When a business is to be handed down to the next generation, tax is often one of the factors that has the greatest impact on how the generational handover can be carried out in practice.
A sale or transfer can trigger a substantial tax bill, which can make it more difficult to finance the handover and maintain the business’s liquidity. The rules on tax succession are therefore a key tool in many generational handover processes.
In this article, we examine how tax succession – subject to certain conditions – makes it possible to defer taxation, so that the generational handover can be organised with greater financial flexibility for both the seller and the next owner.
What is tax succession?
Tax succession typically occurs when a business or shares are transferred in connection with a generational handover.
Tax succession means that the seller of a business is not taxed on their capital gain at the time of transfer. Instead, the buyer assumes the business’s tax history – including dates of acquisition, acquisition costs and the tax that has not yet been paid on the capital gains that have arisen during the seller’s ownership.
Taxation is thus deferred until the buyer, or a subsequent owner, one day sells the business without succession.
Example of tax succession
A father transfers his business to his daughter under a tax succession arrangement. The father is therefore not required to pay tax on the increase in value that has occurred during his period of ownership. Instead, the daughter assumes her father’s original acquisition cost and the accrued deferred tax liability.
If she later sells the business without succession, she must pay tax on both the increase in value that has occurred during her own period of ownership and the increase in value that she has taken over from her father.
Who can make use of tax succession?
Succession is not available to everyone. In principle, succession can be used by individuals who transfer:
- a business which they run personally, or
- shares or partnership interests in a company that carries on an active business.
The recipient must typically belong to a specific group of people, such as children, grandchildren, siblings and their descendants. In certain cases, cohabiting partners and key employees may also use succession, but only if specific requirements regarding connection, duration and documentation are met.
Why is succession attractive in practice?
The main advantage of succession is that tax is deferred. This can make a generational handover significantly easier to carry out, as the seller does not have to pay tax on their capital gain at the time of transfer.
When tax does not have to be paid immediately, the generational handover can often be carried out without a large cash withdrawal from the business’s funds to finance the tax bill. This makes succession a powerful liquidity tool.
At the same time, the model offers greater flexibility in financing, as the transfer can be structured using a gift, a promissory note and the assumption of deferred tax liability. Consequently, the transfer can be tailored more closely to the family’s financial situation and the company’s needs, rather than being dictated by an immediate tax payment.
Which transfers cannot be carried out by way of succession?
Purely private assets and companies that effectively function as cash reserves with primarily passive capital investment cannot, as a general rule, be transferred by way of succession. The same applies to transfers to persons outside the statutory group of beneficiaries.
In such situations, one must instead utilise ordinary sale, gift or other models, often combined with restructuring, if the aim is to make the business suitable for succession in the long term.
Do you need advice on succession?
Although succession can be an attractive solution, it is rarely entirely straightforward. For many businesses, it requires preparatory work relating to structure, the group of eligible individuals and valuation before the rules can be utilised to their full potential.
At Grant Thornton, we help to clarify whether succession is even possible, whether it is financially attractive for the family, and how it can best be integrated into the overall generational succession plan.
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