Passing on The Family Business
There is an increasing number of family business or farm that will be handing over the reins in the ensuring years. Research carried out on behalf of the Institute for Family Business (IFB) found that only 30 per cent of leading UK businesses that were family controlled in 1996 were in the same hands a decade later. Of the others, 42 per cent were taken over, and family control had been conceded in 28 per cent through a dilution of hereditary shareholding. This means that British firms have been passing out of family control at twice the rate than elsewhere in Europe.
At the heart of any long term planning should be the issue of succession – the process of transitioning management and ownership of your farming business to the next generation.
Succession planning is important because it tackles legal, tax and family issues before they become problems. It brings long-term security to those who have built the business up and incentivises young farmers with a clear path for their future. Yet a 2012 survey of arable and dairy farmers found that nearly half, 44%, had no formal succession plan
Benefits and risks
There are clearly a number of important considerations to take on board when planning to pass a business on to the next generation of your family.
The assets remain within the family business or farm, which can bring long-term security to your children and relatives and the career prospects of the next generation are looked after. All your hard work in building up the business doesn’t go to benefit another owner or company. But there are risks to be assessed as well. You will have no guarantee that your children, later in their lives, will want to take over the running of the firm, or that your children will be best equipped to manage the business.
That is why it is important to prepare the way for a family succession carefully and dispassionately and, most importantly, well in advance of any changeover. The fundamental question you must ask yourself is whether a family succession is the best decision for the firm. It may be that other, younger family members do not have the ambition or the skills to assume control of the business. It may be that a succession can create tensions and conflicts within both the family and the firm itself.
And don’t forget that your family could still benefit through a sale of the business, or through a management buy-out or through a flotation. Or, indeed, through recruiting professional managers to ensure that the enterprise remains a source of income irrespective of the actual involvement of any family members.
Planning a family succession
If it is your aim to pass on your enterprise to your family, it is vital you involve your children in the business as soon as it is possible and in as many aspects of its running as possible, from product development to sales and marketing, from financial management to staff management. This will not only provide them with a proper understanding of how the business works, it will also give them a real chance to discover if certain roles suit and interest them. You will, after all, want them to be as enthusiastic about the future success of the firm as you have been. But never coerce a relative – allow them the space to make their own choices about their careers.
Encouraging them to gain experience of working in other businesses and areas beforehand will help to broaden their outlook on how the business world operates and to deepen their appreciation of what is needed to make a success of developing the family firm.
You must take other, more specific issues into account as well. You will need to decide where responsibility and control lie, and to balance the demands of the business duties you hand to some members of your family with the shareholdings you give to others. Should, for example, some family members be given senior management duties, then their shares might come with full voting rights, while those shares assigned to family members without direct involvement in the firm could be non-voting but with preferential rights to dividends.
From this it should be clear that a family succession cannot be a relatively last-minute decision. It takes years. Even to the point that, when you first set up the business, you should be thinking about its eventual disposal. Timetable across the long term, plotting the stages that will lead up to the transition, noting those of your children or relatives who look best fitted for the roles they may later assume, training them accordingly, and ensuring that relationships between them and other key members of the firm are set on a confident, open footing. When the time comes for you to move aside, manage it in a way that is phased so that the switch of responsibilities is conducted smoothly
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Options
Possible options to consider include:
– Altering the format of the business, for instance establishing the business as a company or LLP;
– Taking out life insurance in order to provide cash for non-farming family members not provided for otherwise
– Splitting the ownership and occupation of land – not all land-owners need to have a direct input into the farming.
– Arrangements such as Farm Business Tenancies can allow those not directly involved in the farming business to earn a return from the farm
– Transferring assets in stages by gift;
– Flexible profit sharing arrangements;
– Limiting use of assets or occupation of land to a set number of years or to a lifetime;
– Establishing s Self-Invested Personal Pension (SIPP), which, although costly to set up, can be an efficient way of providing a retirement income.
– Using pre- and post-nuptial agreements to protect family assets.
What to look for
It is challenging but imperative to be unsentimental about a family succession. The business and the ability of your relatives to benefit from it will be compromised if the firm falters once it has been handed on. So look for family members who possess the right qualities demanded by running a business: good leadership, commercial acumen, the ability to delegate to those more experienced in certain areas than themselves, the vision to grow and develop the business. When considering succession, hold open conversations with your family to find out if they are truly committed to the enterprise for the long haul. But always balance cold-eyed objectivity with fairness – you will have an emotional duty to every family member whether or not they possess the business flair needed to take over the operation of the firm. A successful succession is as much about family harmony as it is about the harmony of the business.
Is the business a genuine inheritance?
Coming to a realistic assessment of the future viability of the business is another important matter (a firm must be worth handing on if it is not to become a burden to your children). So come to a realistic assessment of the value of the business and an equally hard-headed judgement of its potential in the years to come.
Tax
Questions of tax are equally pertinent. There have been several reforms of the capital gains tax system in recent Budgets, and more may be in the offing.
Remember that entrepreneurs’ relief has been introduced. Under the scheme as it currently stands, an owner will be subject to tax at 10 per cent on qualifying gains made from the material disposal of business assets up to the £10 million lifetime limit. Entrepreneurs’ relief may be due on the disposal of all or part of a business, the disposal of the assets in the business after it has stopped trading or the disposal shares in a company. Eligibility for relief is subject to specific conditions being satisfied. In order to benefit from the relief on the disposal of shares in a company, you will need at least a 5 per cent holding in the ordinary share capital and that gives you at least 5 per cent of the voting rights and also to work in the company or to hold a place on its board throughout a qualifying period of one year prior to disposal. Any sales of assets above £10 million are subject to a capital gains tax rate of 28 per cent, although if this is not the disposal of one asset then a small proportion of the gain could be taxed at 18 per cent.
There is also the possibility of a business property relief on inheritance tax if an owner passes a firm or shares to relatives. As a result, you may be able to carry out a transfer that is free of inheritance tax, although the specific circumstances of each business should be explored.
Playing by the rules
There are rules in company law which must be dealt with. If the rules are not followed, the effect can be that the purchase of shares is an invalid purchase and unfortunate consequences may follow.
There are also tax rules to follow. The two keys matters to establish are:
– that the company is a trading company for the purposes of Entrepreneurs’ Relief. This enables the proceeds from the sale of shares to the company to qualify for a 10% tax rate
– that the purchase of shares is for ‘bona fide commercial reasons’. A clearance procedure is available upon application to HMRC.
And finally there are financing issues. What if the company has insufficient cash to pay for the shares in one go? This can trigger all sorts of problems for the unwary but it is possible in many cases to resolve the issues.
Passing on the family business tax efficiently
Imagine this scenario. Mother and father have been running their business as a company for many years. Some of the children are taking more responsibility in the business and it is time perhaps for the parents to let the children take control. The parents would like the profits which may have been accumulated in the company to be paid out to them if it can be done tax efficiently.
Both these objectives can be achieved by using tax legislation which gives favourable tax treatment to an individual when a company purchases some of its own shares.
In broad terms the steps are:
– The next generation is given some shares in the company. This may be a minority holding say 30% of the company and may be done several years before the parents want to relinquish control. No tax charge should arise for the parents or the children due to the availability of tax reliefs where it qualifies as a trading company.
– Sometime later, when parents want to retire, the company buys back their shares. If done correctly the proceeds received by the parents will be taxed as capital receipts for the sale of their shares (rather than subject to income tax). Entrepreneurs’ Relief may be available where both the individual and the company meet certain conditions so the tax charge is only 10% on the receipts less the original cost of the shares.
– Under company law, the company will cancel the shares with the effect that the shares held by the next generation are the only shares in issue. This means they now own 100% of the company.
Are there any problems? Yes there are but we are here to help manage the process.
Do please talk to us so that we can guide you through the minefield to a safe 10% tax bill.
If you thought inheritance tax planning was difficult enough when only a family home was involved, think again. When families own businesses, the complexities are far greater.
Almost half of British small business owners hope to pass on their business to their children, according to research from Close Brothers Asset Management.
But although people are considering succession plans, many are not aware of the tax implications.
There are three million family businesses in Britain, according to the Institute for Family Business, and each year some 100,000 family firms are thought to pass from one generation to the next.
Tax Tips for good planning
Trading businesses qualify for 100pc relief from inheritance tax under a system called business property relief. To qualify, the business must be an unlisted company – or one listed on the junior Alternative Investment Market (Aim) – and must have been trading for at least two years.
A similar relief for agricultural property and land, agricultural property relief, covers farmland and farming businesses, but it has to be a trading farm to qualify – keeping chickens in your garden is unlikely to pass muster with the taxman.
This means that if you fully own a company and you were to die, the shares could be left to the next generation entirely free of tax, and that is incredibly valuable,a lot of people miss out because they don’t realise the criteria; they have too much in investment, for example
A non-trading company, such as an investment company or a company that receives property rental income, does not qualify for the relief.
Business owners should also be aware that business property relief might not apply if they die within seven years of gifting the company to their children. If the children have sold the business during that time, for example, the windfall could be subject to inheritance tax. Additionally, business owners can’t put additional assets into the company, known as excepted assets, to try to get around inheritance tax.
Capital gains tax (CGT) is another interesting factor because gifting business assets means they can be exempt from the tax. If a parent has built a business worth £10m, for example, they could pass it down to their child and pay no capital gains on the value. However, the tax is only deferred. If in this example the child later sells the shares for £20m, they would pay capital gains tax on the full £20m gain.That’s important because of entrepreneur’s relief. Capital gains tax is usually 28pc, but there is a special 10pc rate which applies to businesses up to a value of £10m. For a business worth £10m, this could mean a total saving of £1.8m if the whole business changes ownership.In some circumstances, this means it might be better not to defer capital gains.
Although gains can be held over, it is not always the best answer, It is also worth keeping track of share ownerships fragmented around families in this situation – you need to hold 5pc for at least a year to qualify for entrepreneur’s relief and you need to work for the company, as an employee or an office holder. Parents stepping away from the business should think about whether the business should pay into their pension fund, how they will manage proceeds from a sale during their retirement and whether they could retain shares in the business to pay a dividend.
There is no simple answer. Individuals must think about where the business will go on their retirement and who will benefit from its value. When you have made those more emotional decisions, discuss with your accountant about how to manage the process.
Summary
There are a wide range of related planning issues that need to be considered especially the impact of passing on the business on available income after the transfer of the business. Taking an objective view of such matters can be notoriously difficult when personal family relations form part of the equation. Which is why it is essential to consult others who may not be quite so close to the business.
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A non-executive director can play a critical role in offering a proportionate, reliably disinterested viewpoint. And don’t forget that as your solicitors we will be able to make an overall judgement about the direction of a family firm, and will also be in a position to provide professional, expert guidance on how best to handle the often complex tax implications of any succession, and to advise on matters such as shareholders’ agreements and amending a company’s articles of association. The next step? It is never too early to start planning for the day you will hand over the reins. Please contact us for help and advice.
