This article originally appeared in The Herald on Tuesday 27th February 2018
Stoked by tales of giant US companies dodging UK taxes through unfair practices, the public mood today tends to tar sensible tax planning with the same brush as dodgy tax wheezes.
This is both unfair to professional tax advisors and to business owners, entrepreneurs and families who want to pass wealth to the next generation.
For Jack Gardiner, Business Law Partner and Peter Littlefield, Tax and Succession Partner and head of the Glasgow office at Turcan Connell, proper tax planning is all about ensuring clients approach major decisions in a way that suits their specific circumstances and allows them to benefit from the legitimate tax reliefs set out by Government.
"What we are trying to do is to ensure that Government policy, which has been drafted with an eye to encouraging commercial activity, is followed. This is not about devising complex tax dodges," says Gardiner.
Littlefield adds that there are a number of reliefs that families can use to pass wealth securely to the next generation. Combining the use of family investment companies and trusts with the seven-year renewal of IHT relief can be a very effective approach, he points out.
He points out that because inheritance tax law resets the £325,000 inheritance tax allowance at seven-year intervals (ie the amount that can be gifted free of tax to parties other than one’s spouse or charity), it is often beneficial to use this seven-year cycle successively to place money in trust for younger members of the family. If this is done regularly by both husband and wife and possibly by grandparents, substantial sums can accrue in trust over a lifetime.
"This approach will be a drop in the ocean to someone who sells a business for £35 million, but it is still a very powerful approach in many circumstances," Littlefield says.
Trusts can be a very effective means for parents or grandparents to pass wealth to the next generation, while still having that wealth managed privately and independently. The taxation of trusts was greatly complicated by Gordon Brown as Chancellor, so professional advice is definitely needed when contemplating setting up a trust. This is particularly true since there are different kinds of trusts and they have different tax implications.
Trusts are not only for the wealthy. They are also a standard way of protecting the interests of vulnerable people. There are disabled persons trusts and personal injury trusts which can provide a steady income stream to beneficiaries. Many charities are set up as trusts.
However, this is not the place to go into the complexities of trust law, or the Scottish Law Commission’s 2015 recommended changes in Scotland. What is important for the purposes of succession planning, is that trusts offer a way of ensuring that large sums are not placed in the hands of children or vulnerable young people who are ill equipped to receive them.
Matters become more complicated when it comes to the sale of a family business or passing that business on to the next generation. "Succession planning for business owners is fundamentally important and needs to be done correctly. A botched succession can be disastrous for all concerned," Gardiner says.
Some entrepreneurs are so involved in the day to day running of their company that they can be reluctant to even contemplate a situation where they would relinquish control to the next generation. However, this is exactly why external advisors have a very important role to play in ensuring that business owners take the time to treat succession planning seriously.
This is a field that requires the advisor to be someone capable of understanding family dynamics in general as well as the particular relationships that characterise the business they are dealing with. "We have seen instances where the founder of the business delayed the hand-over to the next generation to the point where the children lost interest, and went their separate ways. Within reason, the earlier one starts the succession planning process the better," he advises.
With two thirds of businesses in the UK being family owned, this is a huge topic, particularly since the statistics are against businesses being passed successfully to more than the next generation. The plain fact is that only 20 per cent of UK family businesses survive in the family to the third generation on from the founder.
"The first lesson is that proper succession planning takes time. It will often be necessary to ensure that the skill sets that the next generation are able to bring to the business are supplemented by outside expertise," Gardiner says.
Where there is no enthusiasm from family members to take over the business, and an outside sale is planned, the founder will need time to get the business into proper shape to maximise the sale value.
There are very substantial tax reliefs available when disposing of a family business. Littlefield points out that certain assets classed as business property, attract valuable reliefs from inheritance tax, with the reliefs being either at 100 per cent or 50 per cent. This applies both at death and for lifetime transfers.
The definition of "business property" is any trading business, or interest in a trading business, including partnerships, unquoted shares or securities in a listed company, that give control to the possessor.
Entrepreneurs’ Relief (ER) is very powerful in reducing the amount of CGT paid on qualifying business assets. It is available equally to sole traders and partners who are selling or gifting part or all of their business. It is also available to company directors and employees who hold at least 5 per cent of the ordinary shares in the business and who have voting rights in the company.
It is potentially available on the sale of shares, the sale of partnership interest or the sale of assets associated with a trading business. "Basically, ER reduces CGT down to just 10 per cent from the current rate of 20 per cent, Littlefield points out. Because the relief is available on lifetime gains up to £10 million, the tax saving that can be obtained could be as much as £1 million."