HMRC plan could nearly double tax bills on family business handovers

A £1m family business handover could see the tax bill swell from £200,000 to roughly £393,000 under plans Treasury officials are weighing for Chancellor John Healey's maiden Budget. The target is a little-known structure thousands of retiring founders rely on to pass their companies to their children.

The machinery under review is the 'redeemable preference share'. Retiring founders' families rarely have the cash to buy their parents out, so the company issues the founder shares that freeze their stake and pay out capital gradually as the firm makes profit. The children take immediate control. It's a bridge, and it's been the standard route for staged succession for years.

Those deferred repayments are currently treated as the sale of an investment, charged at capital gains tax rates of between 10 per cent and 24 per cent. HMRC's consultation, published in the summer, proposes to stop recognising the current real value of the shares being bought back. Instead, returns would be capped at what founders originally invested when the shares were first issued — and everything above that baseline would be taxed as an income dividend.

What does this change for retiring founders?

For higher and additional rate taxpayers, the numbers nearly double. Dividend tax runs between 35.75 per cent and 39.35 per cent. On a £1m handover, that's a jump from £200,000 to about £393,000 — a level that makes it financially unviable for the next generation to pay off their parents without draining working capital or selling the business outright.

Mark Goddard, tax partner at KPMG, warned in his consultation response that the overhaul could put families at a "disadvantage" to third parties and ultimately discourage generational ownership. That's the uncomfortable subtext of the whole exercise: Treasury officials have been mulling an overhaul of company distribution rules that would make selling to private equity more attractive than handing the firm to your own children.

The headline proposal — making generational transfers liable to income tax rather than capital gains — has already sparked uproar from entrepreneurs. But Chris Etherington, tax partner at RSM, told City AM the consultation also contains proposals that are "much more troubling" than the capital gains clampdown. The preference share changes are the buried one.

Etherington said the government is "trying to clamp down" on people who may be taking "advantage of the rules to try and get capital gains tax treatment" where income tax should apply. But he urged caution: "As a government, don't… throw such a large net over it that you capture innocent scenarios that fundamentally stop businesses from being passed down to the next generation or to third parties in the right way."

"It could impact management buyouts, it could impact family buyouts, people just wanting to retire. We don't want to do that. That's bad for the economy," he added.

The two-year trap

A second proposal in the HMRC plans targets the conditions for share buybacks. Under current legislation, companies can buy back shares from retiring founders out of accumulated profit over several years, protecting everyday capital for taxes, suppliers and wages.

HMRC is debating a strict two-year cut-off for qualifying for capital gains treatment. If a departing founder still holds shares beyond the 24-month window, the company loses the tax break and the payments become subject to income tax. Advisers warn that forcing businesses to complete buybacks inside two years leaves them badly exposed to supply chain shocks or other disruptions — it's a much shorter timeframe than most succession plans assume.

HMRC did not respond to a request for comment. With the Budget still to come, founders planning a staged exit now face a live question: accelerate the handover under current rules, or wait and risk a regime where passing to family costs nearly twice as much as selling up.