A Family Business Year End Review: Part One

Family Business Year End Reviewby Maybeth Shaw, BDO?Northern Ireland

If managed well, a company can last an infinite amount of time. Its business may evolve and adapt to the changing market and political environments in which it operates.
In contrast, a natural person’s lifespan is not infinite and an exit from the business is therefore inevitable, no matter how much some family business owners prefer to avoid thinking about it.

Exiting the business can fall under two categories; voluntary or involuntary. A voluntary exit may take the form of selling the company or its business, or gifting the shares. An involuntary exit can occur on death, incapacity or bankruptcy.

Planning is essential to minimise the tax impact felt on exit, but how do the shareholders of a family business plan for an involuntary exit when they have no idea when such an event might happen?

The answer is to always be prepared for a voluntary exit and you will then also be prepared for an involuntary one. Performing an annual post year-end review can assist business owners and shareholders to take appropriate measures.

In this first part of a two-part series on A Family Business Year End Review, the conditions required to qualify for the number of capital reliefs available are discussed.
There are three main capital taxes reliefs that need to be considered on exit and therefore 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 arises on the value of the assets transferred, either on date of lifetime gift or on death.
The gift of shares in the family company directly to the next generation will avoid any immediate IHT charge as a potentially exempt transfer (PET) and indeed will avoid it entirely if the transferor lives for seven years after the date of transfer.

If the gift is on or within seven years of death, relevant business assets will attract Business Property Relief (BPR) thus reducing the death estate within the charge of IHT.
100 per cent BPR is available on:

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

50% BPR is available on:

  • controlling shareholding in a trading 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 trading partnership or company in which they have a controlling shareholding.

In determining whether the company is wholly or mainly a trading company, there are a number of areas which HMRC will consider.

Assets which represent excepted assets for IHT purposes will be denied BPR regardless of the trading 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.

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

Entrepreneurs Relief (ER)

The chargeable gain realised on the disposal of shares in the family business will likely be subject to Capital Gains Tax (CGT) at a higher rate of 20 per cent.

Entrepreneurs Relief may be available on the disposal of the shares, applying the reduced rate of 10 per cent of CGT on a £10m lifetime limit of chargeable gains.

The relief is available on disposals of whole or part of a trading business carried on by the individual or on the disposal of shares and securities if all of the following conditions are satisfied within the period of one year before the disposal:

  • Disposal of shares in a trading company or a holding company of a trading group.
  • The individual making the disposal owns at least five per cent of the ordinary share capital and is able to exercise at least five per cent of the voting rights.
  • 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 a substantial non-trading activity.

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

Gift Relief (Hold Over relief)

Business assets may be gifted without a chargeable gain occurring on the shareholders. The gain can be postponed and held over into the base cost of the individual assets and only becomes chargeable on the 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 transfers for Inheritance Tax purposes
  • certain types of gifts which are specifically exempted from Inheritance Tax

If there is some consideration for the asset gifted and this has a value greater than the base cost, it will restrict the amount held over with the balance becoming chargeable to CGT immediately.

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

In the second part of A Family Business Year End Review, we will consider the above capital taxes reliefs in further detail and discuss some options which may help to mitigate future liabilities on an exit from the family owned business.


 

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