AAB: plan tax to secure future on sale of a family firm
Working towards the sale of a family business after years of blood, sweat and tears can be a stressful time for owners. Whether the decision to exit is sparked by retirement, moving on to pastures new, or receiving an unexpected offer too good to refuse, what follows are almost inevitably complex and often emotive negotiations, due diligence, late nights and a raft of paperwork.
With so much to consider, it is understandable that tax planning may not always feature highly on the agenda. While most business owners will take professional advice from the perspective of the company, personal tax planning ahead of a business sale is essential too and, if done well, could result in net cash benefits, as well as securing life-changing wealth for future generations.
Capital Gains Tax
Most business owners will be aware that the sale of their business will give rise to a capital gains tax (CGT) liability on the difference between the sales price and the original cost of the shares. The top rate of CGT on company shares is currently 20 per cent, but business owners can access a lower CGT rate of 10 per cent thanks to entrepreneurs’ relief (ER). Various conditions need to be met in order to qualify for ER, but at the time of writing broadly speaking the 10 per cent rate is currently available to owners of trading businesses where the owner is an officer or employee of the company and has, for a period of 24 months immediately prior to the disposal, held at least 5 per cent of the ordinary shares and voting rights, and is entitled to at least 5 per cent of the assets on winding up, or proceeds of sale.
It is worth noting that the ER rules have been subject to change over the last couple of years, and recent press coverage suggests the relief is under scrutiny by the government. It has been intimated that as part of March’s Budget, the Chancellor may seriously limit or even abolish the relief altogether.
But as things currently stand, where the sale of a business is contemplated far enough in advance, ensuring all conditions are met and maximising access to lifetime ER allowances (currently £10 million of gains per person), must be a key consideration.
Inheritance Tax
Perhaps a less obvious personal tax concern ahead of a business sale is exposure to inheritance tax (IHT). Subject to certain conditions such as type of business and a minimum 24-month ownership period, company shares may qualify for business relief (BR). Before a business disposal, BR relieves 100 per cent of the value of shares irrespective of percentage ownership in a trading (as opposed to investment) company.
Post-sale, the shares will immediately be converted into cash, which does not benefit from any IHT reliefs and will, to the extent that the cash remains in the estate on death, be fully exposed to IHT at the rate of 40 per cent. Pre-sale, there is a window of opportunity for business owners to remove significant value from their estates by transferring shares into a family trust.
As the shares qualify for 100 per cent BR, there is no restriction on the value that may be transferred into the trust (it is limited to £325,000 for cash transfers post-sale), ensuring that substantial value is ring-fenced for the benefit of the wider family.
Assuming that the business owner survives for seven years following the date of the gift into trust, the value transferred falls out of their estate for IHT purposes. One of the attractions of this particular tax planning is they can still retain control of (though not direct access to or use of) the funds in trust.
A gift of shares into trust is also an event for CGT purposes, giving rise to a gain which may either be deferred or, assuming all ER conditions are satisfied, crystallised with tax payable at the 10 per cent rate.
The Family Investment Company
A further potential consideration for the business owner in anticipation of an exit is the establishment of a family investment company (FIC). FICs are becoming more popular, though it is by no means a new estate planning solution and is essentially a private company with family members as shareholders.
Post-sale, the business owner funds the FIC, typically with a combination of a loan to the company and a subscription for new shares. The bespoke company Articles of Association ascribe to the shareholders different levels of control, varying rights to dividends and a different entitlement to the underlying capital value of the FIC.
The FIC allows the transfer of value and control to family members to be undertaken in a staged process over time, which may be more attractive to some business owners than a pre-sale transfer of shares to a family trust.
Loans may be repaid by the FIC to the parents with no income tax implications, and company tax rates are also favourable in comparison with income tax and CGT rates faced by trustees.
The FIC is often referred to as an alternative to the family trust but it is common practice to combine the two and include a trust as a shareholder alongside family members. The trust provides a protective environment for shares ultimately desired to benefit vulnerable beneficiaries, and allows parents to use their IHT allowances (£325,000 per person) which refresh every seven years.
Ultimately, while there is no one universal tax planning strategy for business owners anticipating a sale, it is vital to give careful consideration to all the options available, and as far in advance as possible. There is nothing worse than looking back, post-transaction, and realising that just a few careful tax planning moves could have saved thousands of pounds in tax and secured a safe haven for future family wealth.
Business owners who have worked hard to build up their brand will naturally want to structure their affairs as tax-efficiently as possible, and take advantage of all available reliefs and allowances, but they will also want to ensure that their families are catered for adequately and appropriately.
Lisa Tait is private client tax senior manager at Anderson Anderson & Brown.