If you own and manage a family-owned business, then understandably the vast majority of your time will be spent ensuring that your business runs well and is profitable. This is inevitably a demanding task, so it is perfectly understandable that some significant tax considerations risk being overlooked.
The way that family-owned businesses are taxed is a huge topic, but this article highlights a few of the key considerations.
Choose the right business structure for your family
Most family-owned businesses are structured as companies, but some others are partnerships. Companies and partnerships, however, are taxed in completely different ways.
Companies pay corporation tax and, although the rates of tax may initially be lower than the taxes involved in a partnership, a company’s tax payments often rise when profits are extracted, especially if the business has to pay National Insurance Contributions in the case of directors’ salaries or bonuses.
On the other hand, partnerships are transparent from a tax point of view. This means that profits are taxed as and when they arise even if they are not drawn down, although they are only taxed once. The tax liability falls on the individual partners whereas, as a company is recognised as its own entity, a company is taxed in its own right rather than in the names of the individual directors.
As a general rule of thumb, it is easier to convert a partnership into a company rather than the other way around. If you run your family-owned business as a partnership therefore, it may be worth you looking at this to see if there are tax savings to be made by converting to a company structure.
Review how you are being paid
The directors of a family-owned company have a choice, generally, of paying salaries/bonuses, or paying dividends.
The higher rate of income tax is currently 40% for income between £50,000 and £150,000 (2020/21 tax year) with the additional rate of 45% applied for income over £150,000pa.
The higher rate of tax on dividends is 32.5% and the additional rate is 38.1%. Individuals also get a dividend allowance each year, currently £2,000, so you only pay tax on any dividend income above the dividend allowance.
One important point to note is that salary and bonus payments can be deducted from corporate profits for tax purposes, whereas dividends cannot.
Family businesses should consider all of these tax issues when deciding whether to pay a salary/bonus, or award a dividend.
Can you mitigate tax by involving family members?
There can be benefits in various family members being involved in the business, particularly if they perform smaller roles and are not higher rate taxpayers. You must take care, however, to ensure that any family members who are employed by the business are paid salaries that are commensurate with the job performed. In addition to their salary, you would also need to pay National Insurance if they earn at least £120 per week (£520pcm). You may also become eligible for Employment Allowance, which allows you to claim up to a maximum of £4,000 for National Insurance that you have paid as a result of hiring an employee.
Are you retaining your staff?
The retention of essential staff is of critical consideration for family 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.
Do you have an exit strategy?
It is never too early to contemplate what would happen if the business were sold. The headline rate of 28% for Capital Gains Tax is good, but not as good as the 10% rate that was potentially available before April 2008. However, Entrepreneurs’ Relief was significantly expanded for disposals of qualifying business assets on or after 6 April 2011. For individuals entitled to Entrepreneurs’ Relief, qualifying capital gains up to the lifetime limit of £10m, are charged to CGT at the rate of 10%. A minimum stake of 5% in the company is required, however, and the shareholder must also be an employee or director. Even so, with the right structuring, Entrepreneurs’ Relief can potentially be opened up to various family members.
What about succession planning?
Succession planning is a key strategic matter for any family-owned business. The transition of a family owned business from one generation to the next is a complex process, and can be emotional at times. It is perhaps one of the most significant challenges that any family business will face.
Tax efficiency is an integral part of effective succession planning. It is important to start planning as early as possible and put in place a well thought through plan. For example, a trading business may qualify for Business Relief for Inheritance Tax purposes, but owners of family businesses need to take care to ensure that their business is likely to qualify for this relief, as many conditions are applied under the relevant legislation. Business Relief can mean that business assets qualify for as much as 100% relief from Inheritance Tax. As Inheritance Tax is charged at 40% above the available allowances, this is an extremely valuable relief for preserving the business as it passes to the next generation of the family.
Get in Touch
This article can only give 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. If you would like to discuss any of these issues further, please contact us by email at [email protected], or call 0118 958 9711.
Get in Touch
Jane Whitfield can meet with you to discuss your personal circumstances, your options and your next steps. This would normally take place in our office in Reading, Berkshire. During the coronavirus situation, however, all of our meetings are currently being carried out either by telephone or by video link.
If you would like to meet with Jane, please telephone the office so that an appointment can be made for you. If you would like to take up our offer of a one-hour £95 fixed fee meeting, please click for more details.
Jane is a Solicitor specialising in Private Client matters. Jane is a qualified Trusts & Estate Practitioner with STEP (Society of Trusts & Estates Practitioners) and a fully accredited member of Solicitors for the Elderly, as well as being a Dementia Friends Champion. Jane is also President of the Berks, Bucks & Oxfordshire Law Society.