smallbusiness.co.uk: Helping your business think big

Stuart Skeffington, partner and head of tax and trusts at law firm Stevens & Bolton, explains how family businesses can reduce their tax burden with some sound forward thinking.

Owners and managers of family-owned businesses rightfully spend the vast majority of their time ensuring that the business runs well and (credit crunch permitting) generates profits. In the midst of such a demanding task, it can be easy to overlook some tax considerations that can potentially be significant.  

The topic of tax in the context of family-owned businesses is a large one – however, there are a few key considerations to bear in mind:

How is your business set up?

Most family-owned businesses are set up as companies, butt some do run as partnerships.  These two structures differ in terms of tax, and it is worthwhile for business owners to consider which structure could be most beneficial for their business.

Companies may pay lower rates of tax initially, but further tax (including National Insurance Contributions in the case of salary/bonuses) is often due when profits are extracted. Partnerships however are tax transparent, so profits are taxed as they arise, even if they are not extracted (but are taxed only once). It is generally easier to convert a partnership into a company than the other way around.    

How are you extracting funds?

The business has a choice, broadly speaking, of paying dividends or paying salary/ bonuses. The top rate of income tax is now 50 per cent, and the top rate of dividend tax is lower at just over 36 per cent. Having said this, salary and bonus payments can be deducted from corporate profits for tax purposes, whereas dividends cannot. Businesses should therefore consider tax issues when using either of these methods to extract funds.  

There can be benefits in various family members being involved in the business, particularly if they ––– for example – perform smaller roles and are not paying taxes at the higher rates. Care is always required here to ensure that any salaries are commensurate with the job performed. There can also be complexities in giving away shares to spouses to enable them to capture dividends at the lower rates.

How are you incentivising your staff?

Clearly, the retention of key staff is of critical consideration for businesses of any size.  With cash flows being restricted in these difficult times, consideration can usually be given to granting share options to employees. Certain tax-approved options schemes (such as Enterprise Management Incentives) are potentially very tax-efficient and a good incentive for key workers.  

Are you thinking of an exit?

It is never too early to contemplate what would happen if the business were sold.  The headline rate of 28 per cent capital gains tax is good but not as good as the 10 per cent effective rate that was potentially available before April 2008. Fortunately, entrepreneurs’ relief has recently been significantly expanded so that a shareholder meeting the criteria can capture up to £5 million of sale proceeds at a rate of only 10 per cent.  A 5 per cent stake in the company is required, however, and the shareholder must also be an employee or director.  With the right structuring, entrepreneurs’ relief can potentially be opened up to various family members.

Planning with pensions

In certain instances, an appropriate pension plan for a family-owned business can lead to tax efficiencies. A pensions adviser should be consulted in this instance to assess whether such a plan would be advisable for the individual business.

What about the next generation?

Succession planning is a key strategic matter for any family-owned business. Where the business is a trading concern, it is often possible (depending on the particular circumstances) to give away shares without adverse tax consequences. But care is required here to avoid certain pitfalls that can exist if even a few investment assets are located somewhere within the business.  

It may also be the case that a trading business qualifies for inheritance tax relief (under the business property relief regime); therefore, founders may not be worried about inheritance tax now. If the business is sold however, this relief will be lost, potentially generating a significant inheritance tax bill in the future. Fortunately, planning options do exist here, such as transferring the business into a trust before an exit.

Needless to say, the above gives only a taste of some of the relevant tax considerations where family-owned businesses are concerned. The important point is to remember the significant impact that tax can make, and take advice early and regularly.
 

Stuart is a Partner and head of the tax and trusts team at Stevens & Bolton LLP. Stuart can be contacted on +44 (0)1483 406952 or by email 

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