Succession planning is critical to business continuity, ensuring that new management or family members are well-prepared to take over the reins. However, one of the most challenging hurdles in succession planning is navigating the tax implications accompanying company ownership changes. As discussed in our previous articles, “Securing Your Legacy: Ownership Succession Planning with Worth.Business” and “Unlocking the Potential of Affordable Share Ownership,” the process is often not cost-prohibitive, making affordable ownership restructuring a crucial part of effective succession planning. Yet, this comes with significant tax risks that need careful consideration.
Income Tax
Income tax implications are particularly relevant when employees acquire shares. If the succession plan involves transferring shares at a price lower than the market value, the difference between the market value and the price paid by the employee is considered taxable income. This can lead to significant income tax liabilities for the new shareholders, creating a substantial and immediate tax burden that can affect the financial stability of employees taking on new ownership roles.
Capital Gains Taxes
Capital gains taxes are a significant consideration at the time of the transaction itself. When ownership of shares is transferred, the seller may realise a capital gain, which is the difference between the original purchase price and the market value at the time of transfer. This capital gain is subject to capital gains tax (CGT), which can be substantial if the shares have appreciated significantly over time. If the transfer of ownership does not involve a physical payment—such as in cases where shares are transferred to family members or employees without immediate compensation—the seller may face a liquidity problem. This is because they will owe CGT on the transaction without receiving any cash to cover the tax liability, creating a severe cash-flow issue.
Donations Tax
When shares are transferred without consideration, they may be deemed donations and subject to donations tax. This tax is levied on the value of the gifted shares. In the context of succession planning, if shares are transferred to family members or employees at no cost, the value of these shares could be taxed as a donation. This creates a potential tax liability for the donor, who may not receive any payment to cover the donations tax, and the recipient, who may not be in a position to settle taxes, resulting in financial strain.
Estate Duties
When a shareholder passes away, their estate, including the shares in the business, is subject to estate duties. These duties are calculated based on the value of the shares at the date of death and can be substantial for valuable businesses. This tax can force the sale of the shares or other estate assets to pay the duties, posing a significant risk to business continuity. Additionally, this can create liquidity issues for the estate, as there may not be enough liquid assets to cover the estate duties without selling business assets.
Avoiding Tax Hardship
Tax hardship is unnecessary and avoidable if the succession plan is structured correctly. It is crucial to obtain a tax opinion supporting the transaction, which can be important for future reference and in the event of any tax queries. At Worth.Business, we design transaction mechanisms in conjunction with tax experts to ensure the most negligible tax impact. By comparing different mechanisms, discussing all tax outcomes with our clients, and having tax experts review transaction agreements and provide written tax opinions, we ensure our clients are fully informed and prepared.
If you require professional succession planning advice for your business, let’s get in touch! Our team at Worth.Business is here to help you secure your legacy while navigating the complex tax landscape.