Long ReadNov 16 2022

Mitigating risk in a family business

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Mitigating risk in a family business
(Andrea Piacquadio/Pexels)

For family businesses the cost of energy, transportation, raw materials, wage increases and the fact that consumers have less disposable income have compounded the difficulties they face. 

So, how can businesses prepare for the negative effects that inflation is having?  

Succession planning

The first and most important step that business owners can take is to ensure that the business has a clear succession plan in place.

As part of that plan the next generation should be involved if they wish to take over the business. If not, it may be better for business owners to prepare for a sale or a management buyout. 

The best way of mitigating IHT is to ensure that stakeholders have wills in place.

Furthermore, key stakeholders must make wills. If a business owner dies without a will then until the probate registry makes a grant of letters of administration, there is nobody with any authority to carry on the running of the business. 

This could leave the business in purgatory for six months or even a year. However, if a business owner has a will then their executors have authority to immediately step into their shoes.

As such, executors can continue to take key decisions for the business quickly, which could mean the difference between survival and failure of the business.

Business owners should also ensure that their business is structured in the most inheritance-tax-efficient way. If a key stakeholder dies then, on top of the inflationary pressures being faced, how would IHT be paid? 

Business owners should ensure that by diversifying risk they do not prejudice their business's BPR status.

Key-man insurance is one way of mitigating the adverse effects of an unexpected death. However the best way of mitigating IHT is, again, to ensure that stakeholders have wills in place because if assets pass to spouses/civil partners there will be no IHT. 

The articles of association (if the business is a company) or the partnership agreement should be checked to ensure that shares/partnership interests can pass to the spouses of shareholders/partners.

Trading and BRP 

At a more fundamental level, business property relief may be available if a business is wholly or mainly carrying out a trade, as opposed to investing in property or other investments. 

BPR is a very valuable relief as it fully exempts the value of shares or partnership interests in a trading business from IHT provided that the holder has owned their shares/interest more than two years.

In the current inflationary environment, businesses may wish to move away from holding cash and invest in assets that will rise in line with inflation; perhaps real estate, shares in 'recession-proof' companies, gold, US dollars or index-linked equities or bonds. 

However, business owners should ensure that by diversifying risk they do not prejudice their business's BPR status.

BPR is available to a business that is wholly or mainly trading. Put simply, this means that if more than 50 per cent of its business activities relate to investment then the whole value of the business will not qualify for BPR. 

Some thought needs to be given on how to extract cash from the trading business.

If the investment activities amount to a small proportion of its overall business activities then investing in recession-proof assets is unlikely to be an issue. Furthermore, the investment assets will qualify for BPR under the overall company structure. 

However, if the position is marginal then it may be sensible for a separate company to be set up that carries out investment and is separate from the trading business. This will ensure that it qualifies for BPR and the investment business is hived off. 

Some thought needs to be given on how to extract cash from the trading business to fund the investment business. For example, if the trading business declares a dividend to pay cash to shareholders then there will be income tax in the hands of the shareholders at a maximum of (currently) 39.35 per cent.   

Family investment companies

A company that holds investment assets for the benefit of family members is a family investment company. A FIC ensures that value is retained and managed centrally, avoiding fragmentation of ownership. 

Control can also be maintained by family members acting as directors of the FIC. Although a FIC will not qualify for BPR, the use of a corporate wrapper works particularly well from an income tax perspective if investing in equities, as companies do not generally pay tax on the receipt of dividends from other companies.

If the FIC is funded by way of a loan (repayable on demand) from a parent or grandparent the loan will remain in their estate for IHT purposes, however any growth in the value of the investments will be with the shareholders; that is, the children/grandchildren. 

The use of a trust structure to hold business assets can be particularly effective if the business is to be sold.

The settlor can also drawdown their loan to the FIC free of income tax or capital gains tax.

A hostile business environment may have reduced the value of a business. As such, parent stakeholders might consider it a good time to make gifts of shares or business interests to their children. 

There will, prima facie, be CGT to pay on gifts of business assets that are standing at a gain in excess of the parents' acquisition cost. However, the CGT will be less if the value of those assets is depressed. 

If the business is trading, CGT holdover relief can be claimed, which means that children will be deemed to inherit the business assets at their parents' base cost. 

Alternatively, parents may elect to pay CGT but claim business asset disposal relief, which reduces the rate of CGT from 20 per cent to 10 per cent on the first £1mn of gains. 

If the assets gifted qualify for BPR then there will not be any IHT as a result of the gifts, even if the parents die within seven years – provided that the children do not sell the business assets.  

If tax and succession issues have been planned for, it will put family businesses in a much stronger position.

Using a family trust structure to settle business assets can also be a highly efficient vehicle from both an IHT and CGT perspective. The basic position is that only £325,000 of assets (or £650,000 between a married couple) can be settled into a trust without an upfront IHT charge.

However, an unlimited amount of BPR assets can be settled into a trust without any IHT. The use of a trust structure to hold business assets can be particularly effective if the business is to be sold and/or children are too young or immature to inherit large sums.

Having a clear succession plan, making sure key stakeholders have wills in place, and reviewing the structure of the business will put a business in a much better position to weather the current inflationary storm. 

Unfortunately there is no magic solution, but if tax and succession issues have been planned for, it will put family businesses in a much stronger position. 

Oliver Embley is a partner and Matthew Braithwaite is a partner at Wedlake Bell