An individual owning a successful family business needs to identify clear commercial and family objectives before weighing up the various impacts of either selling or keeping the business.
Having nurtured and grown the family business, either since inception or having taken it over from other family members, the challenge for many successful entrepreneurial individuals is how to move forward when the time comes to retire or simply to free up more time to spend on other ventures.
The immediate reaction might be to sell the successful family business, thereby releasing liquid funds. Many shareholders consider current capital gains tax (CGT) rates to be attractive. The main rate of CGT is 20% and if the qualifying conditions are met, Entrepreneurs’ Relief should result in up to £10m of gains being taxed at 10%. Ordinarily a private company sale takes several months to complete. In addition to upfront cash, typically some of the consideration will be deferred, whether in the form of equity, loan notes or an earn-out. The latter will often require the individual to continue to be involved in running the business for two to five years, but under the direction of the new owners. Subsequently, if still held when the individual dies, the proceeds from the sale form part of the estate and, unless the spouse exemption is available, are usually subject to Inheritance Tax (IHT) at 40%.
Before any decisions are made about the sale of a family business, one of the key issues is to clearly identify the commercial objectives and future needs of the individual and the family. It may be that a profitable family business is a very attractive future investment as it should continue to generate both income and the prospect of future capital growth.
The individual may decide to continue to own the shares, but to put in place others (who may or may not include family members) to run the business. Providing the various conditions are met (e.g., the company must be a trading company/group) then on death, the shares in the family company may qualify for 100% Business Property Relief and as a result no IHT is due. For CGT purposes, the shares uplift to market value at the date of death, so those inheriting are only subject to tax on future increases in value. A challenge, where the plan is to defer selling until after death, is to decide whether the commercial circumstances would have better suited a sale sooner and perhaps a sale process overseen by the deceased in their lifetime.
To spread the risk of reliance on the existing business, it is possible that the profits of the business could be invested in other activities. Within the company, profits would be subject to the relatively low rates of corporation tax. The current rate of 20% is falling to 19% from April 2017 and then to 17% by 2020, whereas the current top rate of income tax is 45%. But care is needed to preserve the benefit of 100% Business Property Relief. The activities of the company must not become ‘wholly or mainly’ of holding investments and the nature of assets held needs to be monitored.
Although the current rates of CGT may make the sale of a company attractive from a tax perspective, the commercial and tax benefits of retaining the business should not be overlooked.
Nick Pheasey (email:firstname.lastname@example.org) Partner, Private Client and Beatrice Friar (email:email@example.com) Associate Partner, Private. For further information about the process of making crucial decisions see: Family business, the challenge of change