By Nathan Sutcliffe
MHA MacIntyre Hudson
PASSING on your family business to the next generation is a significant moment. It's often the culmination of a lifetime of blood, sweat and tears from which you hope the next generation can benefit.
As ever, planning ahead is crucial and the key figures in the older generation will generally have spent a great deal of time mentoring and grooming the next generation to succeed in the business. Having gone through that process, passing it on without an unnecessarily large tax bill is important.
The simplest scenario is a simple gift of shares between family members. Although the capital gains tax rules deem any transfer to have taken place at market value, the gain made by the person transferring the shares can be held-over, subject to certain conditions. This means no capital gains tax needs to be paid on the transfer and the next generation will inherit the original share cost of the outgoing generation.
As an alternative or alongside this, trusts could be used to enable a wider family group to benefit from the business who perhaps don't work in the business or where you don't feel it is appropriate to pass shares directly to them. Again, the gain on the transfer of shares to the trust can be held-over to avoid capital gains tax arising where no cash has been received.
Whilst simple, these scenarios don't provide the shareholders with a financial return for the value they have built up over many years.
To access this value, it is often possible for the new generation to buy-out the older generation using a mixture of cash within the business and debt raised on the assets or cashflow of the business. The first step is obtaining an independent valuation of the business which everyone can become comfortable with. This provides the family with an appropriate starting position. Where the available cash and finance available isn't sufficient to meet the valuation, loan notes (effectively an IOU) for the difference can bridge the gap and allow the funds to be paid over time.
Having raised the necessary funds, we need to ensure the outgoing generation can benefit from entrepreneurs' relief which will allow a 10 per cent capital gains tax rate to be used. Each departing shareholder will need to meet the relevant conditions which include a minimum five per cent shareholding, having a role in the business and the company being a trading company (rather than an investment company).
In most cases, we advise families to obtain tax clearance from HMRC in advance of the transaction to confirm HMRC won't use anti-avoidance rules to treat the proceeds as a dividend. Careful drafting of this tax clearance is required to ensure HMRC appreciate the context to the transaction.
With the benefit of tax clearance and entrepreneurs' relief, the departing shareholders can receive full value for their shares with a 10 per cent tax rate whilst the next generation don't necessarily need to use personal funds to finance the transaction.