Transferring the family business – a tax trap

A few years ago you transferred shares in your company to your children and deferred the capital gain. One of them is now moving abroad. Your accountant warns you this might trigger a tax bill. Why, and can it be avoided?

Business succession

If you decide the time is right to hand over the reins of your business to the next generation, the tax consequences should be part of your planning. While it’s possible to legitimately avoid a tax bill by using holdover relief, it has limitations and traps you need to be aware of.

Transferring the family business

When you give shares in your company to a family member (apart from your spouse or civil partner), HMRC treats the transaction as if you sold the shares at their market value, i.e. what a person not connected with you would pay for them. This means you might face a large capital gains tax (CGT) bill despite receiving nothing for your shares. The good news is that the tax can be deferred indefinitely with holdover relief.

Holdover relief

As long as your company carries on a business (other than an investment business), the capital gain that would be chargeable can be held over until such time as the person you transferred your shares to sells or gives them away. If the latter, holdover relief can again be claimed if the conditions are met. In this way a company can be passed from generation to generation without tax charges.

Conditions. Holdover relief requires you and the transferee to make a joint claim. This is done with the claim form attached to HMRC’s notice HS295 (see The next step ). The time limit is four years from the end of the tax year in which you transferred the shares.

Trap. There are conditions and limitations to holdover relief which can mean some tax is payable. For example, the relief doesn’t apply to capital gains relating to company-owned investment assets, e.g. properties not used for the business. There’s also a tax trap if the transferee decides to move abroad.

So long and thanks for the company!

If the transferee leaves the UK and ceases to be resident for tax purposes within the six years from the end of the tax year of transfer, the gain which was held over becomes taxable. If the tax bill is significant, it might threaten the planned move.

Trap. There’s a further possible sting in the tail.If the transferee doesn’t pay the tax within a year, HMRC can come after you for it.

Tip 1. If the relocation is to work abroad for no more than three years, and the transferee then returns to the UK, the holdover relief is not lost. This needs to be explained to HMRC before they leave the UK to prevent a demand for the tax being issued.

Tip 2. When making a holdover election you and the transferee should read HMRC’s notice on holdover relief ( HS295 ) carefully. It’s tempting to simply sign a form in haste because you’re told it will save you tax without realising that it relies on meeting conditions not only now but for years to come.

Summary

Where you claim holdover relief to defer capital gains tax, it ceases to apply if the transferee moves abroad, other than for short-term work, within the following six years. There’s no escape, so it’s important that you and the transferee understand this condition when the claim is made.