Now that the Office of Tax Simplification has completed its reviews into both Capital Gains Tax and Inheritance Tax, some of the key recommendations could have a lasting impact on the way family businesses deal with succession.
Bringing forward succession
Family businesses are renowned for being culture rich, not cash rich. It is no wonder therefore that shareholders in family businesses take the approach of retaining their shares in a family business until death, as this has historically been considered the most tax efficient approach to succession.
The tax rationale for this is two-fold:
Business property relief
Firstly, family businesses that are considered ‘wholly or mainly trading’ rely on an IHT relief, known as Business Property Relief (BPR).
BPR enables trading business interests to be transferred IHT free, for examples, on death or as a lifetime gift.
Capital gains tax uplift
Secondly, under current rules any shares held at death also receive a CGT-free uplift to market value on death. And it is this second tax benefit, which can only be utilised on the death of an individual, that drives shareholders to hold onto assets until death.
To illustrate, let’s look at a very quick example. An individual passes shares in their trading business to the next generation on their death. The base cost for CGT purposes of these shares is the market value at that date, say, £25 million ($34.2 million). Alternatively these shares could have been transferred during the previous generation’s lifetime with little or no base cost. In this example, by inheriting these shares the next generation could sell these shares with little or no CGT to pay as result of the uplift in value. Assuming the shares were subsequently sold for £25 million, this could save £5 million ($6.8 million) in CGT.
With its clear tax benefits, the approach for many has been to look at succession only at the point of death.
What might change?
The government asked the Office for Tax Simplification to review both IHT and CGT over recent years. These include a review of BPR generally and whether IHT reliefs are fit for purpose. Additionally there has been widespread speculation about an increase in CGT rates, and also a discussion on a Wealth Tax. However, one of the other key recommendations that came out in both reviews is that the CGT free uplift on death should be removed.
So, when the Chancellor of the Exchequer looks to make some well publicised changes to the personal tax regime, whether in a Spring or Autumn 2021 Budget, removing this tax benefit is likely to be one of the main changes made.
While the view from most is that it is less likely that we will see substantial changes to personal tax regime in the short term, it is clear that the direction of travel means that the reliefs that exist are unlikely to get any more generous than they are at present.
The rise of the family buy-out?
Given these potential changes in tax policy, we suggest family businesses should look to reconsider their approach to succession planning, and family governance.
We have found that bringing forward this shift can have a hugely positive impact on businesses and family dynamics if managed correctly.
One approach we are finding hugely popular with clients is the use of a Family Buy Out (FBO). FBO’s can help the next generation to acquire the business from the current shareholders. This allows the current generation to extract value in a capital form, protects the current value of the business for the wider family, whilst passing control and the future growth in value of the group to the next generation.
And while a FBO is not the right solution for all family businesses, there are many alternative approaches families can take including the use of trusts and family investment companies to allow families to take a proactive approach to succession.
If you would like a conversation on what a proactive succession plan could look like for you and your business, please feel free to get in touch with Craig Rowlands.