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…
New NIC tax rates – how are you affected?
NEWS UPDATE
On 7 September 2021 Boris Johnson announced that NI and dividend tax rates will be hiked to help fund social care, pay for COVID-19 support and help the NHS backlog.
In todays Shipleys Tax brief we look at who will be affected and by how much?
Firstly, NI rates will increase by 1.25% from April 2022. This will apply to both primary and secondary Class 1 contributions, which will increase to 13.25% and 3.25% for earnings up to, and above, the upper earnings limit respectively. Class 4 rates will also increase to 10.25% and 3.25%. The additional 1.25% will be carved out as a separate levy from April 2023 – essentially it will be a new tax.
To illustrate what this will mean for employees, the following table is a useful reference, assuming the current NI thresholds apply:
| Salary | Current NI bill | Expected increased NI bill | Change |
| £15,000.00 | £651.84 | £719.74 | £67.90 |
| £25,000.00 | £1,851.84 | £2,044.74 | £192.90 |
| £35,000.00 | £3,051.84 | £3,369.74 | £317.90 |
| £45,000.00 | £4,251.84 | £4,694.74 | £442.90 |
| £55,000.00 | £4,951.84 | £5,519.74 | £567.90 |
Secondly, the dividend tax rates will also increase by 1.25%, i.e. to 8.75%, 33.75% and 39.35% for basic, higher and additional rate taxpayers respectively. This will mean slightly higher taxation for company shareholders extracting income via dividends. However it remains to be seen how tax efficient this route still is compared to other remuneration strategies given the NIC hike above.
If you would like to know how you are personally affected by the above measures and you’re options going forward, please contact us on 0114 272 4984 or email info@shipleystax.com.
Please note that Shipleys Tax do not give free advice by telephone or email.
Back to School Fees Tax Planning: Good advice or good fortune?
UPDATED 27/8/21
IT IS ANECDOTALLY REPORTED that due to the pandemic, birth rates are expected to rise. With estimates for children’s education to cost over hundreds of thousands, can setting up a trust for the benefit of children not only help save tax but also assist with child education costs?
In this article Shipleys Tax Advisers takes a look at some of the traps and pitfalls of the recent trend towards planning for school fees and why professional advice is key to achieving the correct outcome if you want to avoid an expensive HMRC challenge.
YOU SHOULD NOT ACT (OR OMIT TO ACT) ON THE BASIS OF THIS ARTICLE WITHOUT SPECIFIC PRIOR ADVICE. SHIPLEYS TAX PLANNING PROVIDES A BESPOKE TAX CONSULTANCY SERVICE AND CAN ADVISE YOU OF THE RIGHT COURSE OF ACTION.
Bank of (grand)Mum and Dad
Generally, the most common method we come across is the so called “grandparent solution”. This typically involves transferring shares/assets to the grandchildren (usually minors) held via a type of trust arrangement. The idea being that the beneficiaries (e.g. grandchildren) in these circumstances being minors are unlikely to have other income, the trust arrangement allows them to use their annual tax-free allowances such as the personal allowance, savings rate allowance and dividend allowance.
The idea being that beneficiaries (e.g. grandchildren) in these circumstances are likely to be minors and are unlikely to have other income, the trust arrangement allows them to use their annual tax-free allowances…
This is a seemingly a reasonable solution for grandparents who wish to transfer shares/assets to the grandchildren where the donor is not a basic rate taxpayer or where the donor wishes to reduce the value of their estate for inheritance tax (IHT) purposes.
Sorted, you would have thought.
Well not quite, there are significant pitfalls which need considering.
Is the income taxed on the minor?
The major problematic issue is that the income may not be treated as taxable on the minor. This type of scenario is not straight forward and requires careful scrutiny of the settlements legislation and to ensure that there are no direct or indirect reciprocal arrangements in place.
Where parents are setting up trusts for their minor children anti-avoidance legislation can tax any income arising on the parents, so this method may not be tax efficient or indeed even work. In other words, there is a significant health warning with this planning which many are unaware of.
Gift of shares
In other situations, where the adult gift interests in their business to their parents and these are subsequently given to the minor/s in quick succession, the transaction will be at a serious risk of a successful HMRC challenge which will result in the income being taxed on the parents.
Where parents are setting up trusts for their minor children anti-avoidance legislation can tax any income arising on the parents, so this method may not be tax efficient or indeed even work.
If, however, the transaction occurs whereby the asset is held by the grandparents with no onward obligation/intention that the asset will be transferred to the minors, and the shares are held for a reasonable period of time (i.e. where the probity of ownership cannot be in issue) and where all conditions are met, or perhaps due to a change of circumstances, the grandparents of their own volition decide to genuinely gift the asset to the minors, this should not be subject to a successful challenge by HMRC. So, in reality it’s all a question of genuine intention and timing. Getting this right along with the surrounding facts and circumstances, then the prospect of having a successful fees planning increases. However, allowing assets to pass to the grandchildren via the grandparents as part of pre-arranged set-up will undoubtedly fail and will be subject to a successful HMRC challenge.
Sale of shares
In circumstances, where the grandparents acquire an interest in the parents’ business for full market value for/on behalf of the grandchildren, the anti-avoidance provisions do not apply. However, one will need to be mindful that the full open market is actually paid and there are no reciprocal arrangements in place. The cost of this may be prohibitive due to the costs of asset, valuation and other professional fees.
However, allowing assets to pass to the grandchildren via the grandparents as part of pre-arranged set-up will undoubtedly fail and will be subject to a successful HMRC challenge.
COVID-19 Gifting income producing assets – a timely opportunity?
The grandparents could gift/acquire an income producing asset for the benefit of the minors and hold these on trust. This would typically be a bare trust – as opposed to a substantive trust mainly due to compliance and costs. However, this comes with a significant risk as minors (as beneficiaries) will have absolute entitlement and control of the business at the tender age of 18. The parent/grandparent may not wish for the minor to control these assets at such a young age.
It is said that a discretionary trust or an interest in possession trust may therefore be a more appropriate solution here due to its flexibility and control, and, unlike a bare trust, beneficiaries are not entitled to the assets of the trust upon attaining 18 years.
However, the tax anti-avoidance provisions apply here also. If the parents set up the trust with the intention to fund school fees, then a discretionary trust may not be a tax efficient option.
As such, if income producing assets, for example stocks, shares or investment property, is rightfully gifted/acquired by the grandparents for the benefit of minors, the income would be taxable on the minors and could go towards paying for their private school fees.
…if income producing assets… can be gifted/acquired by the grandparents for the benefit of minors, the income would be taxable on the minors and could go towards paying for their private school fees.
With COVID-19, the valuations of income producing assets may be at a value which allows gifting without significant capital gains tax consequences, perhaps a timely opportunity?
HMRC Radar
We have been told that a small minority of school fee planners have aggressive schemes in implementing school fees planning. Currently this appears to fall under HMRC radar as it is not straight forward for HMRC to connect the dots with this planning. However, this does not mean this will continue forever – with the burgeoning big data revolution HMRC as poised to invest in IT systems to enable them to fill the gaps much quicker than they are now.
As such, school fees planning should be based on sound principle and careful thought; a matter of good advice not a matter of good fortune.
YOU SHOULD NOT ACT (OR OMIT TO ACT) ON THE BASIS OF THIS ARTICLE WITHOUT SPECIFIC PRIOR ADVICE. SHIPLEYS TAX PLANNING PROVIDES A TAX CONSULTANCY SERVICE AND CAN ADVISE YOU OF THE RIGHT COURSE OF ACTION.
If you are interested in School Fees Tax planning advice, please call us on 0114 272 4984 or email us at info@shipleystax.com.
Gifting property to the children – avoiding the tax pitfalls
AS THE PANDEMIC becomes more of a way of life rather than something that can be avoided, many are looking to straighten their tax affairs with regards to passing wealth to the next generation and mitigate Inheritance Tax (“IHT”). Current social media trends are questioning whether it is even right to leave a legacy to heirs.
Away from these discussions, in today’s Shipleys Tax brief we look at whether it is possible to reduce or avoid inheritance tax by gifting property to your children, but it can be quite complicated, and it is easy to get it wrong. Professional advice should be taken in advance, but as a quick explainer see today’s blog below
What is IHT?
A brief explainer here. If you plan to pass on assets or money after you die, your heirs could face a tax bill of up to 40% of your estate. Your estate is defined as your property, savings and other assets after any debts and funeral expenses have been deducted. You can reduce or avoid IHT in a number of ways (IHT is often called the “voluntary tax”) There’s a tax-free allowance, and you can also give away a certain amount of your money during your lifetime, tax-free and without it counting towards your estate.
If you plan to pass on assets or money after you die, your heirs could face a tax bill of up to 40% of your estate.
So whats the plan?
No one likes the idea of the taxman taking a chunk of their estate when they die, particularly if it will be necessary to sell a much-loved property to pay the inheritance (IHT) bill.
The introduction of the residence nil rate band (“RNRB” – currently set at £175,000) means that a couple can now leave combined estates worth £1 million free of inheritance tax where this includes a residence valued at £350,000 or more, which is left to direct descendants. However, the RNRB is reduced where a person’s estate is worth more than £2 million and lost where the value of the estate exceeds £2.35 million.
If it looks likely that there may be IHT to pay, the idea of taking steps to reduce this is attractive. Where property is given away more than seven years before the donor’s death, it escapes IHT. Giving property to the children may, at first sight, be an attractive option, but are there are traps to be aware of?
The introduction of the residence nil rate band means that a couple can now leave combined estates worth £1 million free of inheritance tax..
Giving away the main residence
If the main residence is given away, there will be no capital gains tax to pay as long as the main residence exemption applies in full. However, if the property is retained by the children as an investment property, the capital gains tax clock will start to run from the date that they acquire it. By contrast, if the property is gifted at death, there will be a capital gains tax uplift to the value at death, but there may be some inheritance tax to pay (potentially at 40%).
Tax problems arise if the parents give the property to the children but continue to live in it. There are two sets of rules that can affect this adversely – the gifts with reservation rules (GWR) and the pre-owned asset (POA) rules.
The GWR rules apply where a donor gives an asset away but continues to derive benefit from it. An example would be parents who transferred their home to their children but continued to live in it. In this case the rules effectively ignore the transfer for inheritance tax purposes, such that it forms part of the death estate.
The POA rules impose an income tax charge on the previous owner if they give a property away but continue to live in it, based on a notional market rent of the property.
If the main residence is given away, there will be no capital gains tax to pay as long as the main residence exemption applies. However, if the property is retained by the children as an investment property, the capital gains tax clock will start to run from the date that they acquire it.
Investment property
Seeking to take an investment property outside of the death estate can trigger a capital gains tax charge where a property is given to a child, even if no money changes hands. The child is a connected person and the property is deemed to be disposed at market value. This may trigger a capital gains tax bill of 18% or 28% of the gain (to the extent it exceeds the annual exemption), which must be paid within 30 days (but with no proceeds from which to pay the tax).
The best advice?
Giving away property in an attempt to save inheritance tax can be very complicated and it is easy to get it wrong; professional advice should be taken in advance to avoid the many pitfalls that lay in tax legislation.
Shipleys Tax have a wealth of experience providing practical and affordable IHT mitigation strategies.
If you are affected by any of the issues above and would like more information, please call 0114 272 4984 or email info@shipleystax.com to arrange a free no obligation consultation.
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