Paul Arnold, Director, Broomfield & Alexander
For all family businesses, succession planning is a must, given that sooner or later everyone wants or needs to retire.
However, if you own a family business (whether that be in whole or in part), there is more to retirement than just deciding not to go into the office any more. Aside from ensuring that you have sufficient funds to retire, the question of what happens to the business becomes paramount.
Key issues for consideration include, who will manage the business after you retire and how will ownership be transferred?
There are a number of potential exit strategies for a retiring business owner, such as an outright sale, a management buyout or a transfer of ownership to other family members.
Another key issue to consider is tax, with careful planning required to ensure that any potential tax exposure is minimised. Two of the key tax implications for succession planning are briefly discussed below. In addition, some of the potential pitfalls are also identified, which highlights the need not only to obtain specialist advice but also to start the planning process as soon as possible.
1. Entrepreneurs’ relief
The highest capital gains tax rate of 28% is reduced to 10% if the business owner qualifies for entrepreneurs’ relief. This could potentially apply on the sale of an unincorporated business or a sale of shares, provided certain qualifying conditions are satisfied. Each individual now has a £10 million lifetime allowance, where this 10% tax rate can apply.
For a company’s shareholders to qualify for this relief they must, throughout the twelve month period prior to any disposal, hold at least 5% of the ordinary share capital of a trading company and be an employee or officer (i.e. a director or company secretary) of the company (or another group company).
Scenarios where shareholders can (unexpectedly for them) fail to qualify for this lower tax rate can include the following:
• a spouse may own shares but not actually work for the company;
• share options may be exercised prior to a sale, with someone holding at least 5% of the shares falling below the required 5% limit after the share options have been exercised;
• those exercising their share options prior to the sale, and therefore not satisfying the 12 month ownership condition; and
• holding shares with restricted voting rights.
As the rules are complex and not necessary logical many companies have found that they have to restructure their share capital to ensure shareholders qualify, especially given that this relief potentially gives rise to a tax saving of £1.8 million per individual.
There are also other issues to consider, such as business property (for example, the business premises) being held outside the company/partnership. Although a sale of business property may still qualify for entrepreneurs’ relief if sold within three years of the share/partnership sale, if rent has been charged for use of this property it would restrict the element of the gain which qualifies.
Therefore, in assessing ongoing remuneration strategy it is important to factor in the implications that rental income has for entrepreneurs’ relief. In addition, there are further adverse implications should only one spouse own the shares (or be a partner), but both spouses personally own the property used by the business.
It is worth noting that transferring a business to family members may be possible without this giving rise to an immediate tax charge, with any gain being deferred until the transferee themselves disposes of the business.
2. Inheritance tax (“IHT”)
Businesses will often fall outside the inheritance tax regime as they can qualify for Business Property Relief (“BPR”).
This applies for a number of corporate structures, such as unincorporated businesses and unquoted shares (for example, family companies held for at least two years). BPR works by taking the value of the business out of the value of the individual’s estate for IHT purposes, and thereby provides a valuable way for businesses to be left to the next generation.
However, where land, buildings, machinery and plant is held personally and used in the company’s (or partnership’s) business, it will only qualify for 50% BPR. Therefore, 50% of the value will be included in the individual’s estate and potentially be subject to IHT.
Planning can be undertaken in such circumstances, although other taxes such as stamp duty need to be considered. In addition, the use of trusts remains a valuable tax planning instrument.
It is therefore important that appropriate professional advice is sought, and the earlier these issues are considered the better.
Broomfield & Alexander are holding seminars in Cardiff & Swansea entitled Exit & Succession Planning. For more details and registration for each seminar, click on the relevant links below:
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