Want to pass your business down to the next generation? Plan ahead to cut your   tax liability.

If you thought inheritance tax planning was difficult enough when only a   family home was involved, think again. When families own businesses, the   complexities are far greater.

Almost half of British small business owners hope to pass on their business to   their children, according to research from Close Brothers Asset Management.

But although people are considering succession plans, many are not aware of   the tax implications.

There are three million family businesses in Britain, according to the   Institute for Family Business, and each year some 100,000 family firms are   thought to pass from one generation to the next.

Amalia Brightley-Gillott, the editor at Family Business Place, which promotes   family businesses, said: “I don’t think anyone starts a business   planning to pass it on to their children, but as it grows you want   continuity and customers to know that the same values and family will be   involved.”

Gary Heynes, a partner at Baker Tilly, the accountancy firm, said: “The   starting point is looking at the business entity, how the business is   structured, as that changes the rules slightly.”

Trading businesses qualify for 100pc relief from inheritance tax under a   system called business property relief. To qualify, the business must be an   unlisted company – or one listed on the junior Alternative Investment Market   (Aim) – and must have been trading for at least two years.

A similar relief for agricultural property and land, agricultural property   relief, covers farmland and farming businesses, but it has to be a trading   farm to qualify – keeping chickens in your garden is unlikely to pass muster   with the taxman.

“This means that if you fully own a company and you were to die, the   shares could be left to the next generation entirely free of tax, and that   is incredibly valuable,” said Mr Heynes. “A lot of people miss out   because they don’t realise the criteria; they have too much in investment,   for example.”

A non-trading company, such as an investment company or a company that   receives property rental income, does not qualify for the relief.

Patrick Haines, regional head of advice at Close Brothers Asset Management,   said: “Tax planning is intrinsic to the success of passing on a   business, and understanding the tax implications involved in operating and   passing on a business can help protect wealth for retirement – in addition   to the use of tax-efficient personal savings.”

Harvey Bowden and his wife, Ann, are preparing to hand their successful water   softener business, Harvey Water Softeners, based in Woking, Surrey, to their   youngest son, Casey.

“We thought about what would happen to the business constantly as the   years went by, but none of my children expressed an interest until about   four years ago,” Mr Bowden said. “We always had the idea that we   would either sell or pass the business on.”

Casey Bowden, now 32, joined the business in 2004 and became a director three   years ago. He currently owns 2.5pc of the shares and the family have decided   to grow this share to 49pc through his bonus over the next decade. The   remainder he will inherit on his father’s death. His two elder brothers will   each own 2.5pc of the business.

Harvey Bowden said: “If my children hadn’t been keen, I would have sold –    it gets to the point when the strain outweighs the reward. Now Casey has   started to take the strain.”

Harvey Water Softeners also owns rental properties, so as part of the   succession plan the family is splitting out the property arm, which will be   run by son Roy, aged 33, so the water softener company qualifies for   business property relief.

Patricia Mock, a tax partner at Deloitte, said business owners should also be   aware that business property relief might not apply if they die within seven   years of gifting the company to their children. If the children have sold   the business during that time, for example, the windfall could be subject to   inheritance tax. Additionally, business owners can’t put additional assets   into the company, known as excepted assets, to try to get around inheritance   tax.

Capital gains tax (CGT) is another interesting factor because gifting business   assets means they can be exempt from the tax. If a parent has built a   business worth £10m, for example, they could pass it down to their child and   pay no capital gains on the value. However, the tax is only deferred. If in   this example the child later sells the shares for £20m, they would pay   capital gains tax on the full £20m gain.

That’s important because of entrepreneur’s relief. Capital gains tax is   usually 28pc, but there is a special 10pc rate which applies to businesses   up to a value of £10m. For a business worth £10m, this could mean a total   saving of £1.8m if the whole business changes ownership.

In some circumstances, said Ms Mock, this means it might be better not to   defer capital gains. Again to use the example above, it would mean the   parent and child each pays 10pc on their £10m gain, instead of the child   paying 10pc CGT on the first £10m and the full 28pc rate on the rest.

“Although gains can be held over, it is not always the best answer,”   she said. “It is also worth keeping track of share ownerships   fragmented around families in this situation – you need to hold 5pc for at   least a year to qualify for entrepreneur’s relief and you need to work for   the company, as an employee or an office holder.”

Parents stepping away from the business should think about whether the   business should pay into their pension fund, how they will manage proceeds   from a sale during their retirement and whether they could retain shares in   the business to pay a dividend.

Mr Heynes said: “There is no simple answer. Individuals must think about   where the business will go on their retirement and who will benefit from its   value. When you have made those more emotional decisions, discuss with your   accountant about how to manage the process.”