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.
Latest news & blogs…
The Finance Bill 2016 finally received Royal Assent on 15 September, enacting proposals announced in the 2016 Budget, Autumn Statement 2015 and Summer Budget 2015. Amongst other things, Finance Act 2016 includes provisions relating to income tax rates and allowances; restrictions on tax reliefs for travel and subsistence expenses (in effect since April 2016), the reduction of the lifetime allowance on pension contributions from £1.25m to £1m (again, effective from 6 April 2016); and the reduction in the main rate of corporation tax to 17% for financial year 2020.
The Act is based on George Osbourne’s final Budget. The annual Finance Bill usually receives Royal Assent in early to mid-July. This year’s extensive delay has been largely blamed on the Brexit referendum followed by the summer parliamentary recess.
The Finance Act 2016 can be found online here or alternatively you contact us for more information.
HMRC has published further details of its proposals to amend the inheritance tax rules for non-domiciled individuals.
The changes were initially announced at the 2015 Summer Budget which were aimed at preventing non-doms from escaping a UK inheritance tax (IHT) charge on UK residential property through use of an offshore structure, and thereby bringing to an end the permanent non-dom status for tax purposes.
The consultation document suggests that individuals who are non-domiciled in the UK currently enjoy a significant advantage over other individuals for IHT purposes. UK-domiciled individuals are liable to IHT on their worldwide property, whereas non-doms are only liable on property that is situated in the UK.
Any residential property in the UK owned by a non-dom directly is within the charge of the IHT. However, a common loophole is for such individuals to hold UK residential properties through an overseas company or similar vehicle. In such a case, the property of the individual consists of overseas shares which will be situated outside the UK and are thus excluded from IHT.
In an effort to curb such structures HMRC plans to bring residential properties in the UK within the charge to IHT where they are held within an overseas structure. This charge will apply both to individuals who are domiciled outside the UK and to trusts with settlors or beneficiaries who are non-domiciled. The changes will come into effect from 6 April 2017.
Shares in offshore close companies and similar entities will no longer be deemed excluded property if, and to the extent that, the value of any interest in the entity is derived, directly or indirectly, from residential property in the UK. Where a non-dom is a member of an overseas partnership that holds a residential property in the UK, such properties will no longer be treated as excluded property for IHT purposes.
The consultation will close on October 20. The effect of these proposals will mean structures set up to mitigate IHT will now need to be reviewed in light of the above and specialist tax advice sought.
Upcoming changes to tax relief for landlords may result in them paying higher rates of tax as HMRC publishes guidance on how the interest relief restrictions would work.
We saw the changes announced in the summer budget of 2015 and HMRC have now published further guidance. The rules looks to restrict the interest relief a residential landlord can claim to calculate their income tax liability. The restriction is being phased in over four years with interest being restricted by 25% in each year until it takes full effect in April 2020.
How could landlords be affected?
Currently, landlords of residential properties can deduct all interest from rental income to calculate taxable rental profit. When the new measures take full effect, the interest will be completely disallowed and instead a tax credit equal to 20% of the interest will be given against the person’s income tax liability.
This could result in the individual having higher taxable income which could push them into a “higher” or “additional rate” of income tax. Furthermore, if individuals’ income exceeds £100,000 it could start to reduce their personal allowance, affect their entitlement to child benefit and restrict the amount on which they can claim tax relief for pensions.
What can you do?
These measures are controversial to say the least and a judicial review by a coalition of private landlords is currently in progress.
In meantime, Shipleys Tax strongly recommends seeking professional advice to help mitigate the effects of the changes above and take action to manage your property portfolio tax efficiently a there currently a few solutions available.