Is it time to bring forward succession?

Since the Office of Tax Simplification ‘OTS‘ has now completed its reviews into both Capital Gains Tax and Inheritance tax, some of the key recommendations could have a long-lasting influence on the way family businesses deal with succession.

Given the potential for changes in tax policy, we’d suggest that family businesses look to reassess their approach to succession planning.

As a tax advisory team, we regularly encounter inspiring individuals and families who have been substantial creators of wealth, and have found that bringing forward this shift can have an enormously positive impact on businesses and family dynamics if managed correctly.

There are a few ways in which shareholders can realise value from a family business being;

1. Extraction of dividend payments – followed by a gift of shares

2. Direct sale of shares for cash

3. Company purchase of own shares

4. Family Buy Out (“FBO”) vehicle

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Extraction of dividend payments – followed by a gift of shares

Shareholders may choose to extract cash balances in the business via a payment of dividends, followed by a gift of shares to the next generation. Whilst it might be possible to gift shares to the next generation with minimal tax complications (assuming the company’s a wholly trading business), the extraction of cash via dividends could be subject to tax at rates of up to 38.1%. This can make this option quite unattractive for long standing shareholders who wish to realise value for their shares.

Direct sale of shares for cash

A direct sale of shares could be possible to say children or other family members. However, the individuals who would purchase said shares would need cash to fund the purchase. This can sometimes prove to be difficult. If a direct sale was achieved, this could result in capital treatment for the outgoing shareholders, so they’d pay tax at capital gains tax rates of 10% or 20%, dependent on facts and circumstances. However, the practicality of this option, especially in respect of funding, may make this difficult.

Company purchase of own shares

A company could enter into a purchase of own shares. This mechanism carries strict requirements and conditions in order to obtain the preferred capital treatment on shares being sold to benefit from tax rates of 10% or 20%. Furthermore, it’s likely that the business would need the full cash sum required to pay the outgoing shareholders for the buy back of their shares. Finally, this method can be inflexible in some instances where shareholders wish to retain a small percentage of shares in the business and continue to help the next generation transition into their roles.

Family Buy Out (“FBO”) vehicle

A method we’ve found to be popular in recent years due to their flexibility is the use of a Family Buy Out ‘FBO’ mechanism.  FBOs can assist the next generation to acquire the business from the current shareholders i.e parents for example.

An FBO 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.