Essential tax planning before the sale of a business
26 January 2024
The sale of a business is a good opportunity to pass wealth down to the next generation. A business owner can make an outright gift which falls outside inheritance tax if they survive it by seven years. However, an outright gift offers no protection against spendthrift or divorcing beneficiaries.
Alternatively, the business owner can transfer cash to a family trust, but there will be an immediate inheritance tax charge of 20%, to the extent that the sum exceeds the threshold of £325,000.
Fortunately, a unique opportunity exists to transfer more than £325,000 of value into trust without an immediate 20% inheritance tax charge. It involves the business owner gifting some of their shares to a family trust before entering into the contract of sale.
This is because there is a valuable relief for private trading company shares which, if the relevant conditions are met, benefit from 100% business relief for inheritance tax once the business owner has held the shares for at least two years.
If 100% business relief applies, a business owner can transfer their shares into a trust for the benefit of their family without triggering an immediate 20% inheritance tax charge.
If instead the business is sold and then the business owner transfers the proceeds of sale into trust, they can only settle cash of up to £325,000 into trust without an immediate 20% tax charge. This is because the relief is lost as soon as a binding contract of sale is entered into, making it too late to “bank” the valuable relief.
The business owner would generally need to survive the gift into trust by seven years so that the relief is not clawed back. Alternatively, the trustees should consider investing the entire sale proceeds into other fully relievable assets for that seven-year period.
The business owner and their spouse or civil partner would need to be excluded from benefiting from the trust from the outset, so the trust fund is outside their estate for inheritance tax on death. Alternatively, they could be excluded from benefiting at a later stage, and in that case, the inheritance tax benefits would start seven years later.
If the business owner undertakes no planning at all, then in the absence of any available exemption or relief, and subject to their available nil rate band of £325,000, the cash proceeds are exposed to 40% inheritance tax on death.
Capital gains tax
The transfer of shares to a trust will be a disposal for capital gains tax purposes. If Business Asset Disposal Relief applies, the first £1 million of gains will be taxed at just 10%, assuming the business owner’s lifetime allowance is fully available. If gifts holdover relief is available, the tax can be delayed until the trustees later sell or otherwise dispose of the shares. This can be helpful if there is no buyer on the horizon, or if the timing of the ultimate sale to a third-party buyer is uncertain. This avoids triggering a “paper gain” where there is CGT to pay but no funds to pay it.
Letter of wishes
The business owner would write a detailed letter of wishes to the trustees, offering them guidance as to how they should exercise their discretion and, in particular, how the trust fund should be distributed on death. For example, the business owner may wish that the trust fund should be used to finance their children or grandchildren’s school fees and university tuition fees, and that the balance of the funds should be distributed to the children or grandchildren at the age of 25, perhaps to finance their first home. The letter of wishes is completely fluid, tailored to the individual business owner’s wishes, and can be changed at any time.
Business owners have an exciting opportunity to transfer some of their shares to a family trust, provided they do so before entering into a contract of sale of the business. If the shares qualify for 100% business relief, they are exempt from inheritance tax on the way in. A family trust not only offers inheritance tax advantages, but also control for the business owner as they can be a trustee.
The Birketts View
Given a General Election will be coming at some point within the next year, we recommend implementing this planning sooner rather than later, in case a future government were to remove or restrict the availability of business relief.
In implementing any pre-sale tax planning strategy, we would always take a holistic approach, looking at it alongside the business owner’s wider estate planning so as to provide a joined-up solution.
The content of this article is for general information only. It is not, and should not be taken as, legal advice. If you require any further information in relation to this article please contact the author in the first instance. Law covered as at January 2024.