Succession Planning for a Family Business

The transition of a closely-held or family-owned business is an important event for such clients and must be planned for accordingly.

Recent changes to the tax landscape have caused the succession planning strategy to be re-evaluated, resulting in the need for highly skilled advisors adept in planning for an effective succession strategy.

What are the key issues for the succession of a family business?

The transition of a family business from one generation to the next is a complex and, at times, emotional process. It is perhaps one of the most significant challenges that any business will face. A family’s foremost concern is usually to protect both the business and their own wealth and harmony.

The first key principle is to start the succession planning process as early as possible and put in place a well thought through plan. For example, it may be unwise to wait until all other scenarios have been exhausted before looking around for a third party buyer. An effective succession plan should also accommodate the expectations of the different generations, based around a shared vision. The buy-in and understanding of all family members involved is critical to a successful transition.

In a family business, the owners frequently own either all of the shares or a controlling shareholding. They might be concerned that the next generation is not ready to take on the responsibility or may not even wish to be shareholders in the business. They may also be worried that the Government could change the currently favourable Inheritance Tax rules so as to penalise private trading companies. They might want to pass their wealth to the next generation whilst retaining voting control, or allow those members of the family who work in the business to own some shares in their own right whilst being reluctant to let shares pass outright to other family members who do not have any direct interest in the business itself. And they will almost always want to protect the business from the potentially damaging consequences of a future divorce. Each family member who holds or is beneficially interested in shares in the business also needs Articles of Association and any shareholders’ agreements which deal with the transmission of shares and permitted family trusts. Critical points that might have wider implications for the business are often picked up when looking at individual estate planning and dealing with issues in practice, rather than in the abstract.

How can trusts be used to navigate these challenges?

Trusts have been used in England and Wales (and elsewhere) for hundreds of years. They are a popular and highly effective vehicle for controlling the destination of assets, separating management from beneficial enjoyment, protecting younger members of the family from themselves or fortune hunters, mitigating tax liabilities, and maintaining voting control. Owners may well be willing to give shares to children who are working in the business but then worry about how to be fair to their other children. An outright gift of shares will carry with it not only the rights to any future dividends but also voting powers. If there are children who are not working in the business they could still benefit if some shares become held in a trust for them under which they receive income (i.e. the dividends on those shares) for their lives but do not have any say in the running of the business. A transfer to a trust ensures that voting rights remain with the trustees and, depending on how the trust is operated, provides some protection in the event of future matrimonial proceedings. Alternatively, the owners may wish to skip a generation if their children have been well provided for and transfer shares to trusts for the benefit of grandchildren instead. By transferring the shares into a trust the owners can transfer value out of their estates for Inheritance Tax purposes, make use of available IHT, CGT, and Income Tax allowances and reliefs, retain control by being trustees and protect the assets from being squandered by beneficiaries or their future spouses (not just present children and grandchildren but also those who may be born later). Flexibility to vary the entitlements of the beneficiaries, if that becomes necessary or desirable, can also be built-in.

What are the tax implications when planning business succession?

Tax efficiency is an integral part of effective succession planning. We always consider and advise on the tax implications of the devolution of interests in a family business, whether during a shareholder’s lifetime or under his or her will, with an eye on preserving value. Those tax implications usually extend beyond the direct capital taxes (IHT and CGT) to encompass Income Tax, Corporation Tax, SDLT, and VAT. There are often offshore tax implications and conflict of laws issues to consider too, in our increasingly global world.

Trusts are treated as separate entities for taxation purposes and, for many years, trusts owning shares in trading companies have been very favourably treated in the UK for both CGT and IHT. For example, it is possible for an owner to transfer a significant shareholding in a wholly-owned family business to a trust for future generations whilst holding over any liability to CGT. That transfer may well be exempt from an initial IHT charge and there may be no liability to IHT at all even if the owner dies within seven years of the transfer, provided that the shares were previously owned for at least two years and the trustees have not sold the shares since the transfer into trust, whilst any increase in the value of the shares will be outside the owners’ estate.

This article, written by Sue Laing, first appeared in the Lawyer Monthly Magazine.