Chris Taylor of headline sponsors Smith Cooper guides us through the tax implications of succession planning for family businesses.
At some point in the life of family businesses the issue of succession and transfer of ownership raises its head. Some owners look to a sale or possibly an MBO, but the majority of family businesses will want to hand on to the next generation.
Putting aside the issue of whether or not the next generation is willing to take over, there are serious tax implications of handing over the family business. The two primary scenarios, both of which require effective planning, are firstly, handing the business on as a gift, and secondly, selling the business for some cash.
Even if you gift the business to your children there is still the potential for a capital gains tax charge (CGT) to arise because a gift between parents and their children is treated as a gift between connected parties. HMRC therefore substitutes the market value of the business for the actual consideration even where the actual consideration is nil.
You can however take steps to 'hold over' the potential gain (under Section 165 of TCGA 1992) as long as all the qualifying criteria for holdover relief are met. However, you do need to ask yourself if from a tax point of view it is the right time to give the business away during your lifetime. This is particularly acute in relation to a gift of business assets which on death would qualify for 100 per cent business property relief. For assets such as these, retaining them until death is particularly attractive because not only do you get a CGT uplift to market value on death but there is also no inheritance tax (IHT) to pay.
But don't let the tax tail wag the commercial dog, particularly if children are keen to drive the business forward and take ownership. If you do gift the business during your lifetime, children will acquire the business at your original capital gains tax base cost for CGT. This should not be a reason for not transferring the business if there are sound commercial business reasons to do so.
Once the business has been gifted to your children it will have left your estate for IHT purposes but could still be liable to IHT in your estate if you were to die within seven years of the gift and your children have disposed of the business in that period.
The alternative to giving the business to your children is to sell it to them. If you sell the business and meet the qualifying criteria, then entrepreneur's relief comes to your rescue, shielding any gain up to £10m, with tax paid at only 10 per cent. However, the cash you receive will subsequently fall into your estate on death and be chargeable to inheritance tax, unless IHT planning is in place.
The fundamental question is where will the cash come from to make the purchase in the first place?
Your children might find it unacceptable to personally raise money to buy the business especially if there is cash "locked" in the company. The alternative is for the company to buy your shares from you thereby using the company's money to fund the purchase.
Shares purchased by the company are cancelled in this scenario so you may still need to gift a few shares to your children so that when your shares are purchased by the company and cancelled your children will then hold 100 per cent of the business. This is a useful way to extract cash on withdrawal from the business whilst accessing entrepreneurs relief and a 10 per cent tax charge.
