Mixing family with business can be a complicated process, particularly when it comes to the transfer of business ownership to children.
For many family-owned businesses, the transfer of business ownership to children is a big concern that can trigger significant taxation ramifications. This issue can be even more difficult when only one child, out of a family with multiple children, has chosen a career in the family business.
The parent’s dilemma
Before the introduction of Capital Gains Tax (CGT) in September 1985, the answer was easy: either issue the children with shares or admit them as partner/s in the business. Other than state stamp duty and a lot of accounting and banking paper work, the problem was easily solved.
Today, the story is very different. Issuing new shares or transferring existing ownership triggers significant CGT events and, as a business owner, you may be liable for staggering tax implications if you proceed. While some small business concessions may apply, bear in mind that rising business values may limit you to the concessions and discounts available.
The children’s ambitions
The children working in the business also need assurance for their future. Will they benefit fairly from their efforts over their working life? Or will these fruits be shared equally with their non-contributing siblings? And, after their parent’s death, will they be guaranteed control of the business they’ve helped to build?
In short, how do you achieve the granting of equity in the family business without losing a substantial sum of the family capital to the tax man?
A possible solution
One solution is for the working child, or children, to establish an external management entity which contracts to the family company and earns its own profit. This recognises the human capital contribution that this generation is making and will continue to make.
The management entity negotiates a commercial contract with the family business to provide the services of the working child or children.
The primary elements of a management contract ensure:
1. Financial incentives reward the management company with meeting established key performance indicators and/or exceeding financial goals.
2. Significant incentives exist for the working child to improve and grow the business.
3. Clear financial guidelines and systems are established to avoid disputes over remuneration to the management company.
4. The financial goals of the parents and the working child or children are aligned.
This solution ensures the commitment of all parties – parents and their child or children – working towards the common goal of a successful business. It also guarantees performance is measured by a financial formula geared to long-term growth and profit.
Ian Stone is with Nexia Court and Co, for information on the services Nexia Court and Co can provide, please visit their website.