Protect your family business for the next generation
A fundamental principle of Inheritance Tax (IHT) planning is the strategic use of lifetime gifting, provided the donor survives the gift by at least seven years. Gifting significant assets to young adults is fraught with difficulties, with considerations of fast living, unwise investments and poor marriage choices.
One answer to this conundrum might be a Discretionary Trust. Often derided as complex, the concept is simple: one person (the settlor) gifts cash or assets to a Trust, and the assets are then managed by ‘Trustees’, for the benefit of the ‘beneficiaries’. Beneficiaries of these trusts have no control over the assets and no entitlement to Trust income or assets. Whether they receive anything from the Trust is entirely at the discretion of the trustees. It is quite possible for the settlor to also be a trustee, enabling them to retain influence over the Trust assets and distributions.
To prevent up-front IHT charges, cash settled into a Trust is generally limited to £325,000 per person every seven years. However, much larger values can be settled for shares in an owner-managed trading company due to Business Property Relief (BPR). The current 100% BPR is due to be capped at £1 million from April 2026 and despite protests, these changes seem to be coming forward unaltered. So there is a limited time for family businesses to get the best from the present regime.
|
Case study 1 - Family company shares and a discretionary trust A business owner’s trading company is worth £2 million. After a successful career, he is comfortable financially. However, he takes no action to avoid family arguments. He retains the shares and dies 10 years later when the shares are worth £2.5 million. Following the BPR change in April 2026, the IHT payable will be £300,000, and the company is quickly sold to fund the bill. If the business-owner had instead gifted these shares into a Discretionary Trust before 5 April 2026, there would be no IHT on the initial settlement, nor on his death, because this is over seven years later. With the shares held within a Trust, all share growth and dividend income falls outside his Estate for IHT purposes, and he retains full control of the company as a director and as the lead trustee. The Trust’s IHT position is unaffected by his later death, because the Trust instead pays IHT at a lower rate (up to 6%) on every 10th anniversary of the original settlement. At the first 10-year anniversary, the Trust might face an IHT liability (based on the £2.5 million value) of just under £45,000, which can be spread over 10 years, interest free. His heirs find that funding annual IHT payments of £4,500 per year out of business profits/dividends is far more affordable than finding £300,000 on his death. In this scenario, the use of a trust has swapped very expensive generational IHT for a more affordable regime and has made it more likely that the business can remain within the family. Whilst a Trust can bring its own complexities and specific advice should always be taken on a case-by-case basis, a Discretionary Trust remains a very useful tool for families seeking to balance lifetime giving with asset protection. |
|
Case Study 2 - Assessing the impact of potential future tax changes on gifts In the run-up to Rachel Reeves' second budget speech in autumn 2025, and with rumours of lifetime taxes soon being potentially subject to tax, some families may now decide the time has come to pass on the family business to the next generation. There are many wider considerations in terms of suitability, appropriacy, the needs of the business and fairness, but what are the tax consequences of doing so? |
Capital Gains Tax (CGT)
Gifting shares in the family business to family members has a CGT consequence as the gift is deemed to take place at 'open market value' and, in most cases, the market value will not be known. The open market value is the estimated value of the shares if the transaction took place between a willing buyer and a willing seller. Tax would then be payable on the gain, which is the difference between the ‘base cost’ of the gifted shares and their value. In many cases, this can create a 'dry’ tax charge, which means tax becomes payable even though no money changes hands.
Gift Hold-Over Relief
There remains a valuable tax relief available that can avoid the dry tax charge. The relief applies where the gifted shares are in an unquoted trading company. The need for a formal valuation can be avoided in circumstances where the donor is permitted to 'hold-over' the capital gain. In essence, this usually means the donor’s capital gain is deferred until the donee sells, i.e. the donee effectively ends up paying tax on the gain which arose during the donor’s ownership.
Using our previous example, of a business owner’s trading company worth £2 million. If he decided to make a lifetime gift(s) to his adult children. He would be contemplating a CGT liability of some £480,000 (perhaps £380,000 where Business Asset Disposal Relief (BADR) applies and the gift is made before 6 April 2026). With a successful claim to gift hold-over relief, the immediate CGT liability falls to zero and there will be no IHT providing the donee retains the asset until the death of the donor or if the donor survives the gift by seven years.
The BADR tax rate will increase to 18% from 6 April 2026. Specialist advice is required to ensure the relevant conditions are met and to understand the wider implications of making these elections.
This relief is not available for shares in investment companies such as buy-to-let property companies.
For further information on anything discussed in this insight, please contact your usual Crowe contact.
Contact us
