Introduction

Family owned businesses make up a large percentage of businesses in Northern Ireland. All businesses face challenges; however, family businesses face their own unique and emotive challenges, particularly around succession, leadership and family relationships, all of which can affect decision making and ultimately the strength and success of the business. Family is often the number one priority in family businesses but a successful family business must find the balance that meets the needs of the family while also sustaining the commercial needs of the business.

If managed well, a company can last an infinite amount of time. However, due to the unique status of a family business, it may come as no surprise that most family businesses do not make it beyond the third generation. By this stage the ownership of the business has potentially changed from one individual that started the business, to siblings in the second generation and cousins in the third generation. More people, more relationships, day-to-day involvement of a larger number of shareholders and different interests of family members can all make running a successful business very difficult.

These issues can be addressed through early implementation of appropriate policies and procedures to allow for the smooth and successful transition of the business from one generation to the next. However, in creating these policies and procedures the business owners will have difficult decisions to make about who the business will transfer to and how this will be achieved. For example, does the successor that runs the family business also inherit ownership, or is the ownership to be held by a wider family group? These difficulties result in many business owners neglecting to put in place a succession plan, despite knowing that such a plan is critical to the protection of the business in the long term.

Fail to plan, plan to fail

The succession of the business can happen by choice (for example a planned sale or gift of shares) or be forced (for example, on death). The ideal position is for the business owner to have in place a clear succession plan dealing with the running of the business and future ownership (if these two are to be different) and for this to have already been communicated to the family so it does not come as a surprise, particularly where the family are also dealing with an untimely death and emotions are high.

We’ve all heard the saying “there are only two certainties in life – death and taxes”. If business owners do not prepare for death/succession they should at the very least plan to minimise the tax impact felt on such an exit.

But how do the shareholders of a family business plan for a forced exit when they have no idea when such an event might happen? The answer is to always be prepared for a chosen exit and you will then also be prepared for a forced one. Performing an annual post year-end review can assist business owners and shareholders to take appropriate measures.

Potential tax reliefs available

There are various tax reliefs available on the sale or gift of a business in the UK. Each has its own set of conditions that must be satisfied to secure these reliefs and it is important that shareholders consider these conditions regularly to ensure that a business will qualify, as the tax at stake can be significant if these reliefs are denied.

There are three main capital taxes reliefs that need to be considered as part of a post year-end review of the business; Business Property Relief, Entrepreneurs’ Relief and Gift Relief.

Business property relief (“BPR”)

On the passing of the business to the next generation, inheritance tax (“IHT”) arises on the value of the assets transferred using the loss to donor principles, either on the date of lifetime gift or on death.

The lifetime gift of shares in the family company directly to the next generation will avoid any immediate IHT charge as such transactions are potentially exempt transfers (“PET”). IHT will be avoided entirely if the transferor lives for seven years after the date of the lifetime gift.

If death is less than seven years from the date of the lifetime gift, relevant business assets may attract Business Property Relief (BPR) thus reducing the death estate within the charge of IHT.

100 percent BPR is available on:

• a business or an interest in a business, as an individual or share of a partnership,
• shareholding in an unlisted company, and
• other securities in an unlisted company provided that the transferor has a controlling interest.

50 percent BPR is available on:

• a controlling shareholding in a listed company, and
• land, buildings, machinery or plant used immediately before the transfer and used wholly or mainly for the purposes of the transferor’s partnership or company in which they have a controlling shareholding.

There is no positive requirement that a company needs to be “trading” for the purposes of BPR. Generally, a business will qualify for BPR unless it is wholly or mainly:

• dealing in shares or securities
• dealing in land or buildings
• making or holding investments

Assets which represent excepted assets for IHT purposes will be denied BPR regardless of the status of the company. An excepted asset for IHT purposes is an asset that is not used for business purposes throughout the two years immediately preceding a transfer or is not required at the time of the transfer for future use in the business in question.

Cash balances may be excepted assets, to the extent that they are not required for day to day activities or for specific business plans.

BPR is an important and valuable relief and should be protected where possible. The availability of BPR may provide business owners with greater options regarding who will inherit the shares in the company, without the added consideration of the gift giving rise to a significant inheritance tax liability.

Entrepreneurs’ relief (“ER”)

The chargeable gain realised on the disposal or gift of shares in the family business may be subject to Capital Gains Tax (“CGT”) at the higher rate of 20 percent.

Entrepreneurs’ Relief may be available on the disposal of the shares, applying the reduced rate of 10 percent of CGT on a £10 million lifetime limit of qualifying chargeable gains.

The relief is available on certain qualifying business disposals which includes the disposal of shares and securities if all of the following conditions are satisfied within the period of one year before the disposal:

• The disposal is of shares in a trading company or the holding company of a trading group;
• The individual making the disposal owns at least five percent of the ordinary share capital and is able to exercise at least five percent of the voting rights; and
• The individual must be an officer or employee of that company.

The holding of investment properties, other investments, or large amounts of surplus cash on deposit in the company may lead to substantial non-trading activity which would threaten the trading company test. HMRC treat non-trading activity of 20 percent or more as being substantial.

To maintain the eligibility of the shares for ER on disposal, the working capital requirements of the business and the need for and benefit of holding cash in the company should be considered regularly.

Gift relief (also known as Hold Over relief)

Business assets may be gifted without a chargeable gain crystallising on the owner of the assets. Again, shares in a company may qualify. Where this relief is available, the gain is deferred and held over into the base cost of the asset and thus will only become chargeable to CGT on a subsequent disposal by the transferee.

Hold-over relief may be claimed for:

• gifts of business assets;
• gifts of unlisted shares in trading companies;
• gifts of agricultural land;
• gifts which are chargeable lifetime transfers for IHT purposes; and
• certain types of gifts which are specifically exempted from IHT

If there is some consideration for the asset gifted and this has a value greater than the base cost, this will restrict the amount of gift relief with the excess cash becoming chargeable to CGT immediately.

Again, the trading status of the company will determine if the shares are eligible for the relief.

Gift relief gives the business owner the flexibility to gift their shares to their children without suffering an immediate CGT charge. If ER is available, business owners may decide that the 10 percent rate is a reasonable rate of tax to pay to allow the successor to receive a base cost uplift on the shares to current market value.

Conclusion

Whilst most business owners understand the importance of succession planning, the majority are yet to implement policies that they know are vital to the smooth operation and continued success of their business. In many cases there are very real reasons why businesses haven’t yet implemented these polices and in the meantime consideration should be given to the taxes that may arise on the sale or gift of a business. Early planning and impartial professional advice are key!

Claire McGuigan is a Director in Corporate Tax with BDO Northern Ireland.