Company directors taking advantage of the relief on inheritance and capital gains tax to hand over control to the next generation should keep their own finances separate.
There comes a time in the life cycle of every family business when ownership, for whatever reason, has to be put into younger hands. Thanks to the current highly favourable tax position on inheritance - part of the Government's desire to encourage wealth 'cascading down through the generations' - the time for doing so has seldom been better.
Since 1992 there have been very generous concessions - 100% business relief from inheritance tax and holdover relief for capital gains tax - for those who pass a trading company on to the next generation. In practice, for directors who control more than 25% of a trading company, inheritance tax is generally not a problem. 'Even if you hold less than 25%, there is still 50% relief,' explains David Bowes of accountants Grant Thornton. 'Only if you are an investment or a property company (neither of which qualify for relief) do you normally have the usual inheritance tax problems.' It is the shareholding, he explains, and not the size of the company which defines eligibility.
Sole traders, partnerships, shares in a company controlled by the donor at the the time of making the transfer (excluding quoted companies) and substantial shareholdings carrying more than 25% of the votes in an unquoted company are all eligible for 100% business relief. Gifts qualifying for 50% relief include any land, building, plant or machinery used mainly in a business carried on by a company controlled by the donor or by a partnership in which he or she was a partner at the time of transfer, shareholdings carrying 25% or less of the votes in an unquoted company or shares in a quoted company controlled by the donor.
'But you have to be careful about not putting yourself in a worse position,' Bowes points out. 'If a 70% holding of shares, qualifying for 100% business relief is reduced to a 20% holding, business property relief would be restricted to only 50% in future. A reduction to a 30% holding would still allow 100% relief to be available.' According to Michael Otway of stockbrokers Carr Sheppards, 'the real problem is not so much tax. It is persuading entrepreneurs, who probably set up the business, to hand over the reins. One of the best ways of doing this is to ensure that there is a self-administered pension fund which can guarantee a certain standard of living in retirement.' He and other experts suggest that if a generous self-administered pension scheme is put into place, controlling directors are more likely to be prepared to give assets to children and grandchildren, secure in the knowledge that they will not suffer in retirement as a result.
At its most basic the strategy is this. A small self-administered pension scheme is set up within the company which is funded to pay maximum benefits to the retiring controlling directors. This sets them free to give away the company as it secures their standard of living in retirement. Shares in the company are then gifted to the next generation with 100% business tax relief from inheritance tax. If the children are minors, or grandchildren and other young relatives are to inherit, the shares can be put into a suitable trust with no immediate capital gains tax liability as holdover relief is available.
'The gift is completely free from inheritance tax anyway if the donor survives seven years,' explains Bowes. 'If not, business relief may still apply at the donor's death but only if the shares still qualify for relief at that time and if they continue to be owned by the same donees. If, for example, they have been sold, there will be no relief at all.' Peter Leach, a partner at Stoy Hayward - and author of the firm's Guide to the Family Business - similarly believes that tax considerations are simply the practicalities. 'The key to a smooth transition between the generations is for the outgoing generation's finances to be separate from the next generation. This is the usual stumbling block.' He points out that, aside from self-administered pension schemes, there are a number of ways of achieving this. Others include the use of employees share option schemes, and separating out the trading activities from the assets of the company, such as property, and passing them on separately. 'The retiring generation can keep the property - either holding it within the pension fund, or directly - and the trade can be handed down.' This is precisely what Bristol-based independent financial adviser Peter Hargreaves of Hargreaves Lansdown and his partner, Stephen Lansdown, have done. The business has recently moved to a new office block owned by Hargreaves and Lansdown personally and leased back to the company.
According to Hargreaves there are several advantages to such an arrangement. First, the rental income from the property is a pension for both partners and a widow's pension for their wives. 'But if you leave the property within the company and subsequently sell it at a profit, the capital gain is subject to corporation tax and income tax if you distribute the profits as dividends. In other words it is subject to double taxation. This way it (the property) is a ready-made pension fund.' There is also, of course, the human side of the business. Brian McRitchie of Coopers & Lybrand points out that succession often involves the whole family and several generations. 'The older management may well have an emotional attachment to the business and have difficulty giving it up. You have to get them to answer the question "What will happen to the business in the long term if I don't address these issues?".' Most advisers point out that the fact that 100% business relief has not been around for long - and may not remain - provides the most persuasive case for dealing with the problem of succession now; a future government could radically change the system and make it considerably harsher. 'I would be very much suprised if the situation is still the same in 10 years' time,' warns Otway.