Succession: planning for success

Succession planning is the process of passing a family’s business and assets from generation to generation in a positive and effective way. It deals with ownership and control, which need not necessarily pass at the same time.

There is no single solution for succession, and the best way forward will depend on your family and your business. However, our experience is that failing to plan for succession leads to limited and less tax-efficient options, and can cause serious problems for both the family and business.

One issue concerns when to hand over management control and ownership of business assets, and several factors will influence this decision. Tax will be a relevant consideration for many, given the interaction between inheritance tax (IHT) and capital gains tax (CGT), but it should not be the driving force behind your decisions.

Your succession plan should be informed by a clear understanding of what you and your family want for the future. It can be easy to make assumptions about what your children or other family members would like to do with their lives, and these may not be correct. The best approach is to start with open discussions where everyone is free to share their true feelings.

This includes being clear about your hopes for the future. Do you want to remain in control of the business, or be involved in some other capacity, for as long as possible? Or do you want to retire and hand over management responsibility?

Both possibilities present difficulties. If you are going to remain in control, consider what will happen if you become incapacitated and make sure you have suitable contingency plans in place. Think about what this will mean for your successor, who may have to wait until past their own retirement age before they can take over the running of the business.

If you want to retire, how will you fund your retirement? Perhaps you have been funding, or will be able to fund, a private pension; maybe you’ve set aside cash savings for retirement.

Alternatively, you might look to retain certain parts of a diversified business (such as let properties) to maintain an income, as long as the rest of the business is sustainable on its own.

It can be dangerous to assume that your successor will be able to provide for your needs out of business income. First, factors beyond your control, such as your successor’s bankruptcy or divorce, or a breakdown in your relationship, may leave you penniless (and even homeless). Sadly, we have seen this happen. Second, it can risk triggering the reservation of benefit tax rules, referred to later in this article.

You may decide that the best solution is to reduce your involvement in the business, giving your successor more daily control over it. For example, when operating as a partnership, you can continue to be a partner with a right to income, which can be more efficient for IHT purposes than full retirement.

The successor is the person(s) who will take over the land or business. In many cases, it will be one or more members of your family. You could look to the next generation, and in some cases it may be appropriate to look beyond that to grandchildren or great-nieces/nephews.

The first question is: who is willing to take on the business? Some family members may have made a career elsewhere and may not want to give it up to take over the business, while others would like nothing more than to take it forward into the future.

Second, does your potential successor have the necessary skills, which will vary depending on the nature of your business? These may include business skills such as bookkeeping and marketing, or agricultural and environmental skills. Potential successors will often have learnt such skills while growing up within the family business, and any skill gaps can be addressed before succession takes place – either within the business, through external training, or by working for another business for a time.

If you do not have a successor, it may be the right choice to sell the business to provide you and your family with cash or other assets. Alternatively, you might choose to let land out to a tenant, so your family can retain ownership and receive some income.

You may want to make provision for those family members who will not be taking on a share of the business.

If you have a diversified business, it might be possible to split off certain elements to pass on to other beneficiaries. For example, one child might take on the farmland, another the holiday rental properties or residential/commercial lets. However, consider whether the main business will be sustainable without the income from other elements.

If planning far enough in advance, you can also take steps to build up a separate inheritance for other beneficiaries. Some families do this by investing in residential properties or life insurance to provide for non-farming children.

You will need to think about your business structure and what it means for succession, and ensure that related documents reflect your plans.

If you are currently operating as a sole trader, forming a partnership with your successor can support the continuation of your business on your death. If you already have a partnership, you can bring in your successor as a partner. In either case, the partnership can continue after you have died, as long as there is a written partnership agreement and at least two partners remain.

This is an opportunity to ensure you have an up-to-date partnership agreement that reflects your respective roles in the business, as well as your succession plans. You can also think about transferring partnership capital to the next generation of partner, although you should not do this without taking tax advice.

If you have a company, you have a clear mechanism through which to separate ownership from control, using the issue or transfer of shares and the appointment of directors. Where there are multiple shareholders, you must have a shareholders’ agreement governing the relationship between shareholders and how they will exercise their voting rights.

There is a choice to be made between transferring assets in your lifetime or on your death, and this involves considering both IHT and CGT. While most outright gifts to other individuals in your lifetime will be exempt from IHT on your death if you survive at least seven years from the date of the gift, CGT may be chargeable, depending on the nature of the asset and if it qualifies for relief.

IHT can sometimes be saved by making lifetime gifts, whereas CGT can typically be saved by passing assets on death, because no CGT is payable and there is an uplift in value. This means the beneficiary acquires the asset at the date-of-death value.

Note that if you gift an asset but still benefit from it, this is a ‘gift with reservation of benefit’, and on your death you will be treated as the owner of it for IHT purposes.

Understanding what tax exemptions and reliefs apply to lifetime transfers and transfers on death can help you to decide on the best course of action for you, your family and the business.

The IHT nil rate bands mean that, depending on your circumstances and assets, you may be able to leave £325,000 to £1m free of IHT, as well as any reliefs that may apply.

You may also be able to benefit from one of two important IHT reliefs on your assets and business. Agricultural property relief (APR) applies to agricultural land and buildings that are occupied for agriculture, including let farms, while business property relief (BPR) applies to a business that is mainly trading. Activities that actively generate a profit will be classed as trading (such as farming land in-hand); if you receive rent or other passive income from an asset, this will be classed as an investment. If your business carries out more than one type of activity, the question will be whether it is mainly trading or mainly investment.

Broadly, where assets are not likely to be subject to IHT on death (either because they benefit from APR or BPR, or because they are covered by nil rate bands), it can be more tax efficient to hold on to them until death. However, where assets are likely to be subject to IHT, you could save tax by making a lifetime gift, if CGT is lower than the rate of IHT. However, there is the risk that if you die within seven years, both IHT and CGT will be paid, and you will be worse off than if you had retained the asset and just paid IHT on death.

There are various CGT reliefs, but the most relevant one from a succession planning perspective is holdover relief. This applies to a gift of assets that are used in a trading business, or that qualify for APR. It also applies to a transfer of assets to a trust. Where holdover relief is claimed, the person making the gift does not need to pay CGT. Instead, the recipient of the gift takes on the donor’s base cost for the asset, increasing the CGT that would be paid if they sell it in the future.

Of course, things can be a lot more complicated, so it is always worth taking advice on your specific circumstances.

A will is an important part of succession planning, particularly if the intention is to pass on assets upon death rather than during your lifetime. A will’s primary purposes are to identify what you want to happen to your assets, and to appoint executors to carry out those wishes.

You should make sure that the lawyer preparing your will has experience dealing with family businesses (and farming clients, if relevant). They should ensure your will is compatible with any business documents, such as a partnership agreement.

In many cases, you can pass assets outright to a beneficiary. However, you may wish to retain some level of control by using a trust. This can apply to both a gift in your will and a lifetime gift.

There are many different types of trust, each of which can be customised to your circumstances; always take advice on which would be most suitable for you. For example, you might use a life interest trust to provide for a surviving spouse but ensure that assets pass according to your wishes they die, or you might use a discretionary trust to provide flexibility in the way your assets can benefit various family members.

In addition to a will, you should ensure you have lasting power of attorney (LPA). A will only takes effect on your death, whereas LPA allows you to appoint someone to make decisions on your behalf and manage your affairs during your lifetime if, for example, you are incapacitated by accident or illness.

There are two types of LPA, one dealing with property and financial matters, the other with health and welfare decisions; you can make one or both. You can also make more than one of each type: for example, you could appoint one person to handle your business affairs and another to deal with your personal finances.