Exits

The inheritance tax maze

May 07 issue
 

Jonathan Turner
Jonathan Turner
Passing on business assets or shares to your children requires careful planning and consideration. Marc Barber finds out how to ensure a smooth succession

'Family businesses are nightmares,’ says Jonathan Turner, chief executive of fuel supplier Bayford & Co, who conducted a buy-out from his father and uncle several years ago.

Opting for a straight buy-out was felt, by everyone involved, to be a clean and straightforward way of handing power to Turner. ‘You need to do what’s naturally right for the vendors,’ he says. ‘There’s no self-esteem in someone giving you a company; I bought this business for a fair value.’

The mix of business, family and money can easily create a toxic, combative atmosphere. When Turner was 18, he says he vividly remembers a friend’s father, who was forced to float his company because, over the years, shares had been distributed to various relations.

‘The float happened because there was a web of family shareholders that wanted to sell and going public was the quickest route to take,’ muses Turner. ‘Losing control of a business like that has always stuck in my mind.’

A buy-out was the right decision at Bayford & Co. ‘I want to be proud of what I’ve done. If I mess it up, then I’m the one who suffers. By selling the business to me, my father and uncle have ring-fenced the value they have built up in the company over the years,’ he says.

The benefit of experience
The expertise and knowledge gained by Turner’s father and uncle have not been lost, as they’re both still heavily involved in the company, albeit on contracts of employment. ‘What we’ve done is visionary,’ eulogises Turner. ‘They can either enjoy their wealth or loan money back into the business if they choose to do so.’

If your succession strategy is more conventional and you want to pass on shares to your family, then the Inheritance Tax (IHT) system in the UK remains a favourable one, if something of a moveable feast.

Richard Garrod, a tax partner at accounting firm Mazars, says: ‘The important thing is to plan what you’re going to do from the beginning and, as soon as your business is up and running and profitable, start thinking about your exit.’

While it may not be top of your list as you grow your business, if you do pass shares on to your family at death then any IHT ought to be null and void as Business Property Relief (BPR) kicks in.

Garrod says you need to be careful that you don’t forgo your right to claim BPR. While it can provide total exemption when passing on shares in a trading company, BPR may be forfeited if you start acquiring assets of more than 50 per cent of the value of that business.

Garrod draws a comparison with Capital Gains Tax (CGT) relief, whereby lower rates are forfeited if non-business assets are acquired exceeding 20 per cent of the business.

Difficulties can arise, says Garrod, if there are properties that you let out or if the company is particularly cash rich: ‘It may end up being more expensive to take the cash out of the business; it will probably be cheaper to pay the corporate tax and leave it in there. When the shares are passed on to the children, they can then access the cash and take it out of the company.’

Taking a back seat
There will come a time when you want to take your foot off the entrepreneurial pedal and perhaps draw a salary or pension from the business. If so, that will rule out paying only 10 per cent taper relief on CGT compared to 40 per cent, which, in the long term, might not be such a good idea.

Garrod says: ‘If a person wants to pay the 10 per cent charge rather than drain the company going forwards, it might be wiser to look at selling shares to the kids for cash now, or maybe for some deferred loan stock payments over a period to trigger the lower tax rate.

‘The kids take a bit of pain and pay for this, but it will be a cost taken from the profits of the company. Nevertheless, it’s giving the parent a one-off 10 per cent tax bill and saving them taking money out of the business.’

Matthew Hansell, a partner at law firm Mills & Reeve, observes that entrepreneurs may not only be worried about what HM Revenue & Customs can lay its hands on, but what can happen if a son or daughter loses 50 per cent of their inheritance through a divorce.

To guard against this, Hansell recommends investing a child’s inheritance into a suitable trust. ‘It could be a life interest trust where the child gets the right to income or a discretionary trust. In either case, you must make the trust as flexible as possible so it can adapt to changes in the future,’ says Hansell.

Along with this, there are wills and pre-nuptial agreements that can set out how wealth should be distributed. As for lifetime gifts, Hansell observes that for the 2007/2008 tax years, you can only put £300,000 worth of assets into a lifetime trust, which doesn’t seem much when you consider the average property price in the UK.

He says: ‘If they want to put in larger amounts, such as a large cash sum for a child to buy a house or something, people are now using bear trusts. They work as a form of nomineeship for asset protection, so that it keeps the fund separate from the child’s and spouse’s funds. It won’t become what is called matrimonial property.’

As a curiosity, Hansell notes, situations are occurring in which children are dragging their parents into the offices of law firms. ‘If a parent is remarrying, the child is now worried about their inheritance and wants it protected. It’s a rather different social change actually,’ he says.

Protect your assets

Antonio Risorto, associate director of IHT planning matters at accounting firm Vantis recommends the use of trusts to protect assets, warning that the removal of BPR by the next Chancellor could leave a lot of people vulnerable. He adds that, if passing shares on to your children, you need to be aware that the clock for claiming taper relief is reset and therefore the shares shouldn’t be sold for two years. If the transfer is between husband and wife, then the taper relief isn’t reset.

Hansell suggests that talk of BPR being abolished tends to be scaremongering. Trusts are, he admits, useful for protecting your relief against future events. He explains: ‘If you put a certain amount of shares into a trust and freeze the relief that is available, then if the company does something to preclude that going forwards, at least you have that amount of shares protected.’

It’s not a surprise to hear advisers say that you should seek advice, but when it comes to IHT, changes are made annually and eligibility for the nil-rate tax band could easily be lost.

There is no need for this to happen, given the large number of options to ensure you keep enough of your own wealth and pass it on as you deem fit. Bayford & Co’s Turner is a fine example of this, as is Victoria Bannister, the MD of Sportsshoes Unlimited, an independent shoe retailer.

Bannister has taken over the business gradually from her father during the past four years. She says that, while the shares are yet to be transferred, the lines of succession and who gets what in the family are clearly delineated.

As for Bayford & Co, the company seems to be going from strength to strength, employing over 200 people and targeting profits of £10 million by 2010. With Turner at the helm, six businesses have been acquired in the past 18 months. ‘I have loans and debts and my exposure to risk is certainly greater,’ he admits breezily, but he categorically wouldn’t have it any other way.

A lot of care and thought has evidently gone into the success and it’s working a treat.

Estimated liabilities on property

Estate : Tax
£500,000 : £86,000
£750,000 : £186,000
£1 million : £286,0000
£1.5 million : £485,000
£5 million : £1.9 million

Source: Vantis Tax