to a BV. Here it is also explained that you only have to settle for cessation profit when converting a sole proprietorship to a BV if you opt for a noisy conversion and asset and liability transaction. If you opt for the silent conversion to the BV, the cessation profit is not taxed in this conversion.
The cessation profit is an important factor in deciding which type of conversion to choose. When the cessation profit is relatively low, in most cases, it will be most favorable to choose a conversion where you have to settle for cessation profit. It should be noted that you can use cessation profit deduction and the fact that you can convert cessation profit into an annuity.
To limit the taxation of cessation profit, it is possible to convert it into an annuity. An annuity is a savings pot, in which you can save tax-friendly, which is paid out at a certain moment. In most cases, the payout will start when the retirement age is reached. The legislator gives the possibility to convert the achieved cessation profit into an annuity so that the entrepreneur who achieved the cessation profit can save for his retirement.
How does this work in practice? Suppose you sell your sole proprietorship for €225K. The company has a book value of €100K. This results in a cessation profit of €125K. This profit is, in principle, taxed, but as we have seen, the law offers several possibilities to reduce this tax.
First of all, everyone is entitled to cessation profit exemption once. This is a discount of €3,630 on the profit. This leaves a taxable profit of €121,370. Since you are still an entrepreneur in the last year of your business, you are entitled to the SME profit exemption of 14%. This reduces the taxable cessation profit to €104,378. You can see that over €20K is already untaxed. However, you still have to pay tax on almost €100K. The rate is around 50%, so without applying the conversion to an annuity, you still have to pay more than €50K in income tax.
As mentioned, the law provides a way to avoid paying a large amount of tax. You can convert this gain from the cessation of your business into an annuity. You deposit the amount with an insurer who will make periodic payments to you, for example, when you reach retirement age. These payments will eventually be taxed.
The big advantage is that, upon cessation of your business, you do not immediately have to deal with a tax charge. You can set aside the entire amount and therefore invest with a gross amount, which will lead to higher returns. Additionally, an important point is that tax rates are lower when you reach retirement age.
Especially with regard to gains from cessation obtained by conversion, liquidity problems can also play a role. When you convert a sole proprietorship to a BV and you have to settle the gained profit, you will effectively have to pay taxes on a profit that you do not realize. As a result, you may not have the necessary liquidity. You may also not have the liquidity to sufficiently deposit the policy for the gain in an annuity.
Therefore, it can be very interesting for the new BV to act as an insurer. In that case, your own BV assumes the obligation to make a certain (periodic) payment to you at a certain point in time.
The advantage of this is that you do not have to immediately deposit money in an annuity policy and you have the money at your disposal during the term of the policy. However, always keep in mind that at a certain point in time the payment and the associated tax must be paid. The amount of the gain from cessation that you are allowed to convert into an annuity depends on your age. This increases to an amount of €447,047. In short, this means that the older you are at the time of cessation, the more you can convert into an annuity.
From the above, it appears that even with a significant gain from cessation, the tax charge can largely be avoided by choosing the right structure.
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