Concern about potential damage to agriculture in the UK triggered by changes to Inheritance Tax rules in the budget has overshadowed the potential damage to the wider family business sector. Perhaps this shouldn’t be a surprise. Family businesses have always been quiet contributors to economies around the world, including the UK’s. This makes them easy victims for politicians who will always be more influenced by the noisy.

Many families owning businesses have been able to take advantage of 100% Business Relief when one generation dies, allowing the next generation to inherit the business without incurring Inheritance Tax on its value. Now Rachel Reeves, the Chancellor of the Exchequer, in her first budget, has gone against 50 years of practice by restricting the relief to 50% of assets over a value of £1 million, thus potentially presenting the executors of a will of a family business owner with a significant tax bill to pay when the current owner dies.

How Trusts Are Affected by the New Tax Rules

Bigger, older family businesses have often taken advantage of trusts to facilitate the tax efficient intergenerational transfer of the business, as well as to protect the business from trouble and strife among the shareholders and threats from unwanted external acquirers. But the new rules will introduce IHT payment implications for businesses held in trust as well, as their ability to use business relief to restrict the effect of the 10-yearly 6% IHT charge otherwise imposed on many trusts will also be reduced, leaving trustees looking to the business to generate cash periodically to pay the taxman. The ability of family businesses to seek the shelter of trusts in the first place will also be impacted as the transfer of a business to a trust is also a potentially taxable event which will no longer be able to benefit from relief to nearly the same extent.

The implications of all this have yet to be considered in full – including by the government. As Sir Michael Bibby, chairman of sixth-generation family business Bibby Line Group, and also chairman of the Family Business Research Foundation notes, ‘There are stats out there showing how much additional tax is going to be raised, but very little research has been done into the other consequences. I worry that there are going to be a lot of unintended consequences.’

Of course, the Chancellor’s logic is simple: if you own a company, why shouldn’t it be added to your estate for tax purposes when you die, along with your house, your money, your car and your other assets? The logic is particularly compelling if you are sympathetic to seeing IHT as a means for facilitating wealth redistribution. And there are many who share this logic – and not just those from the left. Some individuals who have accumulated considerable assets, business and otherwise, as a consequence of their own efforts have long since served notice to their potential beneficiaries not to expect anything when they themselves have gone; if the next generation wants wealth, then they too will need to earn it for themselves. Marlene Engelhorn, inheritor of a £21 million legacy as consequence of her membership of the founding dynasty of BASF and also an advocate of wealth distribution, made the news this year when she announced that the bulk of her fortune is to be redistributed. Ms Engelhorn is Austrian where there’s been no inheritance tax since 2008 and obviously, she is a fan of the Chancellor’s logic – indeed she has argued for inheritance tax to be reintroduced in Austria. But, as the US mathematician and philosopher Morris Kline observed, ‘logic is the art of going wrong with confidence.’ Is the Chancellor’s move to tax family businesses on transfer an expression of this particular art?

Will the £1 Million Threshold Hit Small Businesses the Hardest?

The Chancellor’s claim that only businesses worth more than £1 million will find themselves subject to IHT does seem a bit disingenuous. A business worth £1 million is still a very small business – particularly, as farmers have asserted, if it sits on and includes a sizeable plot of land – or any other valuable business-critical asset for that matter. More importantly, family businesses typically do not see themselves as ‘owners’ of business assets so much as ‘stewards’, doing their best to preserve the integrity of the business and pass it to future generations. Lumping the business in with the ISAs – and indeed the pension fund, which has also now been brought within the scope of IHT – looks like wilfully misunderstanding what ‘family business’ is all about. Business leaders, entrepreneurs, farmers, and former TV motor-journalists now acting as farmers, have been lining up to reinforce these arguments, some claiming that family businesses will see their investment strategies impacted for the worse as a consequence, and others going as far as to say that some family businesses and farms will have to be sold or even shut down for good. For the Chancellor to argue that the emptiness of the nation’s coffers now demands that family businesses do their bit also seems disingenuous, not least as the amount likely to be raised is miniscule compared with, say, the amount that might have been raised if duty on petrol had been increased – an option which the Chancellor passed on. Besides, critics are beginning to grumble that the IHT raised might well be more than offset by the damage done to a significant pillar of the economy.

Early Succession Planning: A Necessary Shift for Family Businesses?

IHT, for example, will not be due if the asset is transferred more than 7 years before death. Expect a flurry of family business owners to start succession planning earlier than they were otherwise intending. Of course, this might be a good thing: many advisers suggest that it is a bad thing to start succession planning too late. On the other hand, early planning might well lead to the wrong decisions being taken by those too young and therefore not ready to take them. Either way, family business advisers will probably see more work coming their way, as will those involved with valuing business assets. Back to those ‘unintended consequences’ again.

Are There Lessons to Be Drawn From Other Countries?

Detailed research again needs to be done, but the lessons are likely to be complicated and difficult to interpret. The Daily Mail, as is to be expected, refers to ‘Labour’s Sweden-style Tax Revolution’, suggesting that the budget will take the UK’s tax take as a percentage of GDP closer to ‘countries such as Sweden and Norway.’ At the risk, perhaps, of stating the obvious, The Daily Mail doesn’t think this will be a good thing. However, those who admire Sweden and Norway’s high tax and spend economies should note that neither country, along with Austria, imposes inheritance tax at all. On the other hand, Germany’s Mittelstand has long been cited with admiration by UK business leaders and politicians alike as providing a model for how to nurture successful family businesses with a long-term perspective – but German policy makers have for a long time been enthusiastic proponents of inheritance tax. The German inheritance tax regime has considerable complexity and nuance, with significant exemptions for some businesses, farms and forestry. Interestingly, the exemptions in Germany in some circumstances are tied to the business continuing to maintain a wage bill above thresholds set in the tax code – which at least shows that the German code attempts to respect and foster the act of ‘stewardship’ which is a key objective for so many family businesses. The German code also overtly taxes beneficiaries rather than estates and sets different rates dependent on all sorts of variables including the distance in family terms of the beneficiary from the original owner. ‘German business leaders do complain about their tax system,’ observes Christian Buhring-Uhle of succession, corporate and family business consultants AvS Advisors based in Munich, ‘But it’s not inheritance tax they complain about so much as corporation taxes, and the sheer complexity of the system which means that most people really don’t understand how it works.’

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About the author: Rupert Merson is a leading authority on owner-managed, entrepreneurial and family businesses and the problems they confront as they seek to grow. He has worked as a consultant and facilitator for clients on a broad range of issues including formation, governance, strategy, ownership, remuneration, succession, turnaround and organisation development. As an advisor, Rupert was a partner in BDO Stoy Hayward in London from 1993 to 2009. He now leads his own firm of advisers.

As Adjunct Professor of Strategy and Entrepreneurship, Rupert currently teaches a range of MBA electives on owner management, entrepreneurship, family business and corporate turnaround, and frequently teaches on executive education programmes on strategy and organisational development including the recently launched Leading the Family Office executive education course.

Rupert also mentors LBS students and alumni through the Family Enterprise Mentoring Programme run by the Institute of Entrepreneurship and Private Capital (IEPC) at London Business School.