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THINK TANK Can family trusts be used to plan inheritance and management control? Manish Kapur and Suvira Agarwal find out Family Businesses and Succession Planning B usiness families continue to dominate the business arena, despite India becoming a global economy. In fact it will not be wrong to argue that they continue to be the life line of the business world within the country. Challenges faced by business houses The increasing competition in the post-liberalisation era was a test of the resource capabilities of Indian busi- ness houses, both in terms of financial resources and managerial capabilities. The period was marked by internal family feuds, a conflict between fam- ily interest and business interest, and the lack of skills and competence to manage their businesses. The need to re-write the role of business families from owners to custodians and from management to guidance has been strongly realised. In today’s environment it is less real to say ‘Business as Family’ than ‘Family as Business’. Business fami- lies have been forced to reconsider their business models and the need was felt to separate ownership from management and induct professional CEOs and CFOs to run their respective businesses. The importance of a well-defined succession plan and the creation of a leadership pipeline involving training and grooming of the next generation, is valued by the families. This article focuses on the wealth created by family businesses as reflected in the ownership of the equity shares (listed and unlisted) of the family’s flagship companies. This constituent of family wealth not only needs to be preserved and protected, but also nurtured and grown further for regardless of family dynamics; Ensuring continued involvement of the family in the business and having a ‘sense of ownership’; Policies and framework for passing on the baton to future generations; Continued business management by professional CEOs; Tax neutrality / efficiencies in trans- fer of wealth to the next generation; Fund needs of individual family members (participating and non- participating) and; Splitting income among family members. Consequences of not having a succession plan Succession planning in Indian fam- ily businesses is a very sensitive issue since it requires the family’s accep- tance of a rational and professionally- managed structure of the business, especially with regard to the growing spread of the family over generations. The task has to be completed during the lifetime of the patriarch, to pro- vide perpetuity and certainty to the business that he has nurtured in his entire life. Recent experiences of leading business families, have highlighted the downfall of not laying out a well thought-out succession plan. Lack of succession planning may have certain undesirable consequences such as the following: As per the Indian Succession Laws if a person dies intestate, his wealth (investments in group companies), gets divided equally among his natural heirs l Businesses built over generations are split unless the heirs continue to work harmoniously – valua- Recent experiences of leading business families, have highlighted the downfall of not laying out a well thought-out succession plan future generations. Constituent of family wealth Wealth accumulated by an indi- vidual over his or her lifetime may be in the form of real estate, jewellery, cars, artifacts, antiques, cash, and most importantly, investments in various group companies, quoted securities, and mutual funds. Financial planning is required not only to earn wealth, but also to preserve and grow it, particularly the investments in group companies. Key objectives of succession planning While the main objective of succes- sion planning is to take care of issues such as distribution and management of wealth for the next generation, com- petitive competencies and grooming of the next generation, and motivation and retention of professionals in the business, one has to also be mindful of the following issues while drawing up a succession plan: Continuity of business and growth 22 CFOCONNECT June 2012

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Page 1: Family Businesses and succession Planningcfo-connect.com/images/article/think-tank-family-business-june12.pdf · Succession planning requires ... lished succession plans. For example,

thInk TaNK

Can family trusts be used to plan inheritance and management control? Manish Kapur and Suvira Agarwal find out

Family Businesses and

succession Planning

Business families continue to dominate the business arena, despite India becoming a global economy. In fact it will not be wrong to argue that

they continue to be the life line of the business world within the country.

Challenges faced by business houses

The increasing competition in the post-liberalisation era was a test of the resource capabilities of Indian busi-ness houses, both in terms of financial resources and managerial capabilities. The period was marked by internal family feuds, a conflict between fam-ily interest and business interest, and the lack of skills and competence to manage their businesses.

The need to re-write the role of business families from owners to custodians and from management to guidance has been strongly realised. In today’s environment it is less real to say ‘Business as Family’ than ‘Family as Business’. Business fami-lies have been forced to reconsider their business models and the need was felt to separate ownership from management and induct professional CEOs and CFOs to run their respective businesses.

The importance of a well-defined succession plan and the creation of a leadership pipeline involving training and grooming of the next generation, is valued by the families. This article focuses on the wealth created by family businesses as reflected in the ownership of the equity shares (listed and unlisted) of the family’s flagship companies. This constituent of family wealth not only needs to be preserved and protected, but also nurtured and grown further for

regardless of family dynamics; Ensuring continued involvement

of the family in the business and having a ‘sense of ownership’;

Policies and framework for passing on the baton to future generations;

Continued business management by professional CEOs;

Tax neutrality / efficiencies in trans-fer of wealth to the next generation;

Fund needs of individual family members (participating and non-participating) and;

Splitting income among family members.

Consequences of not having a succession plan

Succession planning in Indian fam-ily businesses is a very sensitive issue since it requires the family’s accep-tance of a rational and professionally-managed structure of the business, especially with regard to the growing spread of the family over generations. The task has to be completed during the lifetime of the patriarch, to pro-vide perpetuity and certainty to the business that he has nurtured in his entire life.

Recent experiences of leading business families, have highlighted the downfall of not laying out a well thought-out succession plan.

Lack of succession planning may have certain undesirable consequences such as the following: As per the Indian Succession Laws

if a person dies intestate, his wealth (investments in group companies), gets divided equally among his natural heirs

l Businesses built over generations are split unless the heirs continue to work harmoniously – valua-

Recent experiences of leading business families, have highlighted the downfall of not laying out a well thought-out succession plan

future generations.

Constituent of family wealth Wealth accumulated by an indi-

vidual over his or her lifetime may be in the form of real estate, jewellery, cars, artifacts, antiques, cash, and most importantly, investments in various group companies, quoted securities, and mutual funds.

Financial planning is required not only to earn wealth, but also to preserve and grow it, particularly the investments in group companies.

key objectives of succession planning

While the main objective of succes-sion planning is to take care of issues such as distribution and management of wealth for the next generation, com-petitive competencies and grooming of the next generation, and motivation and retention of professionals in the business, one has to also be mindful of the following issues while drawing up a succession plan: Continuity of business and growth

22 cFoCoNNeCT June 2012

Page 2: Family Businesses and succession Planningcfo-connect.com/images/article/think-tank-family-business-june12.pdf · Succession planning requires ... lished succession plans. For example,

thInk TaNK

Succession planning first requires a mechanism to untangle the complex web of shareholdings….It is desirable to remove layers of investment companies from ownership of the flagship listed company and simply transfer ownership to single or multiple trusts

tions can get compromised l Businesses may pass over to a

person who may not have the right skill sets or vision

l Decision-making becomes dif-ficult and family conflicts germi-nate

l There is uncertainty regarding business growth

l There is a negative impact on the brand or brands

l It generates uncertainty for other stakeholders, employees, inves-tors, vendors, and customers

l Wealth gets locked at the invest-ment company level

Legal heirs may have to go through long drawn out legal battles to claim their rights Further, it is a proven fact that fam-

ily businesses do not survive beyond the third generation – thus proving the age-old saying, “shirt sleeve to shirt sleeve for three generations”.

approach in succession planning

Succession planning requires adopting a two-pronged approach to ensure the smooth transition of owner-ship of group companies, and passing over the management baton to worthy successors.

Trusts and wills are commonly

used tools to transfer and bequeath wealth to family members. Family boards and family councils are tools to unite family members on common platforms for consensual business de-cisions, based both on the experience of elders and enthusiasm of the youth.

As reported in the press, the GMR Group, the Murugappa Group, the Tatas, and Dabur are some illustrative business families that have well-estab-lished succession plans. For example, in the Tata Group, trusts hold a major-ity stake in the holding company and thereby, govern the management of group companies. The GMR Group has set up a Family Business Board to work out a three-year strategic plan for the various businesses of the Group. The Murugappa Group has shifted the ownership of individual businesses from family members to professional managers and constituted a nine-member Murugappa Corporate Board.

Similarly, various high net worth individuals (HNIs) have either settled trusts or executed wills to ensure the smooth transmission of wealth to the next generation.

Complexities in transferring ownership and management

As the size of the business grows, additional fund requirements are met through investments by extended fam-ily members and friends. This pattern of investment slowly transitions into a complex network of investment com-panies being controlled by multiple family members and friends. There-

fore, there is no direct control either over invest-ment companies or opera-tive companies by a single individual, or a segment of the family. Businesses are controlled by a maze of cross-holdings between different companies.

Therefore, any suc-cession planning first re-quires a mechanism to un-tangle this complex web of shareholdings which various segments of a joint family may have in each others’ companies, so that they have clear ownership of the businesses they manage. It is desirable to remove these layers of investment companies from the ownership of the flagship listed company

June 2012 cFoCoNNeCT 23

Page 3: Family Businesses and succession Planningcfo-connect.com/images/article/think-tank-family-business-june12.pdf · Succession planning requires ... lished succession plans. For example,

thInk TaNKand simply transfer the ownership to single or multiple trusts. Of course, the tax efficiencies for such transfer need to be carefully evaluated.

Another complexity which the Indian business families face is that there are multiple stakeholders for the leadership position. Slowly, a trend is evolving wherein groups such as the Tatas and Infosys have chosen the most competent member to manage the business, regardless of whether he belongs to the promoter family, or not. This is a reflection of the family’s willingness to separate family hier-archy from organisational hierarchy.

Will vs trustA will is a tool for transferring

wealth after the lifetime of an indi-vidual, whereas, through a trust an individual has the option to share his wealth with his family members dur-ing his lifetime. Also, through a trust, the settler provides a governance and distribution framework.

A will becomes operative only after the lifetime of the testator, whereas a trust becomes operative during the lifetime of the settler.

To execute a will, the executor has to apply in the court for probate. Probate is a court process in which the will is required to be submitted in the court and therefore, becomes a public document. On the contrary, the trust is a private document between the set-tler, trustees, and beneficiaries.

A will, if not properly constituted, may result in a long-drawn litigation, however, a properly constituted trust will not be a subject matter of litiga-tion.

Further, a trust is being increas-ingly used as a tool for asset protec-tion. Even if the settler’s company has suffered huge losses, the assets trans-ferred to the trust will remain safe.

Therefore, while wills have been used for ages, more people are using the trust route to transfer assets and create income for their family mem-bers, including unborn persons.

Legal constitution of a trustThe Indian Trusts Act, 1882, defines

a trust as being a legal obligation an-nexed to ownership of properties and

arising out of a confidence reposed in the trustees by the settler for the benefit of the beneficiaries. Therefore, there are three parties to a trust - set-tler, trustees, and beneficiaries. The settler and the beneficiaries may be the same entity.

A trust may either be a revocable trust (wherein the settler can revoke the trust at any time) or an irrevocable trust. Further, a trust may either be a determinate trust, where the ben-eficiaries are pre-determined and identified and their interests are also clearly defined; or a discretionary trust wherein the settler reserves the right to change the beneficiaries and their interest from time to time.

With a view to using the trust mechanism to not only hold the pool of family assets and investments but also to grow the common pool by effective deployments of the same, corporate trusteeship services are provided by financial institutions such as Kotak Mahindra and IDBI, among others. Further, trustees are assisted by management and advisory com-mittees formed by the settler to advice and assist the trustee in managing the trust asset.

Taxability on transfer of assets to a trust

Where the assets are vested in a trust, and the beneficiaries are im-

Slowly a trend is evolving wherein groups such as the Tatas and Infosys have chosen the most competent member to manage the business, regardless of whether he belongs to the promoter family, or not

mediate family members, normally, no taxes on transfer or gifts should apply.

Taxability of a trustPrimarily a trust is a pass-through

entity and there is no dual-level tax on the trust and the beneficiaries. The trustee as a representative assessee of the beneficiaries, is responsible for filing the tax return.

Stamp Duty on constitution of a trust

The Stamp Duty is payable at the prescribed rate on settlement of a trust. If an immovable asset is transferred to a trust, it is necessary to have the same registered.

Off-shore trustsIncreasingly, offshore trusts

are being used to acquire overseas assets and to explore business oppor-tunities. However, off-shore trusts will be subject to Foreign Exchange Regulations since an off-shore trust is deemed to be a trust formed outside India, and is therefore, a non-resident entity.

While Indian residents can remit funds overseas to settle a trust, the transfer of assets will be a capital account transaction and therefore, require RBI approval.

Similarly, the acquisition of shares by the offshore trust will be subject to the Takeover Code and the sectoral caps provided in the FDI Policy.

ConclusionSuccession planning is a complex

and sensitive topic and requires thor-ough analysis and planning. The CFO being a trusted advisor to the promoter needs to apprise him of the necessity, benefits, possible tools, and structures of an effective plan and thereby, avoid the pitfalls of not formulating an effec-tive succession plan.

The authors are Manish Kapur, Partner, M&A Tax, KPMG, and Suvira Agarwal, Sr Manager, M&A Tax, KPMGThe views expressed herein are the personal views of the authors and do not necessarily represent the views of KPMG or any of its member firms

24 cFoCoNNeCT June 2012