Passing on the Family Business: Tips for a Smooth Transition

Family businesses are often the lifeblood of the UK economy, representing a deep legacy of entrepreneurial spirit. 

These businesses aren’t just about profit margins—they carry significant emotional and historical weight. As such, one of the most challenging moments in the lifecycle of a family business is deciding how to pass it on to the next generation. 

The question is, how can you achieve this without incurring burdensome tax liabilities, and what steps should you take for a smooth transition?

At ASWATAX, we help clients navigate the complexities of tax law and succession planning to protect the family legacy.

Table of Contents

• Key Takeaways

• Why Succession Planning is Essential

• The Tax Implications of Passing on a Family Business

  • Business Property Relief (BPR)

  • Gift Hold-Over Relief

• Passing on the Family Business During Your Lifetime

• Using Trusts for Succession Planning

• The Role of Employee Ownership Trusts (EOTs)

• Preparing the Next Generation

• Conclusion

Key Takeaways

• Early succession planning is crucial to avoid tax liabilities, family conflicts, and disruptions to business continuity.

• Inheritance tax (IHT) and Capital Gains Tax (CGT) can be mitigated using Business Property Relief (BPR) and Gift Hold-Over Relief.

• Passing on the business during your lifetime can reduce estate value and potential IHT.

• Trusts are useful for protecting business assets and reducing tax liabilities.

• EOTs provide a tax-efficient way to transfer ownership to employees, benefiting both the business and its workforce.
  

Why Succession Planning is Essential

Succession planning is often a sensitive subject. Families can be hesitant to discuss the eventual handover of the business, especially when it’s still running successfully. 

Yet, it’s vital to plan early, because the lack of an adequate succession plan can lead to conflicts among family members, operational disruption, and a potentially hefty tax burden.

The primary goals in succession planning should be:

• Ensuring business continuity;

• Minimising the tax liabilities involved in the transfer;

• Protecting the family’s wealth for future generations;

• Avoiding potential legal disputes.
  

Without proper planning, the dream of leaving a lasting family legacy could become a financial nightmare. Business owners should consider not only the smooth transition of leadership but also how to transfer ownership without falling into costly tax traps. 

The worst case scenario is realising you could have explored a different option and saved hundreds of thousands in tax.

The Tax Implications of Passing on a Family Business

When transferring a family business, the biggest concern for most owners is inheritance tax (IHT). In the UK, HMRC charges IHT at 40% on estates that exceed the £325,000 threshold.

For business owners, this can represent a significant threat to the ongoing viability of the enterprise if not planned for in advance. 

Fortunately, there are reliefs available that can help mitigate this.

Business Property Relief (BPR)

BPR is one of the most important reliefs available for family business owners. It can potentially reduce the value of a business that is passed on, either during the owner’s lifetime or as part of their estate, by up to 100%, provided that certain conditions are met.

For most family businesses, the following assets typically qualify for BPR:

• Shares in a company

• Sole trader businesses

• Interest in a partnership

However, there are strict conditions that need to be met for BPR to apply. 

Tax Implications

For instance, the business must have been owned for at least two years before the transfer, and it must be a trading business. Investment or property companies, for example, may not qualify, which is a common pitfall for family-owned property portfolios.

We assist clients by obtaining non-statutory clearance from HMRC to confirm the availability of the relief.

Gift Hold-Over Relief

Another useful relief is Gift Hold-Over Relief, which allows business owners to transfer their business or shares without an immediate capital gains tax (CGT) liability. 

Essentially, the recipient of the gift “inherits” the original cost of the asset, meaning that the CGT is deferred until the next generation eventually sells the business. 

This relief can be particularly valuable when combined with BPR, as it ensures that the business can be passed down without a substantial tax bill that would otherwise hinder the transfer, namely avoiding IHT and CGT completely.

Passing on the Family Business During Your Lifetime

There are several ways to pass on a family business, and one option is to do so while you are still alive. This can be done via gifts or by gradually transferring shares in the company. 

This method has several advantages, such as the ability to guide the next generation through the complexities of running the business. It can also help you take advantage of certain tax reliefs, like Gift Hold-Over Relief, which we mentioned earlier.

Another benefit is that lifetime transfers can reduce the value of your estate, thereby limiting IHT liabilities. If the business qualifies for BPR, this could eliminate the tax entirely on the portion of the estate related to the business.

However, timing is key. If the transfer is made too late, there’s a risk that the business may no longer qualify for certain reliefs. Additionally, the business owner must survive for seven years after making the gift for the transfer to fall outside the estate for IHT purposes.

Using Trusts for Succession Planning

Trusts are an increasingly popular tool for transferring family businesses, allowing you to maintain control over the assets while passing on the economic benefits to the next generation.

There are several types of trusts that may be used in this context, including:

• Discretionary Trusts, which allow flexibility in the distribution of income and assets;

• Interest in Possession Trusts, which give a specific beneficiary the right to income from the trust.

Trusts can help mitigate IHT liabilities and ensure that the business is protected in case of divorce or other unforeseen family issues. However, there are complex rules around trusts, and it’s important to seek professional advice to avoid unintended tax consequences.

The Role of Employee Ownership Trusts (EOTs)

In recent years, more family businesses have started to explore Employee Ownership Trusts (EOTs) as a succession planning tool. EOTs allow the ownership of the business to be transferred to the employees, incentivising them and ensuring that the company remains in good hands.

EOTs offer several tax advantages. The sale of shares to an EOT is exempt from CGT (providing for tax savings in the hundreds of thousands usually), and the employees may receive tax-free bonuses of up to £3,600 per year. 

This route not only helps secure the future of the business but also rewards the workforce who have contributed to its success.

That said, EOTs are not suitable for all businesses. The decision to go down this path should be carefully considered, with the interests of both the family and the employees taken into account.

Preparing the Next Generation

Even with a watertight succession plan and all the necessary tax reliefs in place, the success of a family business transfer ultimately depends on the next generation’s readiness to take the helm. 

Grooming future leaders should begin early, ideally by involving them in day-to-day operations and ensuring they have the right skills and experience to take on the responsibility.

Open and honest communication is essential. Family dynamics can complicate matters, and without clear agreements and discussions, disputes could arise. 

A formal family charter or shareholder agreement can help define roles and expectations, ensuring that everyone understands their position within the business.

Conclusion

Succession planning for a family business is an intricate process that requires careful consideration of tax implications, family dynamics, and the long-term future of the company.

At ASWATAX, we specialise in navigating these complexities, ensuring that your family legacy is preserved for generations to come. We understand family dynamics. Whether it’s maximising available tax reliefs or implementing trust structures, our team is here to guide you through the process. 

Speak to us today to ensure your family business is set for success, both now and in the future.

Meet Omar Omar is a Chartered Tax Advisor (a.k.a an expert on tax issues) and founder of ASWATAX. He regularly shares his knowledge and best advice here in his blog and on other channels such as LinkedIn. Book a call today to learn more about what Omar and ASWATAX can do for you.

*Disclaimer: ASWATAX is a firm of Chartered Tax Advisors, and we strive to provide accurate, up-to-date tax insights. Tax laws may change, so this content is for general guidance only and not a substitute for professional advice. Seek independent tax and legal counsel before making decisions. ASWATAX is not liable for any loss from reliance on this information. Use at your own risk.