How to tie up legal and tax succession issues

Handing over a business can be fraught with hard-to-grasp legal intricacies and tax implications.

So it is perhaps unsurprising that many prefer to stick their heads in the sand rather than attempt to get to grips with the basics of succession planning.

But the consequences of this can be catastrophic both from a business and personal perspective.

Although less than half of farmers interviewed by Farmers Weekly had created a succession plan, nearly 80% did have wills in place.

See also: Why it’s time to talk about succession planning

This indicates that most want to pass on the business and assets to the right person, but have not necessarily tied those wishes into their succession and tax planning.

“It is essential that your succession plan, wills, pensions and investments work together to achieve the required outcome, and that your family are involved in that decision-making process from the outset,” says Sean McCann, chartered financial planner at NFU Mutual.

Succession in numbers

Our research shows 72% of farmers think a succession plan is important to ensure the future of the business, so it is vital all stakeholders have a valid will and, where appropriate, a partnership or shareholder agreement in place.

This will ensure the ownership of the business ends up in the right hands at the right time.”

When it comes to drawing up a plan, the first step is to really understand ownership of the asset and business, says Tom Hewitt, private client partner at solicitor Burges Salmon.

“That may sound obvious, but family businesses may be split between a number of different relations and generations.”

Sometimes, there is a mismatch between what the family believes to be the case and the legal reality.

A common example is where the farm is thought to be owned by the older generation outside the partnership. But the partnership accounts have, for many years, shown it as a partnership asset.

In those cases, there may well be an argument that part of the farm’s value has already shifted to the younger partners.

Separate business ownership from control

Mr Hewitt says it is often best to treat ownership and control of the business separately.

“Ownership is most important from a tax perspective – but control may be most important to some family members, and there are a number of ways to achieve that split.”

In a partnership, the parent can remain a managing partner with weighted voting rights, while handing over a larger partnership share to their children.

In a company, it is possible to create a shareholders’ agreement or different share types for voting and assets.

Alternatively a trust could be created to pass on ownership while the trustees retain control, he adds. “The good thing about trusts is they are flexible, so if circumstances change the trustees can act accordingly.”

Start the discussion early

The important thing is to begin the family discussion early, and ideally create a succession plan in conjunction with lawyers and an accountant, says Mr Hewitt.

“They can provide guidance on the scope of the plan, and ensure everyone understands it.” They will also take into account the likely effect of divorce, incapacity and the need for well-written wills.

Dying intestate – without a will – means farmers have no control over who receives their assets or business, and could result in a hefty inheritance tax (IHT) bill, he explains.

“When writing a will, you also need to tailor it to reflect your succession plan, and to account for potential changes in your financial and family circumstances.”

Farmers should also consider what happens in the case of incapacity, and create lasting powers of attorney for their financial affairs.

Future-proof succession plans

“It is critical for the continuity of the business that someone can sign the cheques and make business decisions.”

Future-proofing succession plans also involves the emotive subject of divorce. “We are doing a lot of pre-nuptial agreements now.

“If they are reasonable and prepared properly, with both sides taking legal advice, the courts should follow them – and it is something we definitely recommend,” says Mr Hewitt.

Tenant farmers have another interested party to consider: their landlord. “Even if you have a good relationship, don’t assume your landlord wants the succession to happen.

“For Agricultural Holdings Act tenancies with succession rights, you have to consider whether someone in the next generation is eligible and suitable.

“The landlord is perfectly entitled to test those questions and the process is not quick or certain until the tribunal has made a decision.”

Maximise tax efficiencies

More than 60% of farmers see succession plans as useful for maximising tax efficiencies, with the two key taxes being IHT and capital gains tax (CGT), says Mr McCann.

“Agricultural property relief [APR] and business property relief [BPR] can help to reduce or even eliminate IHT on farming and other qualifying business assets.

“However, there are many potential traps, particularly for diversified farms, so it is important to get advice to maximise the benefit.”

As long as the landowner lives for seven years after gifting an asset, and doesn’t reserve any benefit, an asset will qualify for 100% IHT relief, says Mr Hewitt.

However, where a benefit from it is reserved then the gift may incur IHT on death – and that can happen accidentally.

“For example, if you pass over a significant interest in the partnership, you must also hand a similar share of profits.

“One way round this can be to hand over the farm to the next generation and rent it back to the partnership. That way you can retain your interest in the partnership and continue to take a profit share.”

Avoid the inheritance tax trap

The biggest IHT trap is where the older generation continue to live in the farmhouse and let out the land for grass keep, he warns.

“HMRC assumes such an arrangement is akin to a tenancy, so the farmhouse is not eligible for APR. We see it time and again, so it must be tackled in the succession plan.”

CGT is often forgotten about, but arises both on the sale and gift of assets, says Mr Hewitt. “Provided the asset is used for agriculture, it should be eligible for holdover relief, so the gain becomes the liability of the beneficiary, should they sell or gift it on.”

Assets such as let buildings and cottages are more likely to attract CGT, so businesses should be prepared for that liability, he adds.

So, the legalities and tax issues have been tackled – but for succession planning to operate smoothly, it is essential that the older generation plan for their retirement, says Mark Chatterton, director at accountants and business advisers Duncan & Toplis.

Physical retirement v financial retirement

“There is a difference between physical retirement and financial retirement. Everyone needs to have a pension and by the time you reach 75, if not before, you really ought to be triggering your pension and reducing your income from the business. It is time to step back from being the key decision-maker and retire gracefully.”

So at what age should people start paying into a pension? According to Mr Chatterton it should be from their early 20s, even if it starts out as a relatively small monthly sum.

“The fund will grow, and when you have a profitable farming year you can put in larger sums, which will reduce your income tax liability,” he says.

“Once you have a pot of £100,000 or more you can start looking at using a self-invested personal pension [Sipp] to buy farm assets such as land or buildings.”

However, converting those assets back into cash that can be drawn down or used to purchase an annuity can take time, so it is vital to plan ahead.

“The ideal scenario is for the younger generation to build up their own fund, and buy the asset off your Sipp into their own, but that can take years.”

Diversified assets

Many landowners rely on diversified assets – such as residential property lets – to provide their income in retirement. But property let to non-agricultural occupiers does not qualify for APR from IHT, so it may be better to hold farmland and take a rent from that, if the business can sustain it.

Pension rules mean that from the age of 55 a 25% lump sum can be taken tax-free from a pension fund, which perhaps can be used as a deposit on a smaller house, freeing up the main farmhouse for the younger generation, says Mr Chatterton. “Another alternative is to do a house swap.”

One subject that few people like to broach is the possibility of the older generation needing nursing home accommodation.

But given that this costs an average of £38,000 a year, and often considerably more, it is something that should be planned for, he adds.

“If the older generation gifts away capital, there may need to be a written agreement that the recipients pay for any future nursing home fees.”

An alternative is to consider an insurance policy to cover the fees.

The consequences of getting it wrong

A sharp increase in family farm litigation in recent years highlights the importance of inclusive and watertight succession planning.

“Formal partnership agreements and contracts are very useful, but rare – only 40% of respondents to the Farmers Weekly survey had a partnership agreement in place,” says David Kirwan (right), senior partner at Kirwans solicitors.

Common arrangements include youngsters working on the farm for minimal pay, on the understanding they will inherit the farm, which may not happen due to a conflicting will or the lack of a will.

“Do something now, like allocating shares in the company or partnership – don’t wait until someone dies, as the result is often acrimonious and disastrously expensive.”

Creating the right business structure around different farm enterprises or diversifications can make succession and tax planning simpler, says Mr Kirwan. “You need to look at the viability of a business after death; don’t leave problems for your children to inherit.”

Under intestacy rules, the spouse typically receives a large proportion of the estate, with the balance split between offspring – potentially creating considerable tax liabilities and uncertainty.

“Even a will isn’t set in stone – it must be revisited regularly as it will be voided upon marriage and divorce, and can be contested after death if it doesn’t reflect your wishes or those of the family,” says Mr Kirwan.

“The worst litigation of all is between family members, so be open, transparent and proactive or you could dissipate the entire value of the estate in legal costs alone.”

Case study: The Mercer family

Robert Mercer with sons Tom Robert and Alec

Roger Mercer with sons Tom (left) Robert (middle) and Alec

Roger Mercer and his sons Tom, Robert and Alec are the fourth generation to manage the 1,600ha mixed farming estate at Blakenhall Park, Burton on Trent, Staffordshire.

Roger believes there is an intermediate step when it comes to succession, and that is to encourage the younger generation to grow their own business.

“Rather than just waiting for someone to retire, the idea is that the younger generation build up their own future,” he says.

“I believe young people are better in control of their own destiny as soon as possible, and certainly before they are 30. The way to drive a family business forward is to give them that control.”

Mr Mercer encouraged his sons Robert, Alec and Tom to set up their own enterprises on or off the home farm when they were in their mid-20s.

Under one brand, all on one farm

Robert now runs a free-range pork business, with Alec producing free-range poultry, both of which are sold under the Packington Free Range brand.

Both are based on the farm, renting the land off the main Mercer Farming operation, with borrowings secured on family assets.

Tom had the same opportunity to leverage against family assets, and launched Moma Foods in London, selling oat-based breakfast products.

“Succession models need to cope with those who do not work within the family business,” says Mr Mercer.

“He attends our quarterly meetings as a non-executive director and has a stake in some of the business.

“We have a mixture of companies, partnerships and other entities – each of the boys holds 75% of their own business and the rest of the family shares 25%, to spread the risk,” he adds.

Share and share alike

“It also helps build the total family pot so that when succession does happen there is more to share between family members.”

The family holds quarterly board meetings, with an independent chairman, and keeps most of the land in trust, separating business and assets.

“There is no answer that fits all farms, but there is so much enthusiasm and drive in youth it is a shame not to make the most of it,” adds Mr Mercer.

“Many of the older generation fear handing over the reins, but you don’t have to pass over the farm and disappear into the sunset.

“It is about creating a business structure that gives the younger generation control.”

NFU Mutual logoThis article is brought to you in association with NFU Mutual

Succession planning is often a difficult issue for farmers.

It can be quite a daunting topic to raise with family members, whether it’s because of the emotional issues that come with retirement or how to pass on a farm fairly to siblings.

NFU Mutual believes it’s important to start having conversations now involving all members of the family who are involved with the farm and to seek expert advice on the financial implications of the options open to them.