Succession planning for the family business is one of the most frequent discussions I have with clients, alongside the size of the tax bill.
The two can go hand in hand – by structuring the business appropriately profits can be protected to create a stronger and more profitable business for the next generation.
Separating out or diversifying parts of the business can give greater flexibility in planning how assets are passed on in the family. Tax paid now and in the future can be significantly reduced by using a company structure for part of the business, whether this is an established farm enterprise or a new venture. However, lower company tax rates do not mean that a company is always the answer.
Low corporate tax rates mean that trading as a company can be very attractive – corporation tax is levied at about 20%, compared with the additional top rate of personal income tax at 45%. So, as long as you don’t extract profits in the short term, there is more to invest back into the business with a company than if trading through an unincorporated structure.
Every £100 profit/cash earned within a company could leave £80 left to repay debt or be available for further investment. The same £100 for an unincorporated trader paying tax at higher rates of tax and national insurance could leave just £58.
However, a decision can’t and shouldn’t be made solely by focusing on the tax of the income.
Capital tax reliefs for farm businesses are equally important. For example, incorporating the whole of the farming business and leaving the property assets outside the company may restrict very valuable inheritance tax reliefs, particular where the farmhouse is concerned.
Equally, where non-trading activities such as rented property income grow to become a significant part of the total income, moving these to a separate company may protect the capital tax reliefs on the main business.
Separating out a trade or activity can give an opportunity to consider how assets are passed to the next generation.
For example, a daughter may want to take on the day-to-day farming operations, but a son who has trained as a land agent may be more interested in managing property interests such as rented cottages or commercial lets in converted buildings.
Rather than having one global business, a company could be formed to carry on the farming work by contracting for the home farm and third parties, while a land owning family partnership can retain the property rental business alongside the farm.
Setting up a contracting company
It is important in many cases to establish for tax purposes that a trade is being carried on, rather than simply an investment. Through a properly organised whole farm contracting agreement, HMRC accepts that the landowner is still farming.
There is no problem with the landowner/farmer and the contractor being connected. With the right mix of crops and particularly if there is some external contract work, the machinery and labour can be put into a separate company to then contract to the home farm. An element of profit can be protected at corporate tax rates and used to reinvest in future machinery purchases.
The company can also benefit from limited liability, should there be an uninsured loss.
Diversifying for profit
Diversification does not have to mean setting up a paint-balling venue. There are many different types of diversification projects, such as energy generation, in which farm businesses are investing.
Using a company can protect profits in these projects and also help in other ways to maximise tax reliefs and VAT recovery, while ring fencing the core business from new risks.
A client recently installed a district heating scheme which earns income through Renewable Heat Incentive (RHI) payments. Because most of the heat would be supplied to the main house, there were considerable restrictions on the availability of capital allowances and ability to recover input VAT.
But by setting up a company to be an energy producer, not only will capital tax reliefs be available on the shares after the qualifying period, the trading business can recover the VAT and claim the capital allowances.
In cashflow terms the household still pays for its heat to avoid any benefit in kind charge, but the cash is used to repay the initial financing and is still within family control rather than paying a third party energy supplier.
So, a company can be a useful vehicle in the right circumstances to protect profits from tax and provide a vehicle to aid decisions on succession. However there are many traps, so it is important that consideration of any restructuring begins early so there is time to ensure that the most efficient solution is reached.
Should I set up a company?
Possibly. A company could reduce your tax bill, but consider first if you have you used all available tax reliefs under your current structure:
- Annual Investment Allowance – plant and machinery allowances are currently very generous – up to £500,000 a year of which you can set the whole against income. However, watch the dates – the current rate of allowance runs until 31 December 2015 and what you can claim will be affected by your accounting year end.
- Pension contributions – can be used to work for you and the business by using the family scheme to invest in buildings such as grain stores
- Are profit sharing arrangements among the family as beneficial as they could be?
- Can you make use of farmers’ averaging to reduce tax bills where profits fluctuate?
What can I use a company for?
A company can be used alongside existing business structures to protect profits and to aid succession planning.
Consider: A contracting company for the home farm
Separating different activities (livestock and arable), especially where there is a separate management agreement, for example pigs, or capital intensive investment such as free-range eggs.
Diversification projects such as a swimming pool for hire, district heating scheme, farm shop, B&B, caravan site.
Company health warning
While there are many ways you can use companies to supplement existing arrangements, you need to be careful. The use of a mixed partnership structure has grown in farming over recent years.
This is where one of the partners is a limited company, taking a profit share without contributing significantly to the partnership business but benefiting from low company tax rates. In future such the company partner in such arrangements will simply be taxed as if it were an individual.
It is also important to understand that a company structure brings with it obligations and legal requirements which vary with the size of company. These include strict deadlines for filing reports and accounts, also the need for personal and company funds to be kept separate.