Succession of a family-owned business: tax aspects

Lack of adequate planning for the succession pf family-owned businesses leads to high business mortality, which prevents a successful generational handover and has negative effects on family economies and employment.

Therefore, the succession of a company must be approached by means of planning that allows the testator’s will to be reconciled with tax optimisation in order to minimise tax costs and so that the successors do not have to bear such a high tax burden that it hinders the continuity of the business.

Below we focus on the tax aspects of family business succession. In the following article you will find information on the main legal aspects.

1. Tax planning and preparatory operations: what are the advantages of a holding company?

Before making a will, it is important to carry out an evaluation of the testator’s estate and, if necessary, to carry out any restructuring operations deemed appropriate.

The incorporation of a holding company involves the contribution by the members of the family group of their shares in the various entities to a newly created parent company. The shareholders only participate in the parent company and from there control the group companies, which are wholly owned by the holding company. This facilitates organisational and strategic management, in a centralised manner, minimising risks and creating a group image, and also allows for the optimisation of the taxation of the group as a whole.

Furthermore, the holding company is an ideal instrument to benefit from the Wealth Tax (IP) exemption applicable to shares in companies, as well as the reductions in Inheritance and Gift Tax (ISD) and the exemption in Personal Income Tax (IRPF) for the donation of a company.

The contribution of shares in group entities to the holding company may give rise to a capital gain for the contributing shareholders that is subject to Personal Income Tax. However, this restructuring may benefit from the deferral regime of Corporate Income Tax (IS), which allows the taxation of this capital gain to be deferred until the time when the share in the group is transferred.

On the other hand, structuring the group vertically, i.e. through a holding company, reduces the tax cost of dividend distributions, since dividends are only subject to Personal Income Tax when they are distributed by the holding company to the shareholders, but not when they are distributed by a subsidiary to the holding company (in which case they are subject to the holding company’s Corporate Income Tax with a 95% exemption). The holding company is also necessary to benefit from the tax consolidation regime, which allows the profits of some group entities to be offset against the losses of others, so that only the consolidated profit is taxed in Corporate Income Tax.

2. Taxation: cases that may arise in the succession of the family business

2.1. What reduction applies in the event of death?

State legislation provides for a reduction in ISD of 95% (or more in some Autonomous Communities) for the mortis causa acquisition of the family business. The purpose of this reduction is to prevent the generational takeover of the company from leading to its death due to the lack of liquidity needed to pay the tax, thereby preserving the business and employment.

The requirements to be able to benefit from this reduction are, in summary, the following:

a) The company shares must be exempt in the IP of the testator. This exemption requires that the company carries out a real economic activity (it does not apply to asset-holding companies), that the shareholding of the deceased is at least 5% (or 20% together with the shareholdings of his spouse, ascendants, descendants or second degree collaterals), that the deceased had been effectively exercising management functions in the company and that he received most of his income from work or economic activities for these functions.

b) The successor must be the spouse or descendant of the deceased; in the absence of either of these, ascendants and collaterals up to the third degree may apply the reduction.

c) The successor cannot transfer the shares within 10 years of the death of the deceased.

2.2. What reduction applies in the case of a donation?

In the case of a donation of shares, a reduction in the ISD of 95% is also applicable, provided that the following requirements are met:

a) The shares must be exempt from the IP of the donor.
b) The donee must be a spouse or descendant.
c) The donor must be 65 years of age or older, or in a situation of permanent or absolute disability or severe disability.
d) The donor, if he/she was exercising management functions, must cease to exercise them and cease to receive remuneration for them from the time of the donation.
e) The donee must keep the acquired shares and the right to their IP exemption for at least 10 years, unless he/she dies earlier.

Many Autonomous Communities establish alternative reductions, sometimes with higher reduction percentages and with different requirements.

The donation of shares implies a capital gain for the donor, due to the difference between their value at the time of the donation and their acquisition value, which must be taxed in his Personal Income Tax. However, this capital gain is exempt if the donation can benefit from the state reduction of 95% in ISD.

Due to the wide variety of situations in which a family business and its shareholders may find themselves, it is advisable to obtain comprehensive advice that takes into account all aspects, in particular succession and taxation.

At Lozano Schindhelm, we provide advice on the succession planning of the company with the aim of achieving continuity after the generational handover and the tax and organisational optimisation of the process.