An overview of tax and family considerations when planning for the succession of a family business in the UK

Succession planning should be viewed as a process rather than an event. A successful business must not be reliant on one key individual. As such, ultra-high-net-worth business owners should be encourage to take steps early on, as part of this process, to ensure a smooth transition to the next generation when they are no longer around.

A will is the cornerstone of good estate planning; not only does a will set out how business interests pass on the death of a founder, it allows executors to take business decisions immediately following the founder’s death. If a person dies intestate, their administrators have no authority until a grant of letters of administration is made, which may take upwards of six months.

Before making a will, the business owner should have frank discussions with their children. For example, are there certain children who will take over management roles? Are there rivalries between children that may lead to deadlock? If one child is to take over management, should others be compensated with other assets? Is it more appropriate for non-family members to continue the management of the business? Do the next generation want to take over the business? These are key questions, and if all parties are on board this should ensure a smooth transition of the business, whether it is to the next generation or to a third party through a sale or listing.

Considering IHT

Another key consideration is inheritance tax (IHT) which, if not managed properly, can force an unintended break down of a business. The general rule is that when a person dies domiciled in the UK or owning UK-situated assets, assets in excess of the nil-rate band (NRB) will be subject to IHT at 40 percent. However, interests in unquoted trading businesses that have been held for more than two years will not be subject to IHT, whatever their value, because of business property relief (BPR).

Pre-IPO planning

For listed companies, BPR is available to relieve 50 per cent of the IHT on the death of a shareholder and only if the holder’s shares give overall control of the company. As such, in most instances, shares in listed companies will not qualify for BPR, so it is prudent for business owners to carry out succession planning before an initial public offering (IPO) takes place.

For an unlisted trading company about to list, the founder might consider the use of a family trust to settle their shares. Generally, an individual can settle only up to the value of their IHT NRB into a trust, without an upfront IHT charge of 20 per cent. However, where the assets being settled attract BPR, an unlimited value can be settled without any IHT. As such, provided that, pre-IPO, the company is trading, the settlor has held the shares for more than two years and there is no binding contract for sale over the shares, an unlimited value can be settled, making trusts an attractive planning option.

Following the IPO, the shares will not attract BPR but, crucially, the value will be outside the settlor’s estate for IHT. The trust will have its own IHT regime involving IHT charges every ten years and when capital leaves the trust. However, these smaller IHT charges can be more easily managed than an unexpected and immediate 40 per cent IHT charge on the death of a shareholder. Importantly, the ownership of the shares will remain within the settlor’s family to ensure cohesion and the settlor can be one of the trustees, so control is retained.

Gifting shares

Another option is for a founder to gift shares in the business to their children to take value out of their estate. Outright gifting is simpler than a trust but provides less asset protection, as once the shares are gifted they are more vulnerable to attack by a divorcing spouse or creditor in bankruptcy of a child. A shareholder agreement could be put in place to guard against some of these risks.

When settling shares into a trust or gifting them, capital gains tax (CGT) should always be borne in mind. With unlisted trading companies, holdover relief is generally available, which means that the donee will be deemed to inherit the shares for the donor’s base cost so the CGT is deferred until the donee’s later disposal of the shares. Business asset disposal relief may also be available to reduce the rate of CGT from 20 to 10 per cent but only on the first GBP1 million of lifetime gains.

Conclusion

The takeaway point for family business owners is to act early, but only where markets in a post-COVID-19 world permit. Generous tax reliefs may be lost later on in the business cycle, reducing the scope for succession planning and there is also a possibility that the UK government could reform or even abolish BPR and holdover relief to pay for its COVID-19 spending.

For business owners looking to sell, tax considerations should be balanced against the economic implications of the pandemic, which may force them to hold fire on a planned sale until there is recovery in the market.1

 Currently GBP325,000 per person or GBP650,000 for spouses.