Succession Pact Vs. Donation: Which Option Is Best for You to Pass on Your Business to the Next Generation?

Passing on a family business to the next generation is a momentous decision that involves not only emotional and legacy aspects but also significant legal and tax considerations.

In Spain, two of the most commonly used tools to facilitate this transition are the succession pact and the donation. Both options allow the transfer of ownership during the owner’s lifetime, but present key differences in terms of legal effects, tax burden and legal requirements.

In this article, we will provide an in-depth examination of the characteristics of each mechanism, their advantages and disadvantages, and the key factors to consider when selecting the most suitable option for your specific situation.

Our goal is to provide you with a clear and concise guide to help you make an informed decision that aligns with the interests of both your business and your family.

Inheritance pact: advance planning with tax advantages

The succession pact is a legal agreement that allows planning the succession of the business during life, establishing how the assets will be distributed after the death of the owner. This instrument is particularly useful to ensure the continuity of the family business and to avoid conflicts between heirs.

Advantages of the succession pact

• Tax efficiency: Assets passed on through an inheritance pact are taxed as an inheritance (in most cases), which can result in a lower tax burden compared to a gift. Of particular interest can be a cumulative inheritance pact, where you pass on most of your assets during your lifetime (reserving a few) and divide the inheritance into two parts (first, through the inheritance pact, during your lifetime; then, upon death, for the remaining assets). This allows separate tax benefits to be applied in two separate tax returns, which, if filed jointly, would be incompatible. As an exception, inheritance agreements of particular attribution with the delivery of a present are considered a donation.
• Legal certainty: As a binding agreement, it provides certainty about the future distribution of assets.
• Flexibility in management: The owner can continue to manage the company until his or her death, ensuring an orderly transition.

Considerations

• Geographical limitations: The succession pact is recognised in autonomous communities with their own civil law, such as Catalonia, Galicia, Navarre, Aragon, the Basque Country and the Balearic Islands.
• Irrevocability: Once granted, the succession pact cannot be changed unilaterally, which requires careful planning.
• There are different types of succession agreements, and it is therefore necessary to pay attention to the specificities of each typology, depending on the case.

Donation: immediate transfer with tax implications

Donation involves the transfer of assets during the owner’s lifetime, allowing the heirs to assume ownership and, in some cases, management of the business immediately.

Benefits of donation

• Immediate transfer: Heirs can start managing the company without waiting for the death of the owner.
• Simplicity: The donation process can be simpler and faster than other transmission mechanisms.

Considerations

• Personal Income Tax (IRPF): The donor may be taxed on the capital gain generated by the donation, especially if the company has increased in value since its acquisition. The donation of shares in the family business would be subject to the partner’s personal income tax only to the extent that a part of these shares is considered “not affected” by the business activity: that is, for the part of the shares that could not benefit from the ISD tax reduction.
• Inheritance and Gift Tax (ISD): The donee must pay this tax, although reductions and allowances depend on the autonomous community and the fulfilment of certain requirements, such as maintaining the company for a certain period of time.

To benefit from the tax advantages, the donor must be at least 65 years old and cease to manage the company, as well as have a shareholding of more than 5% at individual level or 20% at family level and have carried out management functions for which he/she received more than 50% of the total income (this last requirement can be met by another person in the family group); and the donee must maintain the activity for a minimum of 5 years (in Catalonia).

Comparison between inheritance pacts and donations

The choice between a succession pact and a gift depends on many factors, including geographical location, tax situation and personal and family preferences. It is advisable to consult a legal and tax advisor specialised in family business succession to assess which option is best suited to your particular case.