SUCCESSION PLANNING - FARM AND BUSINESS
We have a long history of acting in matters of both farming and business succession planning. Succession planning covers a wide area, not only because of the numbers of areas of law it traverses, but also because of the interdisciplinary nature of the problems that can arise.
Succession planning necessitates the involvement of a lawyer with a high level commercial agreement drafting skills, and also knowledge in wide areas of law including capital gains tax law, income tax law, duty law and often trust and/or corporations law.
A successful succession plan should also involve the client’s accountant and financial (and/or agricultural) advisor.
Often there can be relationship impediments to completing the succession plan, in which case, it may be wise to involve a counselor or other person skilled in dealing with relationship issues in a succession planning context.
Farm Succession Planning
Farm succession planning refers to the orderly transfer (usually over time) of management, responsibility, ownership and control of farming assets from one generation to the next generation. Succession is like any other plan in that the earlier you start, the more options you will have.
You firstly need to ascertain if anybody wishes to carry on the farming business, as there will not be a succession plan if nobody wishes to continue to farm. Once you have a successor, there are a number of issues to be considered in a succession plan:
- Moral entitlement - discuss the contribution of each generation to the development of the family assets;
- Respective needs - identify the needs and wishes of each family member in each generation;
- Transfer of control - consider transferring management and control of the farm, usually over time;
- Ownership transfer - consider how to transfer ownership of the farm;
- Relationship maintenance - manage the process in a way that maintains and repairs relationships between family members repairs; and
- Non-farming children - consider what provision to make for non-farming children.
Firstly, any succession plan must be based on an understanding, even implicitly, of the value of the respective contributions of the outgoing generation and the successor generation to the development of the farming and assets and, where applicable, the off-farm assets. Often the basis of a dispute between two generations is that each has a very different view of the value of their respective contribution to the farm assets. It is desirable to have an open discussion about this.
A family may, for example, decide that a son who has been on the farm working for a limited wages over 25 years (during which time the farm assets have greatly expanded) and the parents who have been on the farm for 40 years, and have spent some of those years in semi-retirement, have made roughly equal contributions to the assets. This does not necessarily mean that each generation will take a half-share of the total asset pool. That division will depend upon the circumstances, including the needs and wishes of the respective parties. It is just that a clear view of the value of the respective generational contributions is a good starting point upon which to ground any succession plan because both generations are then more likely to feel that their contribution has been appropriately respected.
The needs of the outgoing generation will include having sufficient income and security to live a reasonable lifestyle and the needs of the continuing generation will include having an economically viable farming operation. Often the continuing generation will have high financial needs because the cost of education in children and servicing debt. On the other hand, the outgoing family will probably have dedicated their working life to the farm and understandably they want a reasonable standard of living in retirement.
The financial position of the family farming operations vary greatly. Where there is a very successful farming operation with little debt and extensive off-farming assets, the needs of retiring generation on the one hand and the younger generation continuing to farm and on the other hand, can be easily satisfied. However, it is often the case that farms have relatively high debt levels and insufficient off-farm assets to support the retiring generation in their later years.
Farm Advisors say that, as a broad proposition, in the 1960s in the wheatbelt in an average season and with average commodity prices, farming costs where about one-third of the total returns whereas today, that cost figure is around two-thirds or higher, in some cases. This declining profitability per acre of land has led many farming families to acquire more land through debt in a bid to ensure long term viability.
Where there is significant debt, it is necessary to examine all of the options available to see how best to balance the competing needs. There are many ways to achieve this including:
- Outgoing generation is paid a lease for part or all of the farm;
- Outgoing generations still shares in the income from the farm while contributing in the form of seasonal work;
- Outgoing generation is paid out over a number of years.
Transfer of Control
Part of any succession plan involves a transfer of management and control of the farm from the older generation to the younger generation. This is usually best achieved over a period of time. It is often the case of the younger generation, usually a son, starts working on the farm after leaving school and effectively does an apprenticeship for some years and then gradually moves to take more managerial responsibility, and after retirement of his parents, he may become the principal leader on the property.
Again, the way in which this transfer of management and control is achieved, varies greatly from one farming operation to the next. Some of the older generation take a very conservative approach and are reluctant to hand over managerial control to the younger generation and this can cause relationship difficulties between the generations. In our experience, it is not often the case that the older generation hand over the control too early to the younger generation before the younger generation have acquired the appropriate skills to handle it. The converse is more likely to be the case. Understandably, the older generation may not feel comfortable in transferring control to the younger generation until they have acquired the technical skills and business management abilities to handle to task. It is usually best to hand over management control gradually to enable to younger person to learn and grow into that role.
In implementing a succession plan, consideration needs to be given to the ownership structure of the farm. The following four legal ownership and trading structures are those most commonly used by farmers and other small business operators:
A sole trader is one person trading or owning assets in their own name.
- Straight forward to establish and to operate;
- Cheapest to administer;
- Can use primary production averaging system;
- Eligible for small business capital gains tax exemptions;
- Easy to deal with in your will.
- Personally liable for all debts of the business;
- All income and capital gains are taxed in the hand of the sole trader;
- Business ceases on death.
A partnership is an association of two or more persons conducting a business with a view to make a profit.
- Simple to establish and to operate;
- Low cost to administer;
- Income is split between partners in accordance with profit entitlement;
- Offers opportunity to pay partners’ salaries;
- Partnership losses can generally be offset against other income;
- Can use primary production averaging system;
- Eligible for small business capital gains tax exemptions.
- Partners are personally, joint and severally, liable for business debts;
- Income and capital gains can only split between partners in set proportions;
- Partnership ceases on the death of a partner.
A company is a separate legal entity to its shareholders. It is controlled by its shareholders who elect the director or directors who in turn run the company. It is possible to have a company with one director and one shareholder.
- Offers potential for limited liability protection;
- Can employ shareholders and directors and therefore has the potential for salary sacrificing into superannuation;
- Company continues to exist after death of shareholders/directors;
- Company tax rate of 30% (and 28.5% for small businesses);
- Management and ownership of company can readily be divided between a number of people;
- Can leave shares under your will.
- Complex and expensive to establish and to operate;
- Corporations law has to be adhered to;
- Capital gains tax small business exemptions difficult to access;
- 50% capital gains discounts does not apply;
- Can be tax penalty tax if shareholder/directors use company money (Division 7A of the Tax Act).
Family trusts or discretionary trusts are referred as such because the trustee of the trust (which may be a company or one or more individuals) has the discretion to allocate income and capital amongst a wide range of family member beneficiaries.
- Ability to split income including capital gains amongst wide range of beneficiaries;
- Can distribute income to corporate beneficiary and use company tax rate;
- Potential for limited liability if using a corporate trustee;
- Can employ family members with the potential for salary sacrifice into superannuation;
- Can provide asset protection in event of insolvency of a beneficiary (as there is no “share” or “interest” in the trust to be attached);
- Beneficiaries can use primary production averaging;
- Can access CGT small business exemptions;
- Family trust continues despite the death of individuals;
- Ability to transfer control without triggering capital gains tax and (stamp) duty.
- Costly and complex to establish and administer;
- Lack of flexibility for estate planning (you do not have a “share” or “interest” in the trust to leave on your death);
- Does not readily allow for division of ownership and management;
- Has limited (effectively an eighty year) life span;
- Losses must be carried forward.
The Succession Plan
The nature of the succession plan itself will vary depending on each farming family’s particular circumstances, including the following factors:
- The value of the farming assets;
- The income capacity of the farming assets;
- The needs of the retiring generation;
- The needs of the successor generation;
- The contributions of the respective generations to the development of the farming assets;
- The needs of non-farming children.
Business Succession Planning
Business succession planning commonly means planning for the transition in the management and/or ownership of a business. Business succession planning is different to estate planning but is often part of estate planning. Business succession planning deals only with a business. Estate planning deals with what happens to all of your assets when you die. Further, business succession may involve the transition of management and/or ownership of your business while you are alive or upon your death or a component of both.
A properly crafted business succession plan should not only deal with the ownership and control of the business on the owner’s death or retirement, but also cover the position of the owner becoming mentally and/or physically disabled.
The business succession plan will usually include a buy-sell agreement. This is an agreement between the owners of a closely held business for the sale of the equity from one owner to the other in the event of death, retirement or disability. The buy-sell agreement will be prepared by a lawyer. However, in a multidisciplinary input is required in business succession planning and should include the accountant and financial planner (particularly in relation to insurance) as well as a lawyer.