Making family businesses more tax efficient is good planning ... whatever the political landscape
Alan Stewart · Posted on: July 5th 2024 · read
The outcome of the General Election and Labour’s landslide victory means there are likely to be changes to tax rates, rules and allowances.
Making family businesses more tax efficient represents good planning whatever the political landscape.
Many owner-managed businesses operate as companies, whereas others may operate as partnerships or sole traders who will already have the immediate family as owners.
Why add family as business owners?
Firstly, it is worth briefly reminding ourselves why current owners of a company might consider adding their family as shareholders. The reasons could include:
- Succession. Current shareholders may be looking to step away and involve their children more in the business, recognising / rewarding their involvement.
- Remuneration planning. Having family who are both employees/directors and shareholders can create great flexibility as salaries, pensions, and / or dividends can be paid.
- IHT planning. Giving away assets to the next generation can help to reduce inheritance tax. However, the donor would then lose any income generated.
The introduction of a family trust might help to complement or replace direct family ownership. It can facilitate effective succession planning, provide flexibility in distributing benefits, and offer potential tax advantages. They can also be used to bring in children whilst allowing owners to retain control of the shares through trusteeship. However, there can be complexities and detailed legal and tax rules to consider in using trusts which should be borne in mind.
Spreading the income, capital and wealth across immediate family can be tax efficient, however sight of the commercial ramifications should not be lost.
Key tax considerations:
There are many tax issues to consider before adding family as shareholders. As with most things in life, there are pros and cons. The key tax points to consider are:
- Inheritance Tax (IHT) - The IHT allowance is still only £325,000 per person, rising to £500,000 per person for smaller estates, which include a residential property. It could be possible under present tax rules for IHT relief to be obtained on the value of shares held in a trading company using Business Property Relief (BPR). BPR potentially allows shares in trading companies to pass to the next generation without the business or family having to fund significant IHT liabilities, but any gifting of shares can result in tax issues which will need to be fully considered. It is prudent to keep the BPR position under review as underlying activity and assets in the company changes over time, not to mention new Governments bringing in new legislation.
- Capital Gains Tax (CGT) - As a general point, the gift of shares or part of a business to a family member or to a family trust is treated as a sale at market value, despite no cash changing hands. Fortunately hold-over might be available to pass the capital gains tax onto the next generation until the shares or business is sold.
- On a sale of a trading business, the first £1m of gains over a lifetime can be taxed at 10%. If the business is worth significantly more than £1m, it would be beneficial to introduce the immediate family as shareholders. However, the incoming shareholders would need to have at least 5% of the company and become an employee or officer for at least two years prior to any sale.
- Income Tax - Adding family members as shareholders can give access to the lower tax rates and unused allowances. However, owners should carefully consider the rights attaching to those shares provided to family as the Settlements legislation may come into play. Company pension contributions for the family members could be considered provided the amounts are commensurate with their roles within the company. These contributions can help reduce corporation tax as well as provide a tax efficient income in retirement.
- Settlements legislation - This exists to prevent an individual from gaining a tax advantage by arranging to divert his or her income to another person, such as to a lower-earning spouse or other person. This will need to be reviewed carefully as part of establishing share structure for families, particularly where minor children are involved.
- Employment Related Securities (ERS) - ERS issues may arise when directors, employees or their families acquire or dispose of their shares, and this may result in income tax and national insurance issues on the transfers or in the future. Relief may be available for transactions between family members, but this requires careful consideration in advance to avoid any unexpected higher tax liabilities.
In many cases the shares held by existing owners will be valuable, and growing in value, and will thus add to the value of other assets such as the family home.
Conclusion
Navigating the complexities of adding family members as shareholders in a UK company involves a nuanced understanding of tax implications.
There will also often be other considerations besides tax. For example, it may still be advantageous to have a Shareholders’ Agreement to help protect against any changes in future circumstances (such as differing objectives between family members or marriage breakdown).
Owners must therefore approach the process with meticulous planning and professional guidance.
