Making sense of the numbers

15 January 2016

Susan Rix AM , Partner, Business Services |

3 word problem - 2 word solution

The issue of succession is, without a doubt, the hottest topic at family business events.  Statistically, only 35 percent of family businesses pass successfully from the first to the second generation and, of those, only a further 20 percent pass on to the third generation.  As a matter of policy, the Federal Government should be extremely interested in the issue of succession, because all the available research suggests that family businesses are more profitable and more stable than non-family businesses.  

According to the 2010 Family Business Australia Annual Report, family business return-on-investment is 30 percent higher and average debt level is 50 percent lower than for non-family business; and the average employment period of a family business CEO is 20 years, compared to only four years for a non-family CEO.  More stable and more profitable businesses mean better employment and more tax revenue for Treasury.  Keeping businesses within the family also means reducing the incidence of sales to multinational or foreign-owned entities, which we all know increases the likelihood that tax dollars will flow offshore.

In short, policy that encourages family businesses to stay in family hands makes sense.

Legislation that makes it as easy and painless as possible for generational change to occur makes sense.

So is current tax legislation crafted to ensure that family businesses can retain family ownership and remain stable and profitable into the future?

In my view, no.  The reason can be summed up in three words: CAPITAL GAINS TAX (CGT).

CGT is payable when an asset, such as a business, which was acquired or commenced after 19 September 1985, is sold for a price which exceeds its cost base.  The tax rate applied depends on a taxpayer’s own profile.  For example, a company would usually pay 30 percent tax on any gain.

As time marches on, it’s inevitable that the number of pre-September 1985 businesses will not be able to stay in the pre-1985 ownership - for one thing, nobody lives forever!  So when those businesses change hands, any future gains in value will be subject to CGT.

At present, the CGT rules apply regardless of who the parties are in the transaction.  That is, you are treated the same whether you transfer your business ownership to a multinational conglomerate or to your own children.  Under these circumstances, there is little or no incentive to keep the business in family ownership.  

Many family business owners are faced with a hard decision.  Should they...

...keep the business in the family?
(with all of the issues family business brings - including the need to identify and prepare
successors a long way before the transaction occurs)

...or just take the money and run?

After all, the tax impact is the same either way.

But there is another option that many family businesses don’t want to think about.

Under the current rules, no CGT is payable on the transfer of assets to the beneficiaries of a deceased estate.  In this kind of circumstance, there is an effective CGT rollover to the new owner of post-1985 assets, while pre-1985 assets are deemed to have been acquired by the new owners at the market value as at the date of death.  The message here is, under the current rules, the most tax effective succession outcome arises when the owners die.

Many family businesses are structured as trusts in an attempt to avoid the payment of CGT on changes of ownership, but such structures are inherently limited in dealing with many succession issues, and are increasingly on the ATO radar in any case.

My two word solution to this dilemma is: ROLLOVER RELIEF.

That is, when a family business, or shares in a family company, is transferred within a family group, the new owners take on the same CGT cost base as the previous owners, and no CGT liability is triggered.  CGT is only triggered if the business is sold outside of the family group.  If this happens, CGT would be calculated on the old cost base so that, eventually, the same amount of tax revenue would be generated from the sale as it would have, had each transfer been taxed along the way.

Food for thought: with the knowledge that they could pass down the family business tax-free, how many more family business owners would factor that into their succession plans a lot earlier; and what impact might it have on increasing the ratio of family businesses that make it past the first generation?