Tax tips for Family Businesses
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:
Sections
- 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.
Dividends
The Finance Bill 2016, published on 24 March 2016, contains the new rules for dividends.
Summary:
- 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
Impact
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…
BUDGET 2024 – At a glance
THE UK CHANCELLOR, Rachel Reeves, today delivered Labour’s first Budget since 2010 after coming to power over the summer. A mixed bag with no real innovation to restart the UK economy. With much of the announcements being leaked beforehand, there were no surprises other than the significant change to NIC for employers.
Here at Shipleys Tax we provide a summary of the UK Autumn Budget 2024 with some brief insights on personal and business tax measures:
At a glance summary
1. National Insurance for Employers
The employer National Insurance rate will increase from 13.8% to 15% in April 2025, paired with a decrease in the NI threshold from £9,100 to £5,000. This change significantly raises costs for businesses, especially those with larger workforces or lower-wage employees, as NI contributions start sooner in the earnings scale. To offset some impact, the employment allowance is raised to £10,500, allowing about 865,000 small businesses to reduce or eliminate their NI contributions.
2. Personal Tax Adjustments
- Income Tax Threshold Freeze:
The government extended the freeze on income tax thresholds until 2028, drawing more earners into higher tax bands due to “fiscal drag.” This measure indirectly increases tax revenue without changing rates.
- Inheritance Tax:
Several IHT changes have been introduced:
- New AIM Share IHT Rate: AIM-listed shares, previously fully exempt, now only receive 50% relief, leading to a 20% effective IHT rate.
- Adjusted Relief on Business and Agricultural Assets: For estates above £1 million in business/agricultural assets, a 50% IHT relief will apply, aimed at ensuring smaller family-owned estates remain protected.
- Threshold Freeze Extended: The IHT threshold freeze, initially set to end in 2028, now extends to 2030, likely drawing more estates into the tax bracket as asset values rise.
- Pension Pots Subject to IHT: From 2027, inherited pension pots will be taxed, impacting estate planning where pensions were intended for tax-free inheritance.
3. Corporation Tax Steady
Corporation tax remains at 25%, offering stability for SMEs. While no further rate increases were announced, potential policy shifts around capital allowances could incentivize reinvestment in business growth.
4. Capital Gains Tax Increase
Capital Gains Tax is set to increase from 10% to 18% for lower rate taxpayers and from 20% to 24% for higher rate taxpayers, with no changes to the Annual Exempt Amount (AEA) of £3,000. The government’s decision to avoid a drastic hike aligns with investor concerns, especially for business asset disposals, which retain a £1 million lifetime relief. The Capital Gains Tax increase announced in the Budget reduces the gap between Capital Gains Tax and Income Tax rates, although it perhaps remains significant enough to encourage entrepreneurs to invest in their businesses.
Business Asset Disposal Relief changes – The rate of Capital Gains Tax available under Business Asset Disposal Relief remains at 10% this financial year, rising to 14% in April 2025 and 18% in 2026. The lifetime limit of £1m remains unchanged.
Currently, Business Asset Disposal Relief reduces CGT to 10% on all qualifying gains, a major tax incentive that benefits company directors providing the conditions are met. While BADR continues to provide access to reduced rates of Capital Gains Tax, the CGT rate is set to increase from 6 April 2025.
5. VAT and Digital Compliance
SMEs in the e-commerce sector face tighter VAT compliance as the government rolls out new VAT collection mechanisms, aimed at narrowing the tax gap on digital sales. This step aligns with the broader effort to improve tax efficiency in digital transactions.
6. R&D Tax Credits Expansion
R&D tax credits are extended, particularly benefiting SMEs in tech and green sectors. Eligible SMEs can claim up to 20% of R&D expenses, supporting innovation-focused businesses.
7. Apprenticeship and Training Grants
New grants now cover 50% of training costs for SMEs investing in apprenticeships, addressing skill shortages across key sectors
More to follow.
For further assistance or queries, please contact us.
Leeds: 0113 320 9284 Sheffield: 0114 272 4984
Email: info@shipleystax.com
Please note that Shipleys Tax do not give free advice by email or telephone. The content of this article is for general guidance only and should not be considered as tax or professional advice. Always consult with a qualified professional before taking action.
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Tax Reliefs: Are you missing out?
THE UK HAS some of the most complex and voluminous tax legislation in the world, making it all too easy for taxpayers to miss out on valuable reliefs simply because they assume they will be applied automatically. Imagine losing thousands—if not millions—of pounds in tax relief, not because you didn’t qualify, but because you didn’t know how to claim it correctly. Taxpayers often assume that tax reliefs, especially valuable ones, will automatically apply to their financial situation.
In today’s Shipleys Tax brief we look at how misunderstanding tax laws can lead to missed opportunities and financial setbacks and how failing to actively manage and claim tax reliefs can result in costly mistakes using some basic case studies.
(NB: All rates and allowances are as at date of the article.)
The Importance of Actively Claiming Tax Relief
Tax reliefs (such as Business Property Relief (BPR), Capital Gains Tax (CGT) relief, Income Tax reliefs, and Inheritance Tax (IHT) reliefs) can significantly reduce a taxpayer’s liability. However, they are not automatically applied, and taxpayers must ensure they meet specific criteria, actively make claims, and regularly review their tax position to avoid unexpected pitfalls.
Case Study 1: Tribunal Denies Business Property Relief (BPR) Claim
Business Property Relief basics
In the right circumstances Business Property Relief (BPR) allows for the reduction or complete elimination of Inheritance Tax (IHT) on the value of business assets when they are passed on as part of an estate. This relief typically applies to businesses that are trading and do not have the hallmarks of investment trade, the aim being to help protect businesses from being dismantled to pay inheritance taxes.
…taxpayers must ensure they meet specific criteria, actively make claims, and regularly review their tax position to avoid unexpected pitfalls.
Background
A family-owned restaurant that has been actively trading for over a number of years would generally qualify for full BPR, meaning that if the owner passes away, the restaurant’s value would not be subject to IHT when transferred to the owner’s heirs. This ensures that the business can continue without needing to be sold to cover tax liabilities.
The Pitfall: Mrs T’s Fishery Business
In a recent case, Mrs T who had operated a fishery business for 17 years, saw her Business Property Relief (BPR) claim denied by the First-tier Tribunal. The fishery, initially run by her late husband, was once a profitable business involving the stocking of fish. However, after regulatory changes, the business shifted to maintaining a wild fishery with minimal services offered to customers. The tribunal concluded that the business had transitioned into one primarily holding land for investment purposes rather than operating a trading business, disqualifying it from BPR.
Key Takeaway: Regularly review your business model. A shift in business activities or external factors can result in your business being viewed differently for tax relief purposes. In Mrs Pearce’s case, the absence of services like tuition or equipment hire meant the business was classified as an investment, not an active trade.
Case Study 2: Denial of Entrepreneurs’ Relief (ER) on Property Sale (CGT)
Entrepreneurs’ Relief basics
Entrepreneurs’ Relief (now known as Business Asset Disposal Relief) allows individuals to pay a reduced rate of Capital Gains Tax (CGT) of 10% when selling a qualifying business or shares in a trading company, up to a lifetime limit of £1 million. This relief is designed to incentivise business owners and entrepreneurs by lowering the tax burden on the sale of their business.
Background
If a small business owner sells their trading company for £500,000, under Entrepreneurs’ Relief, they would only pay a 10% CGT rate on the sale, rather than the standard rates of 20%. This could result in a significant tax saving of £50,000.
The Pitfall: Denial of Entrepreneurs’ Relief on Property Sale
In another case, a property developer sought to claim Entrepreneurs’ Relief on the sale of a commercial building. The developer believed that the building, held within his trading company, qualified for the relief under Capital Gains Tax (CGT) rules. However, upon review, it was determined that the building had been rented out for several years, and the income from this rental activity was considered non-trading. As a result, the company was no longer classified as a trading company for CGT purposes, and Entrepreneurs’ Relief was denied.
Key Takeaway: Ensure that qualifying conditions are maintained with regular monitoring, usually a good accountant will see to this on an annual review. Entrepreneurs’ Relief is only available if a company is trading. In this case, the shift to generating rental income changed the company’s classification, leading to loss of relief and a significant tax liability.
Ensure that qualifying conditions are maintained with regular monitoring, usually a goods accountant will see to this on an annual review.
Case Study 3: IHT Agricultural Property Relief (APR) Disallowed
Agricultural Property Relief basics
Agricultural Property Relief (APR) allows for up to 100% relief from Inheritance Tax (IHT) on agricultural property, such as farmland, farm buildings, and growing crops, when it is passed on as part of an estate. The goal is to preserve the value of agricultural businesses by reducing or eliminating the IHT burden, ensuring that the business can continue without disruption.
Background
A farmer who owns £1 million worth of farmland can pass that land on to their children with no Inheritance Tax liability, as long as the land qualifies for APR. This can save the heirs up to £400,000 in IHT.
The Pitfall: Agricultural Property Relief Disallowed
A recent IHT case involved a claim for Agricultural Property Relief (APR) on farmland that had been used for grazing cattle. The owner believed the land qualified for relief as agricultural property. However, the tribunal ruled that since the land had not been actively farmed for several years and was primarily used for renting out grazing rights, it did not meet the strict criteria for APR. Consequently, the estate was subject to inheritance tax on the full value of the land.
Key Takeaway: Again as above active farming and monitoring through compliance reviews is critical for APR qualification. Landowners must demonstrate ongoing agricultural use to qualify for this relief. A shift to passive income from land rental, even if it involves agricultural activities, can disqualify an estate from APR.
Conclusion: The Importance of Regular Tax Review
Taxpayers should not assume that valuable tax reliefs will automatically apply or continue to apply without a thorough review of their financial and business activities. Whether it’s Business Property Relief, Capital Gains Tax relief, or Inheritance Tax relief, the rules are intricate, and failing to meet the conditions can lead to substantial tax liabilities. To maximise tax savings, it’s crucial to stay informed, maintain the correct business structure, and consult with tax professionals to ensure ongoing eligibility.
By staying proactive, taxpayers can avoid the costly mistake of missing out on significant tax reliefs.
For further assistance or queries, please contact us.
Leeds: 0113 320 9284 Sheffield: 0114 272 4984
Email: info@shipleystax.com
Please note that Shipleys Tax do not give free advice by email or telephone. The content of this article is for general guidance only and should not be considered as tax or professional advice. Always consult with a qualified professional before taking action.
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