Succession Planning - January 09
This article appeared in the Telegraph Business Club on 9 February 09
There are many important matters to consider when thinking about the future ownership of a family business. Whilst the main focus is likely to be the continued growth of the business, the retiring generation often has to deal with the expectations of succession which the next generation may have.
We have seen many businesses pass successfully from generation to generation over the years, but the legal structures used to effect these transactions have varied significantly. Sometimes a simple transfer of shares between the parties or a buyback of shares by the company does the trick. Sometimes a more complicated structure is used such as the de-merger of different business divisions into new entities, the new entities being owned by different members of the next generation.
One initial point to address is the extent to which the retiring parties require ongoing financial support. If they do, then they would need to consider the tax implications of providing a one-off capital payment or a series of deferred capital payments versus a regular stream of income (or a combination of more than one of these). It is likely that capital gains tax would be chargeable on any outright disposal of shares in the company, but there are exemptions available (such as entrepreneur’s relief) and ways in which to defer the timing of payment (for example by using loan notes).
There would have to be sufficient funds available to meet an upfront capital payment, otherwise the company must borrow to fund this. If funding is necessary, you have to factor the cost of borrowing into the equation. Given the additional cost, it may be better, in some cases, to provide an income to the retiring parties from the profits of the business. If the retiring parties would like to retain a stake in the business regular payments could be made as dividends out of the company’s available profits, which is likely to be more tax advantageous to a higher rate taxpayer.
If the retiring generation have adequate resources and are willing to transfer shares at a discount to market value or indeed gift them to the next generation, it is important to bear in mind that capital gains tax is still chargeable (calculated by reference to the market value at the date of the transfer) although the transferor may be able to avail himself of gift relief, which effectively “holds over” the gain by transferring the shares at their original base cost, thereby increasing the recipient’s gain on subsequent disposal.
You should also be aware that death of the transferor within 7 years of the transfer may trigger an inheritance tax charge, although business property relief may be available, provided that the company is a trading business and the recipient continues to trade the business throughout the 7 year period. It is important that you keep in contemplation your retirement plans so that you are able to take appropriate tax and other professional advice in good time.
It may be that there are concerns about when to transfer ownership to the next generation, in which case you might consider using a discretionary trust structure which would allow the trustees to make decisions as to when ownership should pass. Thought should also be given as to whether any indirect benefit is being given to unintended family members. For example if parents are passing their business interests to an adult child whose marriage is in difficulty now or maybe in the future, the business interest handed over becomes a matrimonial asset capable of division between their child and spouse by a matrimonial Court. In this instance benefit is passing outside of the intended family. If this is a concern, then the parent could consider issuing a new class of shares with limited or no voting rights to their child or creating a trust to which their child has a discretionary beneficial entitlement only. Any financial settlement made can be revisited by a Court in certain circumstances.
Business owners should turn their minds to the issue of succession well in advance of retirement. As well as the timing implications relating to certain aspects of tax planning, it takes time to put the right management structure in place. This is vital for the future success of the business and it cannot necessarily be assumed that at the point of retirement the next generation will be ready, willing and able to take the business on.
There are many ways to structure your succession and the chosen route will depend largely upon individual circumstances. However, one thing is certain. The sooner you consider the future, the more options you are likely to have available, in terms of both personal tax planning and future management of the business and you can be more confident of a smooth transition to the next generation.
Jonathan Morley is a Partner at Rickerbys LLP
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