Inheritance tax and family trusts: succession planning for small firms


Date: 8 October 2015

Inheritance tax and family trusts: succession planning for small firms{{}}The most important piece of advice I would give to any business owner who is considering their affairs, eventual death and inheritance tax planning, is to make sure that they have a will.

Sometimes lots can be talked about with partners, co-directors and particularly professionals such as accountants and independent financial advisers, only for the most simple and obvious aspect to be missed.

Making a will can also highlight many issues that should be considered. In practical terms, any business owner should consider how their interest in the business would be dealt with in the event of their death.

Often it is unlikely that the spouse or children would want the shares in the business, they would generally be more interested in getting a fair price for the business. This brings up further complications, such as whether a surviving business partner would pay a fair price or indeed whether they could afford to pay a fair price.

What is certain is that it is best to address these issues before anything happens. If you don't, it is highly likely that there will be acrimonious disputes and the main beneficiaries will be the lawyers who are paid to fight over things.

Cross option agreement

So what can be done? Our advice would be to look at setting up what is called a cross option agreement. These are generally simple and inexpensive to set up. They give the surviving business partner the option to purchase the shares from the estate of the deceased.

The business partners could give thought in the agreement as to either the price payable for the business or how the price should be calculated, thereby avoiding any long-running dispute on this point. Shareholder and partnership agreements should be drawn up to make sure that what you want to happen on death does happen.

The second part to this would be how the surviving business partner could afford to purchase the shares. What you would generally expect is for the business partners, at the same time as setting up the cross option agreement, to put life policies in place that pay out on death to the surviving business partner.

The surviving business partner would then use the proceeds of the policy to buy the shares in accordance with the terms of the cross option agreement. What would be vital is that the life policy be written into a trust, so that the policy proceeds are not liable to inheritance tax. However, it is very important that the trust document is correctly drafted, appointing trustees and naming the correct beneficiaries. Professional advice should be sought.

Matter of trust

Most business interests in trading companies qualify for business property relief. This means that they are either not liable to inheritance tax or are only liable at a rate of 50%. You should also bear in mind that spouses are exempt from inheritance tax. Therefore, when writing your will you should consider whether it would be an option to leave the shares in the business to people other than the spouse, such as your children.

If you leave the exempt shares to your spouse, you are essentially leaving an exempt asset to an exempt beneficiary and wasting the tax exemption. However, you may be uncomfortable in leaving the shares direct to your children for fear of leaving your spouse without enough to live on.

One alternative, therefore, is to leave the shares, by will, into a 'discretionary trust'. The beneficiaries of that trust would generally include the surviving spouse and the children. Decisions can then be made very easily after the business owner's death as to who actually inherits the shares, taking account of the circumstances existing at that time and where possible ensuring that the entire estate, including the business interest, is dealt with as tax efficiently as possible. The key is flexibility. Such discretionary trusts can easily be included into a standard will and should not cost more than £450 to £500 plus vat.

Finally, Business Property Relief can be very valuable. However, you only qualify for it if you have owned the shares for two years immediately before your death. If you or an elderly relative owns such shares and they're likely to die in the near future then it is vital that the shares are not given away or sold prior to death, because then the valuable relief will be lost and the proceeds of sale would be taxable, potentially at 40%.

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