Lucy Brennan sets out the main tax concerns for business owners of succession planning

When thinking of retiring, most people plan to ensure that they have sufficient funds in their pension to support their future after work. However, those running their own business, which may be the built-up capital that they were planning to use for their retirement, have other factors that need to be considered: the most important being what is going to happen to the business.

Advance planning

Succession planning in any business is vital. Planning what is going to happen to the business on retirement – be that a sale to new owners or a decision to pass the business down to the next generation – can be a long process and should be considered well in advance of retirement. There is no harm in having a five- or indeed ten-year plan in place.

Succession can be a difficult conversation to have, both from the perspective of the person that is looking to come into the business, as well as those that are looking to pass it on. The most important thing is sensitivity and understanding on both sides.

It must be recognised that the business must move on to survive and that those coming into the business are going to have new ideas and must learn from both their mistakes and successes as those running the business have before them.

Often, where there is not a clean sale, those coming into a business will need a level of guidance and it is important that they understand how any change of circumstances will affect them personally. In addition to the extra time they may need to commit, and a potentially new challenge of being in a management position, there is the change in risk in moving from being an employee to business owner.

They also need to understand the change to their remuneration and how they will be taxed. It is important to ensure that they know the key advisers to the business and that a phased transition takes place so that they can benefit from the knowledge and experience built up by the current owner.

Therefore the planning, management and implementation of the succession and how the business is going to be handed over is key. It is important for those retiring to decide if they wish to keep an interest in the business, if they wish to gift it, or are looking to receive money from a sale from the outset so this can be openly communicated.

Prime position

If a gift or sale is desired, consideration is needed to how it will be funded and the tax consequences.

For an outright sale, the owner will want to ensure the business is in the best possible position, both commercially and financially.

Concentrating on finances, it should be ensured that the business has good systems and controls in place over all aspects of its finance function.

The finances need to be in the healthiest possible position; not only ensuring that it is operating at a good margin, but also that the ‘housekeeping’ is taken care of. For example on working capital, are debtors paying the business in good time and does the business pay its creditors on time?

It is also important to consider the structure of the business. For example, are there areas that do not fit in to the main focus of the business that should be separated before being sold, or loss leaders that need to be brought into the main business?

A person buying a business they do not know will wish to perform a level of due diligence on it. In some cases, this will involve accountants coming in and performing a review of the accounting records, and in others it may just be some questions that are raised. Whatever the approach that is taken by the owner, it is worth the advance preparation to ensure that everything is in order and operating as smoothly as possible.

When considering the business owner’s tax position, a transfer of the business, either as a gift or a sale, will create a capital gain for the owner (with consideration on a gift being deemed to be market value). With a trading business they will be hoping to get entrepreneur’s relief on the sale or gift and be taxed at ten per cent on the gain rather than the higher 28 per cent.

There is a lifetime limit of £10m per individual for the claim of entrepreneur’s relief. If the lifetime limit is not sufficient to cover the gain, and the business is a company, then the individual may wish to consider transferring shares to their spouse (which will not create a capital gains tax liability).

In order to gain entrepreneur’s relief on the sale of shares, an individual must have at least a five per cent interest in the business and be an employee (or officer). They do not need to be full time and no specific working hours are stipulated.

Weighing up

With a gift of a business it is likely that the parties to the gift can elect to ‘hold over’ the tax on the gain, with the person acquiring the business effectively paying the tax on the transaction when they ultimately dispose of the asset. Here, one must weigh up the benefits of the ten per cent tax rate under entrepreneur’s relief now, against the ‘unknown’ tax regime in the future.

As well as capital gains tax on a gift there is also potential inheritance tax. Such a gift would be considered a potentially exempt transfer for inheritance tax purposes, meaning there is only inheritance tax on the gift should the donor making the gift not survive seven years.

If death were to occur within seven years, there still may not be a charge to inheritance tax, provided the business is still considered relevant for business property relief (BPR) for inheritance tax purposes. If the business is relevant, at the time of death then it is likely that 100 per cent relief will be given.

However, care must be taken as, if the business has been sold or, for example, an unquoted trading company becomes quoted, the BPR is lost and the gift will be subject to inheritance tax. Should the proceeds of the business sale have been used to purchase a replacement business, then the BPR is preserved.

The final inheritance tax consideration is the change of the asset in the hands of the individual disposing of it. If a business that would benefit from BPR is sold, then the value received (in cash or invested) in the individual’s estate is not likely to benefit from IHT relief on death. Therefore this is an opportune time to consider inheritance tax planning and possibly an update of wills.

Lucy Brennan is a partner in the private wealth group at accountancy firm Saffery Champness