Shares in a family or ‘owner managed’ business may be your most valuable asset, often representing a lifetime of hard work. Effective planning is essential to ensure a successful transfer of the business, or the wealth that it has created, to the next generation.
Fundamental for any succession plan will be timing of a transfer (whether this should be in lifetime or under a Will) and availability of tax reliefs.
Current legislation (which could change if recommendations from the Office of Tax Simplification (OTS) are approved) allows a business that qualifies for Business Property Relief to be transferred free of Inheritance Tax (IHT) on death, at market value. This means that any accrued capital gain is wiped out, and the shares can be sold shortly after death without any capital gains tax (CGT) becoming due.
Whilst this paves the way for efficient tax planning for the next generation, the beneficial tax treatment relies on the business meeting certain conditions with serious pitfalls if not met.
There may be good reasons to transfer some or all of your business during lifetime, such as the need to share responsibility of the business with the next generation, and to show commitment to their future leadership.
Lifetime transfers are complex due to the interaction with other taxes such as CGT, which can be prohibitively costly without tax relief. It is crucial to consider the best method of transferring value, and the availability of tax relief.
Ordinarily, for CGT purposes a gift of a business will be treated as a disposal at market value. This may result in significant tax charges at a time when there are no proceeds to pay the liability. There are two key CGT reliefs which can assist:
- Gift relief enables the tax charge to be deferred, with the gain to date of disposal being passed on to the gift recipient. Although the gain will be taxed when the recipient sells the asset, at that point there would generally be proceeds with which to pay a tax charge.
- Entrepreneurs’ relief (ER) reduces the tax rate from 20 per cent to 10 per cent on qualifying gains. ER has been a far more costly relief for the Treasury than originally anticipated and the government has stated its intention to review the relief. With the Budget on 11 March, the future of this relatively generous relief is now uncertain.
A lifetime gift is a typically a Potentially Exempt Transfer (PET) and provided the donor survives for seven years from the date of the gift, there will be no IHT charge. Depending on the CGT position outlined above, it can therefore be more efficient to gift assets which do not qualify for any IHT reliefs during lifetime rather than pass them on death and be subject to IHT at 40 per cent.
Sale of the business
It is not always possible or desirable to transfer the business within the family, particularly when a sale can realise significant wealth to fund retirement. However, without planning, a sale is likely to result in an increased IHT exposure particularly if the business qualifies for 100 per cent relief for IHT and is sold for cash proceeds which will be subject to IHT.
Before a sale, shareholders may consider gifting shares to a trust to protect value and mitigate future IHT liabilities. In this scenario trusts can be a highly effective vehicle for controlling the destination of assets, protecting younger family members, mitigating tax liabilities and maintaining control.
Succession of the family business is a complex area, and as the government has stated its intention to review these valuable tax reliefs, planning should not only start early, but also be reviewed regularly to ensure maximum success.