Planning whatever the future may hold
by Tom Moore, Tax Partner on 3 May 2012
The family business may be the single most valuable asset owned by an individual. However, without good forward planning a family business may be worth little or nothing once the current owner retires or dies. Even if the business is valuable, tax can erode the value available to pass on.
Here’s a scenario of how forward planning can make all the difference:
Mr Smith, 60 years of age, has owned 100% of a UK trading company since 1980 currently valued at around £2m. It has enjoyed steady growth, has a good reputation and is profitable with accumulated reserves.
It is a very good employer and has retained a number of key staff there is no obvious potential trade purchaser.
We would encourage Mr Smith to consider a share-based incentive scheme. If senior management become shareholders in the company then this is likely to drive up profits (especially since share rewards can be linked to personal and company performance).
Employees with shares or share options are much more likely to remain within the business. Once equity holders, management are more likely to have an appetite to own more of the business and can be a potential market for Mr Smith’s shares in the future.
The existing management may well prove to be the best candidate to purchase some or all of the remaining shares.
Shares can be acquired under a tax-favoured scheme such as EMI with no tax cost. A corporation tax deduction is given on the exercise of the options based on the “gain” on the shares when acquired.
It’s worth noting that the arrangement costs the company nothing (apart from some set-up costs) but has the same benefits as a cash bonus.
In return Mr Smith can expect to see increased profitability and a realistic chance of being able to sell his shares (and extract profit at only 10%) without seeking an external buyer.
The plan means that the company is more likely to continue beyond Mr Smith’s retirement and even after he has died.
Mr Smith’s remaining shares can be gifted during his lifetime or on death to his children with no tax cost since shares in an on-going trading company qualify for reliefs that eliminate capital tax costs.
Without a medium to long-term strategy such as this the business may have little on no value on Mr Smith’s retirement. In the absence of a buyer, liquidation may be necessary almost certainly producing a smaller return and even that will stand at risk from Inheritance Tax. A relatively simple and low-cost plan can make all the difference.
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