Heading For The Exit – Business Succession

Jennifer Adams points out some important issues for owners seeking to pass on their business interest to family members.

On commencement of a business, it is recommended that the owner prepares a business plan. Such a plan defines the owner’s aspirations for his business, and details how those goals may be achieved. 

There is another consideration that should be included – that of disposal, which could mean succession. A tax-efficient method of disposal depends upon the type of business and whether continuation or cessation is planned.  Succession will depend upon whether any family members wish to continue the business. 

On the disposal of a sole trader or partnership business during the owners’ lifetime, the capital gains tax (CGT) charge is calculated separately on each chargeable asset. These assets are mainly land, buildings and goodwill. 

Business succession usually takes the form of a gift. However, the disposal could take the form of a sale instead. The purchase will generally be deemed to take place at market value for CGT purposes, even if the purchasing family member does not pay what the business is worth (see below). For the vendor, entrepreneurs’ relief (TCGA 1992, s 169H) will often be available, shielding any capital gains up to £10 million, with tax paid at 10 per cent. 

As a reminder, the rules state that relief is possible so long as the seller makes what is called a ‘qualifying business disposal’. The main heading of such a disposal is a ‘material disposal of business assets’. This heading is sub divided further as being:

For inheritance tax (IHT) purposes, bear in mind that on a sale of the business, the cash proceeds will be a chargeable asset of the estate (in contrast with a business interest, for which IHT relief may be available – see below), and this should be factored into any succession planning. 

Should the business be gifted to the spouse/civil partner the ‘market value’ restriction does not apply as the donee is treated as having acquired the business at the original purchase price. No CGT will be due until the receiving spouse/civil partner sells the business or any business assets. 

Where it is decided to gift the business to the family (rather than to the spouse) or other partner during the owner’s lifetime, or it is sold at less than their market value, CGT is charged as if the donor had received market value for the business (TCGA 1992, s 18). 

In business gift situations, the ‘relief for gifts of business assets’ rules for CGT purposes may be relevant (TCGA 1992, s 165). This relief generally enables capital gains (or transfers at below market value) on business assets to be ‘held over’ until the asset (or company shares) is disposed of by the donee. No CGT is normally charged at the time of the gift; the donee, in effect, takes over the original cost of the asset.  

Relief may be restricted in certain circumstances, such as where there is consideration which exceeds the donor’s original cost of assets, or should the asset not be wholly used for the entire period of ownership. ‘Hold over’ is only a deferral of tax, not an exemption.

Owners of successful businesses frequently use companies as a trading medium, not least because of the tax benefits that can be achieved.

The family may not see why they should raise money for purchase of the family company shares if the company has a large bank balance. 

The alternative is for the company to ‘buy back’ the owner’s shares using the company's reserves to fund the purchase. Such a transaction would normally be a distribution for income tax purposes. However, so long as certain conditions are satisfied (CTA 2010, s 1033-1048), the seller is treated as receiving a capital payment, thereby attracting more beneficial tax rates, and possibly ‘entrepreneurs’ relief’. 

The shares bought back are normally then cancelled, so the family members taking over the business will need to hold some shares in their own right.

In deciding on a gift of shares within the shareholder’s lifetime, it should be noted that the gift might transfer value out of the estate for inheritance tax (IHT) purposes, but on the other hand as the shares are no longer held, there will be no uplift in value of the shares at the date of death for CGT purposes.

Aside from the CGT issues on a gift of assets such as shares (see above), further problems may be found should the family member receiving the shares also be an employee of the company at the time of transfer. HMRC may argue that the receipt would not have been received if the donee had not been in employment and as such the gift should be charged as employment income. 

Should the intended family members be inexperienced in business matters and/or the controlling shareholder wishes to keep voting control of the shares but remove the shares from their estate for IHT purposes, then the transfer of shares into a family trust may need to be considered. 

The gift will be an immediately chargeable transfer for IHT purposes, but may attract 100% business property relief if certain conditions are satisfied, such as if the donor has owned the shares for at least two years. The donor does not have to completely give up his controlling interest in the company; he can retain 51% personally and gift the remainder into the family trust. Making the donor a trustee will ensure some degree of continued influence.  The gift into trust is generally a market value disposal for CGT purposes, but a form of holdover relief may be available, which applies to transfers which are immediately chargeable to IHT (TCGA 1992, s 260).   

The above is only a very brief outline of some of the tax problems to consider in what is, in reality, an important and life changing decision. Timing of any action is important as is the possibility that there are no family members interested or available for succession. Seek expert professional advice when considering any business transfer.