BEST PRACTICE

by Maybeth Shaw , BDO Northern Ireland

n Part One of A Family Business Year End Review , preparing for a voluntary exit was discussed and how it will also position shareholders for the involuntarily exit by maintaining important capital taxes reliefs available through meeting the various conditions .

In this article , Business Property Relief ( BPR ), Entrepreneurs ’ Relief ( ER ) and Gift Relief ( hold over relief ) are examined , a common pitfall is highlighted and the mitigating options discussed .

Business Property Relief ( BPR )

The gift of shares in the family business directly to the next generation will avoid Inheritance Tax ( IHT ) as a potentially exempt transfer ( PET ) if the transferor lives for seven years after the date of transfer . On death , the gift of relevant business assets will attract Business Property Relief ( BPR ) if the gift was within seven years .

One hunderd per cent BPR is available on the value of shares in an unlisted trading company , though assets on the balance sheet which represent excepted assets will be excluded from the valuation eligible for BPR , regardless of the trading status of the company .

For example , FOB Ltd is a joinery business with the following results for the year to December 2016 and shares recently valued at £ 9m :

Should the owner die , the surplus cash held on deposit would be an excepted asset reducing the value of the shares eligible for BPR by £ 6m , resulting in only £ 3m being eligible for BPR . The £ 6m balance would be liable to IHT , generating a £ 2.4m IHT charge .

By taking steps such as using the cash held on deposit to repay the creditors and utilising the balance to enhance the working capital and / or for trading capital expenditure , the excepted asset could be much reduced . An appropriate extraction policy can then be introduced to reduce the excepted asset to an immaterial amount , allowing the full £ 9m to be eligible for BPR .

Most of the value is left in the company and £ 2.4m of IHT is mitigated .

Entrepreneurs Relief ( ER ) A gain on disposal of shares in the family business is subject to Capital Gains Tax ( CGT ) at potentially 20 per cent . Entrepreneurs Relief ( ER ) may be available on the disposal of the shares which reduces the rate chargeable to 10 per cent . The relief is available on disposal of shares and securities if certain conditions are satisfied within the period of one year before the disposal .

Ensuring an individual owns at least five per cent of the ordinary share capital and is an officer or employee of that company can be remedied by gifting the shares to the next generation ( see gift relief below ) and making them employees . The trading status of the company can be called into question and may require a shift in direction or material capital investment .

A trading company is defined as ' a company carrying on trading activities whose activities do not include , to a substantial extent , activities other than trading activities '.

Whilst each case is considered on its own merits , HM Revenue and Customs use an 80:20 test for guidance in determining the substantial activity , where ‘ substantial ’ is measured in terms of :

• greater than 20 per cent of the assets are used for purposes other than of the trade ­ i . e . investment activities ;

• greater than 20 per cent of the turnover is from non­trading activities ; and

• officers and employees spend greater than 20 per cent of their time on non­trading activities . By taking the example of FOB Ltd , both the non­trading income and the non­trading assets are greater than 20 per cent of the total income and assets . This jeopardises the eligibility of the shares for ER . Unlike BPR this is an all or nothing relief .

With similar steps taken of using the cash held on deposit to repay creditors and utilising the balance for trading purposes or extracting funds if needs be , this can bring the non­trading income below 20 per cent and shift the balance sheet total in favour of trading assets . This could effectively reduce the CGT on the gain arising on a sale of the shares by half .

Gift Relief ( Hold Over relief )

Unlisted shares in a trading company may be gifted without a chargeable gain crystallising on the shareholders . The gain is postponed and held over into the base cost of the shares and only becomes chargeable on the subsequent disposal by the transferee .

The 80:20 test discussed above is also used as guidance in determining the substantial activity of the company for this relief .

Relief is available only where the transfer is made to a UK resident individual or the trustees of a settlement . If the transferee emigrates within 6 years of the tax year of gift , the postponed gain is then charged on the transferee at the date of emigration .

Careful consideration should be given to transferees who are non­resident or may become non­resident in the future .

Conclusion

By utilising excess cash via capital investment , creditor management or reviewing working capital requirements and managing any remaining surplus via the company ’ s dividend policy , valuable capital tax reliefs can be protected and therefore be available when the time comes to assist with a tax efficient exit .

24 www . businessfirstonline . co . uk