Planning for generational handover is crucial, even if not immediate. In family-owned businesses, the next generation often participates in the operations already long before the formal transition. Early involvement, understanding the legal and financial aspects, and considering options like sales or donations can facilitate a seamless transition. Ensuring a smooth generational handover is vital for the legacy and success of family businesses.
Although this article deals with generational handover from the perspective of the Finnish law, it provides ideas on how generational handover can be arranged in other countries as well.
Generational handover – the essence of planning
A generational handover refers to the process of transferring ownership of a family business from one generation to the next. A generational handover can be carried out in various ways during the entrepreneur’s lifetime, by, for example, sale, donation-like sale, or as a donation. Careful planning is crucial for tax implications and ensuring a smooth transfer. In generational handover, a business or part of it is transferred from the entrepreneur to their successor, often by donation or at a reduced price.
When planning a generational handover, it is essential to consider the specific needs of the company. Identifying the key elements needed for the company’s success and understanding the needs of both parties involved are vital to ensuring a seamless succession process.
Below are some key considerations to keep in mind when planning a generational handover:
- Early Involvement: Engaging the next generation early in the business can foster interest and prepare them for future leadership roles.
- Legal and Financial Planning: Understanding the legal and tax implications of different handover methods, such as donations or sales is essential. Consulting with local experts can help ensure a tax-efficient transfer.
- Retaining Control: Entrepreneurs may choose to retain certain rights, such as voting rights or dividends, to maintain control and financial security during the transition period.
- Clear Communication: Open and transparent communication between the current and future leaders can help align goals and expectations, ensuring a shared vision for the business.
- Training and Development: Providing the next generation with the necessary training, mentoring and development opportunities can help them acquire the skills needed for successful leadership.
By carefully planning for generational handover and addressing these key factors, entrepreneurs can secure their legacy and foster a seamless succession, ensuring the continued success and stability of the family business.
Methods for generational handover
As outlined above, there are several approaches to conducting a generational handover. As part of a generational handover the transferor may transfer as many shares as he or she considers suitable to one or more successors. Below is a brief description of the most common methods and their respective benefits.
Each of the succession methods outlined below has distinct advantages from both a business and economic standpoint, as well as from a tax perspective. It is essential to seek professional advice to determine the optimal solution for your family business.
The sale of shares and donation-like sale of shares
The sale of shares can be an effective method for generational handover. In this approach, the current owner sells a part of or all shares in the family business to the successor, usually to a family member. This approach ensures financial liquidity for the transferor.
If sold within the family, the sale price is often set below the fair market value. If the shares are transferred below the market value, so that the consideration is less than 75 % of the fair value of the asset, the transfer will be treated as a donation-like sale. The difference between the price and the market value is considered a “donation” from the transferor to the successor.
In the event of a generational transfer involving the sale of shares, the transferor may be subject to transfer tax. In the case of a donation-like sale, the successor could be subject to gift tax for the difference between the market value and the actual price, see next subtitle “Donation of Shares”.
Donation of shares
In Finland, transferring shares in a family business from one generation to the next without payment is seen as a donation and subject to gift tax. If the shares are transferred to a direct descendant (e.g., a child), tax benefits often apply. Donation may be a good option if the transferor has the economical possibility to transfer the shares for no consideration since the gift tax is usually lower than the inheritance tax in case the shares would pass through inheritance.
The donation of shares in a generational handover provides both the transferor and the successor with significant tax benefits and flexibility in planning for the future of the family business. For the donor, it is free from any capital gains taxation and helps with estate planning, while the successor benefits from lower taxes and a smoother transition into ownership without the need for immediate capital outlay.
Donation of shares with the right of possession
An entrepreneur transferring shares in a family business by donation may retain possession rights to use the property (e.g., voting rights) or receive benefits (e.g., dividends). This can be for a set period of time or for life, often until retirement or until the next generation reaches a certain age.
Retaining the right of possession to the shares enables the entrepreneur to maintain control over strategic decisions and the direction of the business, ensuring that the vision for the business continues to be followed during the possession period. By retaining the right of possession to the shares, the transferor can secure his or her own financial maintenance, allowing the entrepreneur to benefit from ongoing income, while gradually integrating the successor into the business.
Under the Finnish Gift Tax Act, the successor usually pays gift tax. Since the retention right limits the recipient’s rights to the shares, the value of the retention right, calculated according to the instructions of the Finnish tax authorities, is deducted from the taxable amount, reducing the tax burden.
Importance of documentation
To ensure that the possession of any rights is properly recognized for tax purposes, it is important that such rights are expressly set out in the deed of transfer or in other formal documentation.
Finally
In conclusion, planning for a generational handover is crucial for ensuring the future stability and success of a family business. Engaging the next generation early, considering various transfer methods such as sale, donation and donation-like sale are essential. By managing these factors, entrepreneurs can smoothly transfer ownership, maintain their legacy, and maximize tax efficiency.
However, the regulatory landscape requires careful planning to ensure compliance. Therefore, entrepreneurs should seek professional advice to effectively plan and execute the handover and to avoid surprises.
– by Heikki Wide and Sara Mäkinen.
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