Tax tips for Family Businesses
Find out how family businesses can reduce their tax burden with some practical forward thinking.
Owners and managers of family-owned businesses rightfully spend the vast majority of their time ensuring that the business runs well and generates profits. In the midst of such a demanding task, it can be easy to overlook some tax considerations that can potentially be significant.
The topic of tax in the context of family-owned businesses is a large one – however, there are a few key considerations to bear in mind:
- How is your business set up?
- How are you extracting funds?
- What’s New?
- How are you incentivising your staff?
- Are you thinking of an exit?
- Planning with pensions
- What about the next generation?
How is your business set up?
Most family-owned businesses are set up as companies, but some do run as partnerships. These two structures differ in terms of tax, and it is worthwhile for business owners to consider which structure could be most beneficial for their business.
Companies may pay lower rates of tax initially, but further tax (including National Insurance Contributions in the case of salary/bonuses) is often due when higher profits are extracted. Partnerships however are tax transparent, so profits are taxed as they arise, even if they are not extracted (but are taxed only once). It is generally easier to convert a partnership into a company than the other way around.
How are you extracting funds?
The business has a choice, broadly speaking, of paying dividends or paying salary/ bonuses. However, recent legislation has attempted to narrow the tax difference between companies and sole trader/partnerships.
The Finance Bill 2016, published on 24 March 2016, contains the new rules for dividends.
- From 6 April 2016, the notional 10% tax credit on dividends will be abolished
- A £5,000 tax free dividend allowance will be introduced
- Dividends above this level will be taxed at 7.5% (basic rate), 32.5% (higher rate), and 38.1% (additional rate)
- Dividends received by pensions and ISAs will be unaffected
- Dividend income will be treated as the top band of income
- Individuals who are basic rate payers who receive dividends of more than £5,001 will need to complete self assessment returns from 6 April 2016
- The change is expected to have little impact upon non-UK residents
The proposed changes raise revenue despite the so-called “triple lock” on income tax. Perhaps aimed to tax small companies who pay a small salary designed to preserve entitlement to the State Pension, followed by a much larger dividend payment in order to reduce National Insurance costs. It appears that the government is anti-small companies, preferring workers to be self-employed.
These changes will affect anyone in receipt of dividends: most taxpayers will be paying tax at an extra 7.5% p.a. Although the first £5,000 of any dividend is tax free, in 2016/17:
- Upper rate taxpayers will pay tax at 38.1% instead of an effective rate of 30.55% in 2015/16
- Higher rate taxpayers will pay tax at 32.5% instead of an effective rate of 25% in 2015/16
- Basic rate taxpayers will pay tax at 7.5% instead of 0% in 2015/16
This measure will have a very harsh effect on those who work with spouses in very small family companies. For example, a couple splitting income of £100,000 p.a. could be over £5,000 p.a. worse off.
Businesses should therefore consider these tax issues when using either of these methods to extract funds.
There can be benefits in various family members being involved in the business, particularly if they, for example, perform smaller roles and are not paying taxes at the higher rates. Care is always required here to ensure that any salaries are commensurate with the job performed.
There can also be complexities in giving away shares to spouses to enable them to capture dividends at the lower rates.
How are you incentivising your staff?
Clearly, the retention of key staff is of critical consideration for businesses of any size. With cash flows being restricted in these difficult times, consideration can usually be given to granting share options to employees. Certain tax-approved options schemes (such as Enterprise Management Incentives) are potentially very tax-efficient and a good incentive for key workers.
Are you thinking of an exit?
It is never too early to contemplate what would happen if the business were sold. The headline rate of capital gains tax is not good as it once was but there are potentially reliefs available which may minimise the tax burden on exit. With the right structuring, valuable relief can potentially be opened up to various family members through tax planning.
Tax Planning with pensions
Pensions are all the rage now, given the recent changes.
In certain instances, an appropriate pension plan for a family-owned business can lead to substantial tax efficiencies. Also the use of SIPPs and SASSs can be used a valuable tax planning tool to extract funds from otherwise taxable business profits.
What about the next generation?
Succession planning is a key strategic matter for any family-owned business. Where the business is a trading concern, it is often possible (depending on the particular circumstances) to give away shares without adverse tax consequences.
But care is required here to avoid certain pitfalls that can exist if even a few investment assets are located somewhere within the business.
It may also be the case that a trading business qualifies for inheritance tax relief (under the business property relief regime); therefore, founders may not be worried about inheritance tax now. If the business is sold however, this relief will be lost, potentially generating a significant inheritance tax bill in the future. Fortunately, planning options do exist here, such as transferring the business into a trust before an exit.
Needless to say, the above gives only a taste of some of the relevant tax considerations where family-owned businesses are concerned. The important point is to remember the significant impact that tax can make, and to take advice early and regularly.
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In most small family trading companies it is not unusual for the husband and wife to own all the shares. Where a family member works in the business they may wish to give them shares in the company as recognition for their input and hard work.
However, giving shares isn’t as easy as it sounds. There are various taxes that need to be considered on a gift of shares to a family member, including income tax, capital gains tax, inheritance tax and stamp duty.
If an employee of a company receives “free” shares, for example, or if you make a gift of shares to a family member who works in the business, an income tax charge could arise on the market value of the shares gifted. If, however, it can be demonstrated that the transfer of shares is for reasons of family or personal relations, the income tax charge may be avoided.
A gift of shares to a family member is also a deemed to be a disposal of shares for capital gains tax purposes. As the gift is being made to a connected party, it is a deemed disposal at market value. In the case of a gifts it is typical that the person making the disposal receives no monies out of which to pay any capital gains tax which may arise (the gift is treated as a sale at market value). This could discourage family members from making gifts as part of any family tax planning mitigation exercise.
Therefore, capital gains tax is potentially payable on any gain arising even though no consideration is paid. However, providing certain conditions are met, it may be possible to reduce the capital gain on the shares gifted to Nil by way of gift relief. This allows the capital gain (and thus any tax liability) which is deemed to arise on gift of the shares at market value to be postponed. It does this by effectively transferring the capital gain to the recipient of the gift. To claim this relief appropriate submissions must be made to HMRC at the right time.
Stamp duty is also normally payable on the issue or sale of shares and is payable by the person receiving or acquiring the shares. However, if the shares are gifted and no consideration is paid, a stamp duty gift exemption relief can be claimed which is likely to reduce the stamp duty costs to nil.
For inheritance tax (IHT) purposes, a gift of shares to a family member would constitute what is known as a lifetime transfer. Based on current legislation, if you survive 7 years from the date of the gift, there should be no inheritance tax consequences on the transfer of shares to the family member. In the event of your death within 7 years of the gift, IHT relief may be available on the transfer providing certain conditions are met. This could also reduce any potential exposure to inheritance tax to Nil.
Before any transfer of shares takes place, we would recommend that you seek professional advice to ensure that the available reliefs are applicable to your particular circumstances and also to ensure that the various conditions for each tax relief are fulfilled.
The advice above is general guide only and does not constitute any advice whatsoever. You must seek professional advice before taking any action.
For more information please contact us on 0114 275 6292 or email@example.com.
Deductibility of receiver’s and legal fees
In a recent case the First-tier Tribunal (FTT) has held that the fees of a receiver appointed to sell properties forming part of a letting business and legal fees in challenging the receivership and claiming against the bank for their actions in relation to the loan were not allowable expenditure under TCGA 1992, s. 38.
The FTT found that both a receiver’s fee and legal fees effectively paid by the taxpayers on the forced disposal of properties were not deductible for capital gains tax (CGT) purposes.
The taxpayers owned ten properties, nine of which were let out. It was decided to consolidate the various related loans in place into a single loan with one bank.
Two of the properties were sold, with the bank’s permission. The taxpayers intended to use the proceeds to reduce the loan. However, the bank did not do this. It claimed that the taxpayers were in breach of the terms of the loan as the reduced rental income dropped to less than a predetermined percentage of the interest.
A receiver was appointed who subsequently arranged sale of the remaining eight properties. The taxpayers incurred various legal fees to prevent the forced sale and subsequently to claim against the bank. The bank also deducted the receiver’s fees from the sale proceeds.
The FTT found that the receiver’s fee on the forced sale of the properties was not wholly and exclusively in relation to the sale as the receiver carried out other tasks. This was therefore not deductible. This follows the decision in the recent case of O’Donnell v HMRC  UKFTT 347 (TC).
The taxpayers argued that the legal fees fell within TCGA 1992 s.38(1)(b) and were incurred wholly and exclusively in establishing, preserving or defending title to, or a right over, the asset. The FTT disagreed; the work to prevent the forced sale and the litigation with the bank were concerned with their rights and liabilities under the loan agreement with the bank. The expenses were not allowable. The FTT suggested that the fees were all in fact of an income nature.
If you need advice with capital gains tax on properties please contact us on firstname.lastname@example.org or call 0114 275 62 92 and ask for a tax consultation.
From 6 April 2017 a UK residential property will now be subject to UK Inheritance Tax regardless of ownership structure and residence or domicile status of the ultimate owner.
Who will be affected?
The new rules will affect all non-UK domiciliaries and the trustees of trusts they have established who hold an interest in an offshore structure which derives its value from:
- a UK residential property;
- loans (is provision applies to all loans not just those between connected parties) used to acquire, maintain or improve UK residential property; or
- collateral for such loans or who have thereunder made or provided collateral for such loans.
Which assets are relevant?
The new legislation imposes an inheritance tax charge on three categories of property:
Interests (e.g. loans or shares) in closely held companies which derive, directly or indirectly, their value from UK residential property. The interest in the parent company will still be caught even if there is a chain of companies underneath before you get to the residential property. However, if any of the companies is widely held (for example a real estate fund), this will not be caught.
An interest in a partnership, the value of which is directly or indirectly attributable to UK residential property. Unlike companies, it does not make any difference how many partners there are and whether or not they are connected. A real estate fund which is structured as a partnership will therefore fall within the new rules.
The benefit of loans made to enable an individual, trustees or a partnership to acquire, maintain or improve a UK residential property or to invest in a close company or a partnership which uses the money to acquire, maintain or improve UK residential property.
To avoid back-to-back lending arrangements, assets used as collateral for such a loan will also be subject to inheritance tax under the new rules.
An interest in a close company, or a partnership which holds the benefit of the debt or the assets which are used as collateral, are also caught.
UK residential property
The rules will apply where the shares’ (or other interest’s) value is attributable to any UK residential property, whether that property is occupied or let and whatever the property’s value (subject to limited exceptions such as care homes). A property which is being constructed or adapted for residential use will be treated as UK residential property.
The rules will not apply to the extent that the asset’s value is derived from commercial property. It is to be welcomed that previous proposals to include a property which had had a residential use at any time in the last two years have been dropped. Rather, it will simply be the use of the property at the time that the IHT charge arises that will be relevant.
Legislation is still awaited for properties used for both residential and non-residential purposes. Based on the 2016 consultation paper this will be on an apportionment basis.
Value subject to IHT and debts
Where an IHT charge arises on shares etc. under the new rules, the IHT liability will be calculated on the open market value of the shares (or other interest) to the extent that their value is attributable to UK residential property. In determining the value of an interest in a close company, the liabilities of the close company will be attributed to all of its property pro rata. The liabilities attributable to the residential property will be deductible in determining the value within the scope of IHT.
Under the original proposals, debts that related exclusively to the property were to be deductible when calculating the value for IHT purposes, unless the borrowing was from a connected party. In response to concerns that this could result in a double IHT charge, the Government’s solution contained in the legislation and other documentation published on 5 December 2016 is to treat any debt used to finance the acquisition, maintenance or repair of UK residential property as an asset subject to IHT in the hands of the lender, with look through provisions where the lender is itself a non-UK close company or partnership. Similarly, any security or collateral for such a debt will be within the scope of IHT in the estate of the provider of the security.
Whilst this removes the potential for double counting, it would appear to defeat certain IHT mitigation options which the Government previously appeared to accept when the provisions relating to debts were revised in 2013. The application of these rules to debts, whenever created, seems unduly harsh and a restriction to debts created after 19 August 2016 (when an iteration of the provision was first announced), if not to commencement date, would be welcomed.
Two year tail
Newly included in the 5 December 2016 draft legislation are provisions such that following sale of close company shares or partnership interests which would have been within the scope of the new IHT rules, or indeed repayment of a lender’s loan, the consideration received (or anything which represents it) will continue to be subject to IHT for a two year period following the sale or repayment. This appears to be a provision introduced to combat specific anticipated avoidance. However it will, as drafted, have a wider effect and give rise to an IHT charge in normal commercial situations even where UK residential property is no longer held.
Targeted anti-avoidance rule
Any arrangements whose whole or main purpose is to avoid or reduce the IHT charge on UK residential property will be disregarded. This anti-avoidance provision is extremely widely drawn.
If you are affected by any of the above and for advice and guidance on what actions you should take next please contact us on email@example.com or 0114 275 6292.
The above is not intended to be advice, we strongly recommend professional advice is sought before taking any action.