Working towards the sale of a family business after years of blood, sweat and tears, is an extremely stressful time for most business owners. Whether the decision to exit is retirement, moving on to pastures new, or simply receiving an unexpected offer which is too good to refuse, what follows is almost inevitably complex and usually emotive negotiations, due diligence, late nights and a raft of paperwork.
It is therefore understandable that tax planning may not always feature highly on the agenda. Whilst most business owners will take professional advice from the perspective of the company, personal tax planning ahead of a business sale should not be overlooked, and if done well, could result in surprising net cash benefits, as well as securing life changing wealth for future generations.
Capital Gains Tax (“CGT”)
Most business owners will be aware that a sale of their business will give rise to a CGT liability on the difference between the sales price and the original cost of the shares. As things currently stand, the top rate of UK CGT on company shares is 20%, but business owners can access a lower CGT rate of 10% thanks to Entrepreneurs’ Relief (“ER”).
There are various conditions to be met in order to qualify for ER, however broadly speaking the 10% rate is currently available to owners of trading businesses where the owner is an officer or employee of the company and has, for a period of 24 months immediately prior to the disposal, held at least 5% of the ordinary shares and voting rights, and is entitled to at least 5% of the assets on winding up, or proceeds of sale.
It should be noted that the ER rules have been subject to change over the last couple of years and changes to ER were included in the March 2020 budget.
Inheritance Tax (“IHT”)
Perhaps a less obvious personal tax concern ahead of a business sale is exposure to IHT. Subject to certain conditions such as type of business and a minimum 24 month ownership period, company shares may qualify for Business Relief (“BR”). Prior to a business disposal, BR relieves 100% of the value of shares irrespective of percentage ownership in a trading (as opposed to investment) company.
Post-sale, the shares will immediately be converted into cash, which does not benefit from any IHT reliefs and will, to the extent that the cash remains in the estate on death, be fully exposed to IHT at the rate of 40%. Pre-sale, there is a window of opportunity for business owners to remove significant value from their estates by transferring shares into a family Trust.
As the shares qualify for 100% BR, there is no restriction on the value which may be transferred into the Trust (limited to £325k for cash transfers post-sale), thus ensuring that substantial value is ring-fenced for the benefit of the wider family.
Assuming that the business owner survives for 7 years following the date of the gift into Trust, the value transferred falls out of his estate for IHT purposes, but one of the attractions of this particular tax planning, is that they can still retain control the funds in Trust (albeit not direct access to nor use of)
It should be noted that a gift of shares into Trust is also an event for CGT purposes giving rise to a gain, which may either be deferred or, assuming all ER conditions are satisfied, crystallised with tax payable at the 10% rate.
The Family Investment Company “Alternative”
A further potential consideration for the business owner in anticipation of an exit is the establishment of a Family Investment Company (“FIC”). Whilst the FIC is becoming more popular, it is by no means a new estate planning solution, and is essentially a private company with family members as shareholders.
Post-sale the business owner funds the FIC, typically with a combination of a loan to the company and a subscription for new shares. The bespoke company Articles of Association ascribe to the shareholders’ different levels of control, varying rights to dividends and a different entitlement to the underlying capital value of the FIC.
The FIC allows the transfer of value and control to family members to be undertaken in a staged process over time which may be more attractive to some business owners than a pre-sale transfer of shares to a family Trust. Loans may be repaid by the FIC to the parents with no Income Tax implications and company tax rates are also favourable in comparison to Income Tax and CGT rates suffered by Trustees.
The FIC is often referred to as an alternative to the family Trust. It is however common practice to combine the two, and include a Trust as a shareholder alongside family members. The Trust provides a protective environment for shares ultimately desired to benefit vulnerable beneficiaries and allows parents to utilise their IHT allowances (£325k per person as noted above) which refresh every 7 years.
Whilst there is no one universal tax planning strategy for business owners anticipating a sale, it is vital that careful consideration should be given to all the options available, and certainly as far in advance as possible. Hindsight is always a wonderful thing, but there really is nothing worse than looking back post transaction, and realising that just a few carefully considered tax planning transactions could have saved many thousands in tax, and importantly, secured a safe haven for future family wealth.
Business owners who have worked hard to build up their brand will naturally want to structure their affairs as tax-efficiently as possible, and take advantage of all available reliefs and allowances, but they will also want to ensure that their families are not only adequately but also appropriately catered for.
If you are a business owner looking to sell your business, please do not hesitate to get in touch with Lisa Tait, Private Client Tax Senior Manager.
To find out more about Lisa and the Business Advisory Team, click here.