UK: Tax-efficient Succession Planning for the Family Business

Last Updated: 24 August 2016
Practice Guide by Verfides

Tax-efficient succession planning for the Family Business

With careful planning, shares in family trading companies can be passed on to future generations without incurring charges to inheritance tax (IHT) or capital gains tax (CGT), whilst allowing current owners to maintain effective control of the business.

The role of the Family Trust for Business Assets

Although there are capital tax advantages in using trusts to hold shares in family businesses, there are also important non-tax benefits. These benefits include:

  • A trust allows the donor to give away shares but retain a measure of control by acting as trustee. Voting rights attaching to the shares will be exercisable by agreement of the trustees (although the assets must be held for the benefit of the beneficiaries).
  • The assets remain protected in trust, which may be important in cases of divorce or bankruptcy of a family member, or to protect against the claims of creditors.
  • A trust can provide a lifetime income for one beneficiary (e.g. spouse) while retaining the capital for the benefit of other beneficiaries.
  • A trust can provide flexibility in relation to the underlying assets and can allow changes in benefit to take place without having to formally change the ownership of the shares.
  • A trust allows a transfer of assets to be made without having to make a final decision as to which individuals should ultimately benefit from them.

Tax-efficient gifts of shares into a trust

  • Inheritance Tax Exemption - Business property relief (BPR)

Normally, the transfer of assets into a discretionary trust triggers an immediate IHT charge at 20%.   However, where the necessary conditions are satisfied, relief from IHT is available on the transfer of relevant business property. 

Business property comprising “any unquoted shares in a company not listed on a recognised stock exchange” qualifies for 100% business property relief for IHT purposes, once the shares have been held for 2 years. The relief applies to transfers in life and on death.  For most established trading companies, therefore, shares can be transferred into trust with no exposure to IHT.

When considering whether or not shares in a business qualify for BPR it is important to consider the following points:

  • BPR is only available to trading companies. Shares of a company do not qualify for BPR if the business of the company “consists wholly or mainly of dealing in securities, stock or shares, land or buildings or making or holding investments”. The term “wholly or mainly” implies a quantitative test of 50% or more.
  • BPR will be restricted to the extent that share value is attributed to “excepted assets”. Excepted assets are either used mainly for personal rather than business purposes or are surplus for the future requirements of the business (for example, a large cash surplus).
  • Where land and buildings or other assets are used by the company but owned by a controlling shareholder, BPR will only be available at 50%.

If the donor survives seven years the shares will have been successfully taken outside of the donor’s estate. BPR can still operate to secure exemption from IHT if the donor dies within seven years of the gift, although this depends on the shares remaining in the ownership of the donee (the trustees) at the date of the donor’s death.

  • Capital Gains Tax

When the gift of shares is to a trust which is not settlor-interested (i.e. the settlor is not included as a beneficiary), it is possible to defer a tax charge on accrued capital gains in full (“holdover relief”). In addition, there will be no restriction where the company owns chargeable non-business assets as the relief applies to all assets.

Further hold-over relief may also be claimed if the shares are subsequently distributed out of the trust into the hands of beneficiaries. A charge to CGT will only arise on a future disposal of shares by the beneficiaries. 

Any CGT analysis should also take into account Entrepreneur’s Relief which would potentially reduce the tax rate on gains made by the beneficiaries from 20% to 10%. Individuals are now entitled to an Entrepreneur’s Relief lifetime allowance of £10 million of qualifying gains.

Summary

UK trusts provide a tax efficient method for passing the shares in the family company to future generations and also provide a number of non-tax related benefits for safeguarding the family’s wealth. Generous IHT and CGT reliefs allow shares to pass into trust without triggering punitive tax charges.

This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

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Useful Resources
Use supplementary pages SA105 to record UK property income on your SA100 Tax Return.
When you start renting out property, you must tell HM Revenue and Customs (HMRC) and you may have to pay tax.
Use online form service or postal form (SA700) to file a tax return for a non-resident company.
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