Succession planning for business clients - The Law Society · Succession planning for business ... often outline how they want a son or daughter to succeed to ... Since 6 April 2013

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Succession planning for business clients

The following notes are intended as an aid to the participants attending the course to be read in the light of any comments made by the speaker during the course. The speaker’s remarks, comments and notes are intended only to stimulate and guide participants and to suggest possible courses of action to them. The notes are not a substitute for specific research upon a particular set of facts. Participants should take expert advice before taking or refraining from taking any action on the basis of the speaker’s comments and these notes. Whilst every effort has been made to ensure accuracy the speaker cannot accept responsibility for the information contained in these notes, for errors or for matters affected by subsequent legislation. Legislation Extracts from legislation quoted within any of the material are courtesy of http://www.legislation.gov.uk which is licensed under the terms of the Open Government Licence v1.0 the terms of which appear at http://www.nationalarchives.gov.uk/doc/open-government-licence/. Legislation is provided for information purposes only and for ease of reference relevant to the published material. Use of quoted legislation in these materials and published on www.lawskills.co.uk website does not constitute endorsement by www.legislation.gov.uk of LawSkills Ltd or any of its contributors.

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Rose Cottage, Woodman Lane, Sparsholt, Winchester, Hampshire SO21 2NS

Tel: 01962 776442 Fax: 01962 776 525 Mobile: 07850 741262

Email: [email protected]

www.lawskills.co.uk Twitter: @gillsteellaw

LinkedIn: www.linkedin.com/in/gillsteel


1.5 hours and Updating

Aim:

To enable practitioners to approach succession planning for business clients with care, caution and competence

Outcome:

Participants should be able to secure a clear retainer with their business client which they can execute appropriately

Agenda:

Will drafting LPAs for business clients Tax implications

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1. Will drafting

1.1 Scope of your retainer and charges Business owners come in all shapes and sizes each with:

Different business ownership structures

Different operational points of view

Different concerns about their family life

Their own vision for succession to and management of the business

Changing priorities at different points in their life One thing that is usually a constant in the provision of advice is the answer to the question ‘how can I minimise the tax impact on my estate?’ However, tax is not the only driver. Succession to the management of the business is equally as important. Whilst many clients if asked what they want to achieve will often outline how they want a son or daughter to succeed to the business, others will be worried that a particular child’s expectation to do so is unrealistic and that non-family members will be better managers if not owners of the business. So often clients fear the loss of control of the business whilst alive and even worry about this following their death. If simplicity were the only issue in estate planning or Will making then clients would always choose an outright gift:

• Donee is free agent and may do as he likes with the gifted assets

• Potentially Exempt Transfer (PET) for Inheritance Tax (IHT) if made during lifetime; potentially business property relief (BPR) at 100% on death to cover the value of a gift of the business

• No reserved powers or controls for donor – no ability to take the gifted assets back during lifetime or re-direct them on death

• Tax benefits if the donee is a charity The reasons for the outright gift being not as common as might at first be thought include:

• Risk of claims from donee’s creditors

• Risk of claims from donee’s spouse/partner on breakdown of their relationship

• Potential double IHT liability if the deaths of the donor and the donee occur in wrong order after a gift made by donor during his lifetime


Traditionally, where a family wished to pass on wealth to the next generation but with a significant element of protection against profligacy or divorce the solution was to create a family trust as a means of splitting the management and control of an asset from its ownership. Ownership would rest with the beneficiaries of the trust but management and control of the asset would reside with trustees appointed for the purposes. The trustees might also have the power to vary the entitlements of the beneficiaries to take into account future changes in circumstances. The taxation changes to the treatment of trusts in the FA 2006 and the continuing development of anti-avoidance legislation and punitive income tax rates are a large disincentive to clients against making trusts and yet the client’s objectives remain to:

Pass wealth down a generation or more with modest or no tax charges; and Separate CONTROL from OWNERSHIP of the assets to be transferred

Putting cash and most other assets into a trust during lifetime above the available nil rate band (currently £325,000) will trigger an immediate IHT charge at 20 per cent. Since 6 April 2013 the trust income tax rate is 45 per cent. These tax charges have made trusts less attractive for wealthy clients. However, some will still consider making a trust gift in their Will particularly where the gift is relieved by Business Property Relief (BPR). The first challenge is to determine whether the Will writing exercise is about succession to the management of the business as well; and further, whether it is implicit that the drafting of the Will is also an estate planning exercise. The three activities often merge into one set of instructions. Each task should be identified as distinct yet connected in order to be clear precisely what the solicitor’s retainer involves and whether the brief will involve liaising with the client’s accountant, IFA, business managers and family members. 1.2 Key facts required Once you are clear as to what the retainer entails then the second challenge is obtaining the necessary information to formulate your advice. There is no one size fits all when it comes to identifying the ideal business Will but a client’s adviser needs to discover the priorities for both the client and any spouse or civil partner from a tax, business and family point of view. The adviser should:

• Identify the client’s goals and those of any spouse or civil partner – it is no good if a client is married only focusing on the client’s objectives as we know in preparing Wills which do not involve a business. Wills for couples to a degree need to work in tandem and certainly any associated tax planning has to make sense for both parties. Leaving the most valuable asset to the children and the residue to the spouse may seem like good tax planning but may result in the spouse having nothing more than a house to live in and insufficient money with which to support the lifestyle to which he or she has become accustomed.


• Conduct a fact find This is difficult. It requires plenty of confidence on the part of the practitioner to convey to the client the necessity of enabling the full picture of their business and the family context in which it may sit to be shared in order to write something they might perceive to be a simple Will. Of course, the outcome may indeed be a relatively simple Will. However, to know that it is the correct course of action at this time and recognise the financial, fiscal and family consequences of what has been prepared is usually not simple.

The key here is to understand what happens to the business on death if nothing were done and what restrictions on transmission of the business exist under the law, the business documentation and in practice. Once these are clear better outcomes can be achieved by the terms of the Will or any associated changes now to the structure of the business and its finances. Typical questions might include: Will the business or interest in the business qualify for relief at 100%?

Does it qualify as a business? Or is it merely holding or making investments? Will the asset itself be “relevant business property”? Has the intending testator owned it for a sufficient period? Is this likely to be a problem if a gift is made during lifetime?

Does the intending Testator have a beneficiary to take over the business?

If not, will a manager have to be appointed or will the PRs themselves have to do it?

Are business assets separate from personal assets?

Particularly if there are other beneficiaries who are only benefiting from the non-business assets, will they expect their legacies to be untainted by the business? Is this realistic?

Does the business include or exclude the business premises?

With the sole trader, to what extent can you keep the two separate where hitherto they were in the same sole ownership? Is death likely to be an opportunity to separate ownership of the building from ownership of the business and require the business owners to pay a market rent to the building owners?

Is there a Partnership Agreement or Shareholders’ Agreement?

Where the intending testator is a partner or shareholder the Partnership Agreement of Shareholders’ Agreement, if any, will usually cover what happens on death - always ask to see it. Check it for “buy & sell” arrangements which may lose the testator’s estate BPR.


The shareholding structure of the company is best decided on at its formation since shares will be subscribed at par when they have little value. Subsequent changes can of course be made to the shareholding structure but if the company has been profitable its shares will have increased in value and changes in ownership will not be free of risk – e.g. an inability to get full BPR because the business contains excepted assets. Sometimes changing the nature of the shareholding by introducing special classes of shares which do not have the right to vote or have no entitlement to dividends etc. can be a beneficial way of freezing value in the owner’s hands and passing value to the next generation. However, CGT is often a real problem and it tends to militate against people making lifetime gifts.

Level of control required by beneficiaries

100% ownership gives complete control. At present with 100% BPR and CGT tax free uplift to date of death it is tempting for the owner of a company to wish to retain all 100% of the shares until death but in reality a 75% holding will enable him to pass a special resolution, to sell the company, to vary its constitution and put it into liquidation. Also, just to keep control of day to day decision making such as determining dividend policy, it is only necessary for the owner to retain more than 50% of the shares. The rest of the value could be held by his/her spouse or civil partner and/or family trusts. The owner can still exercise control where it counts without having the full value of the shares in his/her hands. This is something which becomes more important if the rate of BPR falls. Therefore if dividends are regularly declared it may be of assistance to the surviving spouse or civil partner to be given some of the shares whilst the testator is alive or at least on death to enable some income to continue to be available to him or her.

Examine with client the external environment outside the family: tax, work, political change etc. – the client will know better than you the impact of external influences on the ability to sell the business or sustain it in the longer term. You, meanwhile, may become knowledgeable about different sectors and as a result may well attract clients with similar businesses as a result. Be willing to conduct your own research at your own cost into sectors and be prepared to make an impact in the sector; apart from anything else the client will be pleased you are showing genuine interest in his business.

Analyse the internal environment within the family - needs, problems, resources etc. – this is bread and butter to a Will practitioner but nevertheless it is a vital part of any Will preparation exercise and more so when the asset concerned may be of significant value and requires skilled management. The value of the business may distort the estate in as much as a farm may be the main asset and also the home of the client and yet only one child is able and willing to take it on even though there are two other siblings and a spouse to be provided for.

Assess client’s attitude to risk – clients come in all levels of sophistication and


take all kinds of risk. The skill here is to identify any and all risks and assess with the client the likelihood and impact of any of them occurring. The outcome should then be a risk profile for that client which the solutions decided upon addresses in line with the client’s confirmed understanding of each risk.

The role of facilitator - In many cases family members may already be working in the business and have an expectation that they will inherit the business on a parent’s retirement or death. However, it is not usually the case that all children work in the business and even if they do they may be itching for a chance to stop and do something else.

Rather like the cases studies on the TV programme ‘Can’t Take it With You’ it is the job of the Wills draftsman to encourage the intending testator to discuss the process of succession openly and fully with their intended beneficiaries so that the risk of relying on untested presumptions with the resultant potential for contentious probates is minimised.

Such a discussion could not only address succession to the ownership but also whether there should be a special business executor. It might also attempt to assist the child who is to take over the business where the gift will fall short of an outright gift, as there are insufficient other assets in the estate to make a fair or appropriate gift to other beneficiaries, to understand why they could not have the business outright. Therefore, consideration will have to be given to including preferential options to purchase for the particular ‘heir apparent’ rather than an outright gift, which proceeds of sale would help to fund other legacies.

In the Fifth episode of ‘Can’t Take it With You’ the programme looked at two family businesses:

“Nev and Alan have built up a £3 million business which son Damian wants them to leave protected for future generations. But daughter Vashti would like the freedom to decide what to do with her share of the business. Now, Nev and Alan have to face up to the fact that they may not trust their daughter to do the right thing. Meanwhile, in the second family of the week, Hans and Anna are in despair over how to hand on their £4 million garden-nursery business to their six adult children, three of whom disagree over who should take charge in the future.”

Design approach taking into account these factors – after all the discussions and investigations the outcome may well be that the prime beneficiary is the spouse despite the fact that this ‘wastes’ BPR for IHT. However, whatever the outcome the approach should fit with the analysis and risk profile agreed with the client.

Practical problems can very much arise where there is a potential for a reduced BPR allowance on the value of the testator’s interest in the business because of ‘excepted assets’ on the balance sheet. This could result in some IHT to pay in respect of the


business interests which would fall to be met out of residue unless the gift of the business assets is made ‘subject to tax’. Whichever route is chosen there may be an unexpectedly large impact on death and the relevant beneficiaries may not be able to meet the IHT bill so that the business has to be sold (assuming it can be) to pay the tax. There are no guarantees that the rates of relief and nature of the relief on death will still apply to the intending testator’s assets in the same way as at the date of giving instructions for preparing the Will. It is therefore sensible to explore with the client whether it might not be better to assume the worst and make a gift to a discretionary trust which benefits the children as well as the spouse or civil partner so that on death if there are unwelcome restrictions on the relief making it impossible to pass the business interests to chargeable beneficiaries then an appointment to the spouse or civil partner could be made in accordance with the provisions of s.144 IHTA 1984 – that means it should be appointed to an exempt beneficiary within two years of death so that the revised gift is treated as though made by the deceased giving rise to relief under s.18 IHTA 1984. The sale of the testator’s business or share in a business will produce funds for the residuary estate; but where are the monies to come from to fund the purchase? Is there any insurance cover in place which the beneficiaries, surviving partners or shareholders are entitled to which can meet the cost? If not, perhaps you can encourage the client to consider the availability of suitable life cover which could be written into trust for this purpose or which could form the basis of cross options between non-family partners or shareholders. Sometimes a sale is inevitable and, particularly with a sole trader business, this may prove difficult if all the goodwill in the business resides entirely with the intending testator. Again, the question of sale should be addressed in case there is any way in which future saleability could be improved before it is too late! 1.3 Updating the business agreements to ensure continuity on death A business owner definitely needs a Will appointing appropriate Executors capable of running the business until sale or transfer. A sole trader always introduces a problem because the main asset is usually the goodwill of the testator and there may be no-one to carry on the business when they have died. A sole trader is a free agent, able to manage their business and arrange how it is to be dealt with on death. It is vital to have both powers of attorney, to deal with the business whilst incapacitated; and, a Will giving appropriate powers to the business owner’s executors to manage, sell and transfer the business following his death.


In the case of a partnership, the first priority is to have a partnership agreement. The Partnership Act 1890 regulates the relations between the parties if there is no express partnership agreement. Partnership agreements usually contain terms as to what should happen in the event of the death of a partner and for what if anything can actually be transferred outside the continuing partners. It may be impossible to transfer to anyone other than an existing partner. The problem then becomes one of valuation and what the terms of the agreement may mean for BPR. Items normally covered in a partnership agreement include:

a) Use and ownership of partnership property – e.g. are the business

premises used by the partnership to be treated as property of the firm or are they the individual property of one of the partners?

b) The rights of the partners to take part in the management of the firm c) Ratios in which profits are to be shared (it is presumed that profits and

losses are shared equally unless stated to the contrary) d) Proportion of contributions to the partnership capital made by each

partner e) Provisions for the expulsion of a partner f) Provisions to cover death, retirement, or resignation of a partner e.g.

When the estate of a deceased partner is entitled to the repayment of

any capital he had invested and the undrawn profits An option for the continuing partners to purchase the outgoing partner’s

share with a valuation clause

NB If there is no express agreement to the contrary, the death of a partner will bring the partnership to an end from the date of death (even if the partnership was entered into for a fixed period of time which was as yet unexpired).

g) Special provisions in view of the nature of the partnership business e.g.

professional partnerships In the case of a company the provisions of the Memorandum and Articles of Association, together with the provisions of any shareholders’ agreement should be checked. Again, a private company limited by shares may have nothing more than standard Memo & Arts. In which case it will be essential to check when the company was incorporated so that you can ascertain which set of Articles of Association apply.


Standard sets of Articles of Association are set-out in the Companies (Table A to F) Regulations 1985 (SI No.805). Most private limited companies incorporated before the Companies Act 2006 regime came into effect, which have a share capital, will adopt Table A, with some amendments. There are Model articles for use by, as a default for, companies incorporated after 1 October 2009 under the Companies Act 2006. Existing companies had the opportunity to adopt the Model articles before 1 October 2009. Transitional provisions amended Table A with effect from 1 October 2007 for companies incorporated under the 1985 Act on or after that date. If the client had some help in setting up the company then there may be alterations to the standard Memo & Arts or even a bespoke set with their own unique provisions for what happens on death. In addition, there may be a shareholder’s agreement dealing with the contract between the shareholders as to who may own shares and how holdings may be valued. The respective rights of the shareholders are contained in the Articles of Association. If, as between themselves, the shareholders wish to adjust their rights, they may do so either by inserting special provisions in the articles or by entering into a separate contract called a “shareholders’ agreement”. It is crucial to establish the provisions governing the transfer of shares on the death of a shareholder so that the careful planning isn’t undone when the transfer of the deceased’s shares to a discretionary trust, for example, is blocked by the other shareholders worried about the interference of the PRs & Trustees in the running of the business. Shareholders’ agreements are governed by the ordinary law of contract and are supplemental to the Articles. Shareholders’ agreements may contain provisions which are capable of being incorporated in the Articles e.g. pre-emption clauses and rights to nominate directors to the board. It is vital to ensure there is no conflict between the Articles and any shareholders’ agreement. The agreement will normally be stated to prevail in the event of any such conflict.

One advantage of such agreements is their confidentiality - Articles have to be filed with the Registrar of Companies and are open to public inspection. Shareholders’ agreements do not. If the Articles provide other shareholders with the right of pre-emption over the deceased’s shares those shares are unlikely to be IHT exempt. This means that instead of BPR relievable shares passing into any discretionary trust in the Will their non-exempt cash proceeds will be in the estate instead which will cause an undesirable headache and much larger IHT bill. In order to qualify for IHT relief on the shares in the first place there must be no binding agreement for their sale, so the right of pre-emption needs to be carefully worded. Non-binding cross-option agreements will not jeopardise BPR.


The shareholders may have entered into cross-options linked to life policies. These may be separate or contained in the shareholders’ agreement. Under cross-option arrangements:

Each shareholder takes out a life policy on his/her life for the estimated value of

his/her shareholding Each shareholder then executes a declaration of trust declaring that the policy

proceeds are held in trust for the other shareholders Each shareholder signs a “put and call” option agreement, binding on the PRs,

providing that, on death:

a) the PRs will have the option to require the other shareholders to buy the deceased’s shares (the put option); and

b) the other shareholders will have the option to require the PRs to sell the deceased’s shares to them (the call option)

One of these options may be exercised to bring about the required sale. The price (usually the fair value at the date of death) will be determined in accordance with an agreed formula. If your client has not put in place the correct arrangement you should take the opportunity to advise him to review the company’s paperwork so that any sale of the shares on death is both possible and tax efficient. The client maybe a director and shareholder of the company and may even be the sole director and shareholder. If there are other surviving directors on the death of the client then in most cases the remaining directors can continue to run the company – unless the company’s Articles require there to be a company secretary (and the deceased had that role) and a minimum number of directors such that the death of the deceased would cause the Articles to be breached. Since 1990 it has been possible to own and run a private limited company without a company secretary and with only one director who is often the only shareholder too. However, if the deceased was that director his death will trigger a breach. If there are additional shareholders then they may hold a shareholders’ meeting to appoint a new director. However, if there are no other shareholders:

For companies incorporated pre Companies Act 2006, it will be the personal representatives of the deceased shareholder who would have to make an application to Court to gain an order for the appointment of a new director – a time-consuming and costly exercise.

For companies incorporated post the Companies Act 2006 regime then article 17(2) of the Model Articles says “In any case where, as a result of death, the company has no shareholder and no directors, the personal representatives of the last shareholder to have died have the right, by notice in writing, to appoint a person to be a director.”


Thus if you discover your client’s company was incorporated before the coming into effect of the 2006 regime and they do not have bespoke articles which address this issue you should advise them to revise the company’s articles. 1.4 Use of trusts Before suggesting particular gifts or structures in the Will it is imperative to consider the eligibility of the business to Business Property Relief (BPR) at either 100% or 50%. This factor may determine the structure of the Will since if the business is eligible for 100% relief it may encourage the owner to gift it to a chargeable beneficiary rather than their spouse or civil partner. If the business is a sole trader business it is likely that it will have to be sold during the administration of the estate so appropriate powers to enable this to happen efficiently will need to be included in the administrative provisions. For example it might be easier to sell an incorporated business and thus the PRs may need to incorporate the business before sale. If the business is to be retained then the earlier succession considerations will need to be discussed and the outcome implemented such as the use of a trust to benefit the whole family or an outright gift to the member who is to continue to trade. Assuming that 100% BPR is available, when the nature of the assets may not stay the same or the needs of the surviving spouse or civil partner cannot be satisfactorily addressed by simply making an outright gift of business assets to chargeable beneficiaries, the use of a discretionary trust can be beneficial. The trust could be for just two years or may be for the 125 year maximum but it would be envisaged that on the death of the business owner the division of the relevant assets will be made as appropriate depending on their status and tax relief applicable at death. As long as an appointment is made within two years of death under s.144 IHTA 1984 there will be a reading back for IHT such that the recipient of the appointment will be regarded as though they were the original beneficiary under the deceased’s Will. Where this new beneficiary is the surviving spouse or civil partner of the deceased s.18 IHTA 1984 relief will apply. There are a number of ways in which this might be addressed:

1.1 Before the Finance (No 2) Act 2015 a popular approach was to use a pilot discretionary trust made during lifetime to which was left relievable assets so that additional trusts could be created under the Will which forced HMRC to consider the application of BPR to the assets bequeathed to the pilot trust whilst at the same time ensuring that any trusts under the Will were not regarded as related settlements with the pilot trust.

1.2 By the use of the Nil Rate Band discretionary trust to which is added by specific direction any 100% relievable BPR assets e.g. ‘I DECLARE that my


Executors may appropriate in or towards satisfaction of the Trust Fund any relevant business property (as defined by section 39(A)(7) IHTA 1984) which I own at my death reduced in accordance with section 104 of that Act or by any statutory modification or re-enactment of them.’

Please note, the formula gift of the NRB as being the largest sum which can be given without IHT being payable will not result in the business property being included in the gift. For such property to attract the relief there must be a specific gift of it to chargeable beneficiaries.

1.3 By the use of more than one relevant property trust in the Will if different

beneficiaries are to be considered for chargeable assets which go only to chargeable beneficiaries and BPR assets which may or may not be eligible for relief at the time of death and this needs testing with HMRC so that a decision on appointment can be made within the two year time frame.

1.4 By the use of a single discretionary trust of the whole estate, which the

Trustees can alter by Deed of Appointment to suit the circumstances on death.

The potential difficulty with legacies which rely on a tax definition to identify the property passing under them, i.e. those which get 100% BPR, is that if HMRC Trusts & Estates (HMRC Inheritance Tax, Trusts & Pensions as it is now known) will not adjudicate (as may well be the case if the residuary estate is exempt and there is no tax at stake), the executors have to decide which assets should be allocated to the legacy. There will be further difficulties where there are excepted assets (s.112 IHTA 1984) in the business. If there is likely to be friction in the family (and particularly if the spouse or civil partner is an executor and hence open to allegations of self-interest), it may be better to identify the property by description rather than by formula, and leave that to a discretionary trust, to again allow flexibility once agreement has been reached with HMRC Trusts & Estates over eligibility for relief. Alternatively, again simply leave the whole estate to a discretionary trust. Other practical problems with using a fully discretionary trust Will are:

The intending testator may not appreciate his Will and his intentions being altered after his death; he may want control beyond the grave!

IHT will have to be paid initially to obtain the Grant and only after the appointment to the surviving spouse or civil partner will any IHT be repaid thereby creating cash flow problems in the estate.

Assets must still be settled property at the time the trustees of the trust

make their appointment for s.144 IHTA 1984 to apply. This means that they


cannot be assets which are part of the estate under administration at the time of the appointment.

It is always possible that s.144 IHTA 1984 will be repealed but frankly this is

probably only likely now if IHT is completely overhauled. Therefore, the use of other trusts, such as a flexible IPDI in favour of the spouse or civil partner which can be altered by the exercise of overriding powers, may be appropriate if transferring a business to the next generation outright would simply encourage a sale and division of the business. Where the estate of the intending testator contains business assets but also significant other assets of great value then it can be beneficial to give the surviving spouse or civil partner the non-business assets and the option to purchase the business assets from any discretionary trust. When the spouse or civil partner receives the residuary estate the surviving spouse or civil partner can then pay into the trust cash by way of the purchase price for the business assets thereby reducing the non-relievable residue which in their hands will just be taxable on their death. Instead, by exercising the option the surviving spouse or civil partner is replacing chargeable assets with relievable assets which can work their magic on the IHT bill on the second death just as much as they did on the first death. If there are insufficient other assets in the residuary estate or personally owned by the spouse or civil partner to fully pay for the relievable assets, then, the balance of the purchase price could always be left outstanding by way of loan (although watch out for the application of s.103 FA 1986). This would again reduce the surviving spouse or civil partner’s estate on death as long as the market price was paid for the relievable assets. If a separate discretionary trust is used to receive BPR assets provided an appointment is made out of the trust within two years of the death and before any immediate post death interest in possession (IPDI) has arisen, the appointment will be read back into the Will. The dispositions made under the appointment will then take effect as if they were made on the death (IHTA 1984, s.144). It should be noted that s.144 only applies where there would otherwise be a charge. The so-called Frankland trap (when absolute appointments are made within the first three months from the death) was removed in an amendment to s.144 IHTA 1984 contained in the Finance (No 2) Act 2015. Amendments made to s.144 following FA 2006 mean that appointments to an IPDI can be made at any time. For the purposes of BPR the minimum period of ownership requirements starts afresh from the time of any appointment. By virtue of s.144(2), a surviving spouse or civil partner should inherit the deceased civil partner or spouse’s period of ownership if the property is specifically appointed (contrast the position where there is an appropriation to a share). In many cases, however, where the interests enjoy full relief it will be tax efficient to appoint them direct to or in trust for the next


generation rather than to the spouse or civil partner in case there is a change in the nature of the interests owned on the later death or a change in the nature of the relief by then. It is also worth remembering how the special reliefs of APR and BPR operate for IHT when making any distributions out of the trust. The reliefs apply to discretionary trustees in general provided they and the assets meet all the necessary conditions. So in the ordinary transfer of value by a discretionary trustee BPR has two effects:

• It reduces the value on which tax is charged; and • It reduces the appropriate rates of tax because of the way the relevant rates

of tax are calculated for discretionary trusts The exception to this general principle is where there is an exit charge in the first ten years. An exit charge arises when property ceases to be ‘relevant property’ – s.65 IHTA 1984. If the resultant IHT is paid out of the remaining trust fund then grossing-up will apply. The calculation of the rate of IHT is based upon half the full IHT rates (effective rate) and the rate of tax actually charged (actual settlement rate) is then 30% of that rate applicable to a hypothetical chargeable transfer. It is the use of a hypothetical chargeable transfer of value in arriving at the actual rate, which does not take into account a deduction for BPR which produces a problem in the calculation of the rate of exit charge but obviously only where the applicable rate of relief is 50% rather than 100%. BPR will, however, reduce the value of the transfer on which the tax is charged; it is just the rate of tax that is affected by the 50% relief. Conclusion Drafting Wills for people who own or have an interest in business assets is never going to be easy. There are some key issues which need addressing but primarily it is about:

Being clear about the extent of the retainer.

Providing the client with the confidence to share with you all the information you need to truly help them reach the right conclusion.

Not being afraid of quoting a reasonable fee for the work involved which is not necessarily your ‘usual fee’.


Applying common sense to the situation as well as full knowledge of the requirements of BPR for IHT and appropriate trust law.

Remember too that the tax tail should not wag the family dog – who must the estate provide for and has the testator done this e.g. a surviving spouse who does not work in or own the business might be unable to manage financially if the business is given to the children for IHT planning purposes and may be forced to make an IPFD 1975 claim e.g. Baker v. Baker [2008] All ER 312.

All Wills need appropriate Administrative Provisions and Wills for business owners particularly need a tailored set, such as the long form in most precedent books, to cover most of the likely needs to manage the business in the estate until sale or transfer.

2. LPAs for business clients

It is tempting to only consider recommending a Property & Finance LPA to a business client but we should treat them like any other individual and recommend that for their personal needs a separate set of LPAs would be sensible i.e. both a personal Property & Finance LPA and a Health & Welfare one. If the business can be run by family members and they are the people who would expect to have the care and best interests of the person in mind in any event then maybe a separate business Property & Financial LPA may not be necessary. 2.1 Should you suggest a separate business LPA for business owners? A business owner may have had the foresight to purchase Key Person Insurance, but this will not assist with the practicalities of running the business if that key person is ill or injured and unable to work or take decisions. Whilst the running of a sole trader or partnership business may be possible with a power of attorney from the outset a company has its own distinct legal status which is separate from the owners. Under Article 81 of Table A the office of Director has to be vacated if the director is or may be suffering from mental disorder and either is admitted to hospital under Mental Health Act 1983 or a deputy has been appointed but not otherwise. Under the Model Article 18 a director ceases to be a director as soon as a registered medical practitioner who is treating that person gives a written opinion to the company stating that that person has become physically or mentally incapable of acting as a director and may remain so for more than three months. It is not the case that other people can step in to run the business without authority. Depending on the relevant Articles which apply it may be necessary for the family to obtain a Deputyship order from the Court of Protection which may take many months. In the meanwhile, unless the business bank accounts have more than one signatory very real difficulties may arise. Payments, such as for the wages of the workforce or


the owner, may not be possible. There could be no one with the legal authority to enter into contracts to keep the business running or to authorise renewals such as for insurance. This is more than likely in the case of a sole trader but remains of crucial importance for all types of business. Whilst it is not possible for a director of a company to delegate their functions as a director through an LPA as long as there is a quorum the directors can hold a valid meeting and pass resolutions. Although directors cannot delegate powers to an attorney they can appoint an alternate director to act in their stead for short absences such as a holiday. In many cases the director will also own shares in the company. The obvious solution is therefore for the owner of the shares to appoint an attorney/s under an LPA and thus ensure business continuity by the attorneys appointing a new director. Should the shareholder have just the one LPA so the same attorney will deal with their personal finances as well as the business; or should the personal and business matters be dealt with separately? This will clearly depend upon the individual circumstances of each business owner and needs careful thought. If the spouse is to be the attorney for personal finances and is the co-owner of the business or has a close involvement in running the business then perhaps one LPA appointing the spouse would be satisfactory. Even if this is the case, replacement attorneys should be considered in the event of, for example, both spouses being involved in the same accident. It should be pointed out that if the business owner becomes incapacitated the spouse may well have their time and attention taken up in caring for them, rather than being able to continue to focus on the business. It makes sense to have two LPAs: one to handle personal finances and one to run the business. For example, in the new FD LPA in Section 7 on page 8 the section allows space for ‘Preferences and instructions’. This is where guidance and restrictions are to be placed. In the box under ‘Instructions’ set out in the box [or refer to Continuation sheet 2 where you set out any restrictions]:

1. My Attorneys under this power must only act on this authority in relation to my shareholding in the company currently trading as ABC Ltd (company registration number 123456789) whose registered office is at Capital House, Tower Street, London WC1 but in respect of which they have all the powers granted to an attorney under the Mental Capacity Act 2005.

2. Any attorney of mine who is a solicitor or accountant has the right to charge for acting as my attorney at their usual charging rates as applicable from time to time.

There may be an obvious choice of business attorney, such as the partner in the partnership or co-director in a company. However, remember that an attorney must


not benefit from the appointment as such and so a partner or co-director or shareholder may be conflicted. In any event, the attorney needs to be someone the owner trusts, but who is also familiar with the business. If the owner wants to keep an element of personal interest in their choice they could appoint a business colleague along with a family member. Their appointment could be joint for some decisions, such as transactions over a certain level or operation of the bank account; and joint and several for all other decisions, so the business colleague can get on and take day to day decisions without always having to involve the family member. However, you should not use one LPA to cover both personal and business matters and say that the client wants on attorney to manage the business and the other to deal with his general affairs – Re Black If the business owner travels abroad extensively as part of the business, having a business LPA effective straight away and not limited to the donor’s mental incapacity could make sense to ensure the smooth continuity of the business during their absence. If the owner has separate personal and business LPAs, on the sale of the business or full retirement from it, only the business LPA needs to be cancelled. The danger is to make the restriction on the business attorneys too complex. A recent case on this issue demonstrates the problem:

XZ v OPG [2015] EWCOP 35 In this case the Public Guardian (PG) refused to register a Lasting Power of Attorney (LPA) with 8 pages of carefully drafted complex restrictions and conditions. He took the view that most of them were ineffective and should be severed. The solicitors asked the court to determine the question and Lush SJ disagreed with the PG. He found the conditions to be impractical rather than ineffective and so the LPA was ordered to be registered. Impracticality is not a reason for refusing to register an LPA. Interestingly, the donor’s case was helped by a provision in the new LPA forms effective from 1 July 2015. Although this case looks at first glance as a victory for the donor, he has put in place an LPA which is essentially impractical.

The facts XZ, who is in his 70s, has substantial assets including properties in several countries but he lives mainly in London. On 4 December 2013 he executed a Property and Financial Affairs Lasting Power of Attorney (LPA). Under this he appointed three close friends and business associates as his attorneys. Two of the attorneys are American and one is Canadian. XZ directed his attorneys to act jointly for all decisions in connection with the sale or purchase of any real estate or any other asset with a value exceeding three million Canadian dollars and jointly and severally for all other decisions. He then imposed 8 sheets of intricate restrictions or conditions some of which were the subject of the proceedings before Lush SJ. Two solicitors acted as the certificate providers.


The main condition in question was that no attorney should act unless they reasonably believe at the time of the decision that XZ lacked capacity to make that decision and there was a genuine financial need for the action being considered. If that precondition is satisfied then the attorneys had to meet either the ‘standard threshold’ or the ‘emergency threshold’. The essence of the standard threshold is that a ‘Protector’, a named friend, has to approve the opinion of two psychiatrists that the donor lacks capacity and this has to have continued for at least 60 days. For the emergency threshold to be met the attorneys must regard the decision as an emergency measure to preserve or realise any asset worth less than 25 million Canadian dollars. The Public Guardian (PG) refused to register the LPA as he considered most of the conditions imposed an unreasonable fetter on the attorneys’ power to act and were therefore ineffective. When the solicitor asked him to reconsider his view and he refused, an application was made to the Court of Protection (CoP) for a declaration that the LPA did not contain ineffective provisions and an order that it should be registered. Dominic Lawrence of Charles Russell Speechlys who drafted the LPA said that the purpose of the safeguards was to ensure that (other than in limited emergency situations) the attorneys could not act until XZ’s incapacity had been unequivocally proved by psychiatric evidence and it has lasted for a defined period. XZ specifically insisted on these provisions as he did not want his attorneys taking hasty decisions which he might disapprove of if his lack of capacity was only temporary and additionally his incapacity had to be genuinely proved. XZ does not like to give control to other people, liking to remain “in the driving seat” and would not sign the LPA without these safeguards. The PG stated that the provisions in question were ineffective because:

1. Specifying a time delay from the assessment of incapacity to the attorneys having authority to make the decision would prove unworkable and not be in the best interests of XZ. The MCA test is decision specific.

2. The Protector does not have the expertise to assess the donor’s capacity nor is he named as an attorney, yet he can interfere with the attorneys’ duty to act in the best interests of XZ.

3. Requiring the agreed opinion of two psychiatrists with various checks by the Protector will lead to time delays and be unworkable.

The law Section 23(1) of the Mental Capacity Act 2005 (MCA) provides: The court may determine any question as to the meaning or effect of a lasting power of attorney or an instrument purporting to create one. Paragraph 11 of Schedule 1 of the MCA provides:


(1) If it appears to the Public Guardian that an instrument accompanying an

application under paragraph 4 is not made in accordance with this Schedule, he must

not register the instrument unless the court directs him to do so.

(2) Sub-paragraph (3) applies if it appears to the Public Guardian that the instrument

contains a provision which—

(a) would be ineffective as part of a lasting power of attorney, or

(b) would prevent the instrument from operating as a valid lasting power of attorney.

(3) The Public Guardian—

(a) must apply to the court for it to determine the matter under section 23(1), and

(b) pending the determination by the court, must not register the instrument.

The decision XZ’s LPA had been completed on the forms which were effective before new forms came into effect from 1 July 2015. Lush SJ highlighted that the new form for the Property and Finance LPA (now called LPA Financial Decisions) has a new section 5 and the donor can complete the box prescribing that the attorneys can make decisions “Only when I don’t have capacity”. Underneath this is a warning that this can make the LPA “a lot less useful. Your attorneys might be asked to prove you do not have mental capacity each time they try to use this LPA.” This warning is the essence of the present case in Lush’s view. Lush acknowledged that having to prove incapacity on each occasion might make the LPA less useful but this is different to the provision being ineffective. Even if some take the view that XZ’s conditions are unwise, XZ appreciates they will make the LPA less effective and his view must be respected. Lush stated that it was not for the PG “to police the practicality or utility of individual aspects of an LPA.” Ineffective means “not capable of taking effect” such as authorising an attorney to make gifts beyond the limited s12 MCA power. The PG had not identified any of the provisions infringed the law in any way, which would make them ineffective; he had pointed out their lack of practicality instead. Lush declared the LPA did not contain any provision which was ineffective or which would prevent it operating as a valid LPA. He therefore ordered the PG to register the LPA as originally drafted with no provisions severed. Practice points

1. Where clients are completing a Financial Decisions LPA great thought needs to be given to which of the new section 5 boxes are ticked. Although matters are improving, financial institutions are notorious for being unwilling to act


on attorneys’ instructions and having to prove the donor’s mental incapacity each time may prove burdensome.

2. If the donor wants detailed restrictions and conditions these may well lead to at best a delay in registering the LPA and at worst, a refusal to register it without severing the ‘offending’ parts. As this case highlights, it is only truly ineffective conditions which the PG can refuse.

3. Consider if any restrictions or conditions the donor wants are actually practical. Point out to donors that even if conditions or restrictions are possible they may make the LPA less useful. Do average assets require complex restrictions or should the attorneys only be appointed if they are trust worthy?

2.2 Reviewing business structure

2.2.1 What happens in the event of mental incapacity of a partner?

In the case of a partnership one crucial fact to be established at the outset is whether there is a partnership deed or agreement (whether written or oral) in place. It is essential to establish exactly what has been agreed between the partners generally, but also specifically has the question of what will happen on the mental incapacity of a partner been discussed and decided on? A well drafted partnership deed or agreement will deal with what is to happen on the mental incapacity of one of the partners and who is to make partnership decisions in their place. If a partner is thinking of appointing a business attorney, the deed or agreement should be checked so ideally the same person is appointed as their business attorney as is recorded in the deed or agreement for making decisions. At the very least, if the donor wants a different person as their business attorney, will the two people get on and work in tandem to ensure the continuity of the business? Or does the agreement need altering to remove the automatic appointment so the attorney would then act? If the partnership deed or agreement is silent on the point and there is no LPA in place, it may be necessary to apply to the Court of Protection for a deputy to be appointed. 2.2.2 Problems with companies

Directors

The Articles of Association usually govern the position of the director who loses mental capacity, but it is always worth checking them! There could be a provision that the mentally incapacitated director will cease to be a director, but this could come with caveats such as a medical report certifying the loss of mental capacity or an application to court being necessary. Following the recent changes to the Companies Act 2006 the


articles may now provide for the removal of the director on a doctor stating the director has become physically or mentally incapable. Although a director cannot delegate their director functions through an LPA, there are still valid reasons for them appointing a business attorney. If the director is also a shareholder and there are no restrictions in the LPA, the attorney will be able to vote on their behalf. Additionally, the LPA could be used in the case of a sole or major shareholder where there is no mechanism in the articles to remove that director. If there are other directors or shareholders they, plus the business attorney, could vote to change the articles to allow for the removal of the director. Failing that, it may be possible for another director to terminate the employment contract of the incapable director.

Shareholders Usually a major shareholder will also be a director. However, it could feasibly be the case that following the successful retirement of the founder and handover to the next generation, an owner has stepped down as a director, but has retained at least some if not all of his shares. Without an LPA in place no one would have the authority to vote on his behalf following the mental incapacity of the shareholder. This could prove a real hindrance in the continuity of the business. Careful thought should be given as to whether another family member involved in the business or one of the directors, should be appointed as the business attorney. This is particularly true where the balance of power in the company is finely tuned by the shares held by certain individuals. Someone with the same business view as the shareholder may be preferred, even if they are a third party being not a family member nor a director.

3. Inheritance Tax implications

A. Tips using BPR The first question posed by the legislation covering BPR is whether the business is a ‘qualifying business’. IHTA 1984, s 103(3) states that, “'Business' includes a business carried on in the exercise of a profession or vocation but does not include a business carried on otherwise than for gain”. This means that, although a client may be unaware of it, a ‘hobby business’ will not qualify for BPR, failing at the very first hurdle.

Once it has been established that the business is one that qualifies at that most basic level, relief is given under s. 104 IHTA 1984 where the value transferred by a transfer of value is attributable to “relevant business property”. There are 6 types of relevant business property, attracting relief at either 100% or 50%.


Diversification

As farming businesses increasingly diversify, in order to maximise earning potential from the land to simply to make ends meet, BPR becomes increasingly relevant. A matter of particular concern is whether a diversified business will fall foul of the limitation of BPR in relation to a business which is ‘wholly or mainly the making or holding of investments’.

Earl of Balfour v HMRC [2009] UKFTT 101 [2010] UK UT 200 was a complex case where the Judge in the First Tier Tribunal found that HMRC should grant BPR in relation to Lord Balfour’s interest in his Scottish landed estate and the Upper Tribunal confirmed this decision.

The Judge said it was ‘belittling’ to suggest that Lord Balfour’s management of the Whittingehame Estate was no more than making or holding investments. He took great care to dovetail the two businesses (the Estate and the partnership) into each other. The various activities on the estate were interlaced e.g. the letting of the farm cottages to employees or persons who could otherwise be of benefit to the Estate is but one example. He said it was unnecessary to make any kind of quantitative analysis of the various activities. Indeed, it was a matter of more general assessment and impression as to where the preponderance of business activity lay rather than making a precise quantitative assessment. He regarded the letting activity as ancillary to the farming, forestry and woodland management and sporting activities.

CRC v Lockyer and Robertson (Personal Representatives of N Pawson, deceased) [2013] UK UT050 (TCC) Lord Justice Henderson found in HMRC’s favour in their appeal against the First-Tier Tax Tribunal’s decision, in which a holiday letting business had been granted BPR. In reaching his judgment, he considered in detail the principles of business activity; investment activity; and services; concluding that the holiday let business was ‘mainly’ one of holding property as an investment, effectively overturning the FTT’s judgment. This significant case identifies the difficult issues involved for Executors in making a claim for BPR, in relation to property used for furnished holiday letting purposes

A B Farmer (1) C D E Giles (2) v. IRC SPC 00216 (1999) The deceased owned the freehold of a farm at which he had carried on a farming business. He also let out surplus properties at the farm. Did the business consist mainly of farming (and therefore be for relief) or mainly letting out properties, in which case the relief would be denied? The Special Commissioner held that: the level of net profits was not the only, or even the principal factor relevant to deciding whether a business consisted “mainly” of making or holding investments. The following factors were relevant to the decision:

1. the overall context of the business

2. the capital employed

3. the time spent by the employees


4. the turnover

5. the profit

Of those factors (1) – (5), the first 4 supported the conclusion that the deceased’s business consisted mainly of farming and was therefore eligible for BPR. Only the last factor supported the opposite view. Taking the whole business in the round and without giving prominence to any one factor the conclusion was that the business consisted mainly of farming.

It is interesting to note that the farming and letting activities in this case had been presented as a single business in the accounts. It would have been much more difficult to argue that the letting activities were relievable if they were presented as a separate business.

IRC v. George [2004] WTLR 75 and [2003] EWCA Civ 1763 - This was an appeal by the taxpayer against the decision of the High Court. The case concerned shares in a company that owned land on which it ran a caravan site. The issue on which the Revenue lost at the Special Commissioners and then succeeded on appeal was whether or not the business of the company consisted wholly or mainly of making and holding investments for the purpose of s.105(3) IHTA 1984 with the result that the shareholding would be subject to IHT.

The Court of Appeal noted that the business did not include ‘dealing in land or buildings’ or ‘making investments’. It did include ‘holding investments’ since land was held for the purpose of receiving licence fees for stationing mobile homes and storage; but it was not ‘wholly’ that of holding investments as it included some other activities carried on for profit such as the sale of caravans and the running of the club.

Where a diverse business has included all the varying activities in one set of accounts, this may help to prove that the business in the round is not one concerned wholly or mainly with the making of investments. Conversely, where the ‘wholly or mainly’ test cannot be satisfied, it would be important for the investment activities to be presented as a separate business so as not to prejudice the availability of BPR in respect of the non-investment activities.

‘Hope’ value

The agricultural value of land will usually be lower than the market value. The difference between the two values can be striking where there is some kind of development potential attached to the land. For example, in McCall [2009] NICA 12 the agricultural value of the land at the time of Mrs McClean’s death was £165,000 (which the Revenue accepted was eligible for APR), but the local council had ‘zoned’ the land for development with the result that its market value was £5.8m! A claim for BPR on the additional value was denied. Although walking the land let out for grazing, liasing with the graziers etc did (just!) amount to a business, it was not a farming business, but rather an investment, so the business did not qualify for BPR.


Using Business Property Relief

ISDX companies - The ISDX is an unregulated trading facility for share dealing in certain companies, some of which are unquoted. Private investors must use a stockbroker, but if an adviser can be found who will recommend specific companies as suitable for investment, ISDX can allow shares to be sheltered from IHT after only 2 years of ownership. Practical difficulties?

(1) The very nature of the market is illiquid. It may take some time to assemble a portfolio, and executors may experience a delay in liquidating the holding.

(2) It may be difficult to identify a stockbroker willing to advise on unlisted securities.

(3) The portfolio must be held until death or a relevant chargeable transfer.

AIM companies - AIM is regarded as the second tier of the Stock Exchange, and at present its shares are treated as unquoted for BPR purposes, allowing the potential for relief. They will not all, however, qualify for relief e.g. falling foul of the ‘wholly or mainly holding investment’ provisions, although many AIM companies are of the relatively high risk low cash character that is typically a trading company.

The liquidity of AIM is restricted, but not as restricted as ISDX. Most financial advisers prefer investments held in a trust fund comprising shares in a selection of companies, rather than direct investment in individual companies. NB: AIM shares will not be treated as unquoted for BPR purposes if they are listed anywhere else in the world.

Fully private companies - There is no ready market for shares in such companies, but occasionally an opportunity will present itself for an investor to take a holding in such a company, thus potentially coming within the conditions for BPR.

Converting debt/ cash to equity - Debt is not part of the value of a business, but if the debt is converted into a shareholding then, if the relevant conditions are met, BPR can apply. Similarly, the purchase of additional shares in an unquoted trading company will be sheltered after 2 years.

Nursing homes - If the investment content of a company which operates a nursing home is not too excessive it may be possible to stay outside the limitations of the ‘wholly or mainly holding investments’ restriction and still obtain BPR on shares in such a company. A claim for relief is much less likely to succeed if the home is merely residential (IHTM25277).

Lloyd’s interests - After the experience of Lloyd’s underwriters in recent years, it is perhaps a brave person who considers joining a syndicate. Nevertheless, those who are underwriters enjoy substantial relief because the investments/ assets which support their underwriting can qualify for BPR at 100%. This relief will, of course, be reduced as and when the underwriting capacity is reduced.


Holding investments/ investment properties - For companies whose activity is wholly or mainly being a holding company of a predominantly trading group specific provision is made (s.105(4)(b)) so they can qualify for BPR in spite of the provisions of s.105(3). There is also the possibility, with careful planning, of holding investment properties through a subsidiary, where the remainder of the subsidiaries are trading companies—the group as a whole may be considered to be trading, but this cannot be guaranteed.

B. Points to note The complexity of BPR (and APR) can create hazards for practitioners that will need to be identified and avoided or dealt with if maximum use is to be made of these reliefs. Clients are also often elderly, and planning may occur at the time of retirement from business: retirement, and especially sale, should be discouraged where a structure can be maintained or put in place that will preserve BPR (and/or APR). It is with such issues that this section concerns itself.

Gifts with a reservation of benefit (GROB)

An IHT charge may arise on the transfer of property which is subject to the GROB rules. BPR may be available, but special rules apply. These operate as if the taxable event is a transfer of value made by the donee rather than the donor. The main rules are set out in FA 1986, Sch. 20, para. 8, and provide that the test as to whether shares qualify for BPR is fixed by considering them as if they were owned by the donor, and had continued to be owned by him since the gift.

In deciding whether or not either BPR or APR is available in relation to the property in the gift, and determining the percentage at which the relief may be claimed the transfer of value is determined as if made by the donor. These rules will apply if

(a) The property qualified for APR or BPR when the original gift was made; and,

(b) Qualifies for relief by reference to the donee.

Thus, for example, if the requirements of BPR are not met, perhaps because the donee does not control the company that uses the asset he has been given, clawback may apply.

Further rules apply to shareholdings which are the subject of a GROB, concerning situations where control is an issue. A decision is made on the hypothesis that the donor owned the shares after the making of the gift, and this will generally facilitate a claim for BPR.

Deductibility of debts

The scope for saving IHT has been dramatically reduced by the changes to the treatment of debts in FA 2013. Certain steps can be taken, however, to minimise the effect of this legislation.


Tainting debts - Care should be taken not to taint pre-existing borrowings by increasing or renegotiating them after 6 April 2013.

Mixing debts - Mixing new non-business borrowing with borrowing that relates to relievable property should be avoided if possible.

Review existing debts - Does existing borrowing relate both to relievable and non-relievable property? FA 2013 provides that repayment of a mixed loan would be set first against the non-relievable property. It is advisable, and arguably most straightforward in planning terms, to try to ensure that no borrowing is set against relievable property that does not relate to that property. Surplus cash in one business, which might be regarded as an excepted asset in BPR terms, could be released to reduce debt elsewhere.

Retirement

Retiring from a business, and particularly selling it, can have catastrophic consequences in terms of BPR. It may be better for an older member of a family business to take a back seat whilst retaining a significant interest in the business through to his death. This will not only retain BPR, but also ensure CGT uplift on death.

The recent case of Swain Mason v Mills & Reeve [2011] EWHC 410, [2012] EWCA Civ 498 raised such issues, and is considered to serve as a warning to practitioners.

The facts Mr Swain, a company director aged 61, was overweight and had previously suffered a heart attack. In 2006 he consulted solicitors about selling his controlling share in the family business. By that time, he was spending a lot of time out of the UK and had agreed, in principle, to sell the company to the current management. The solicitors advised in writing in January 2007 about the tax consequences of the sale. A letter applying for certain tax clearances made reference to Mr Swain’s ‘continuing weak health’, to his heart attack, his diabetes and the fact that he would not return to active work. The letter also showed that Mr Swain, while still domiciled resident and ordinarily resident in the UK, might cease to be resident at the start of the following tax year, just a few weeks later.

Mr Swain made an appointment for a hospital procedure in Thailand on 17 Feb 2007 and told all relevant parties, including the solicitors, that this was his priority and he would not be attending board meetings. The company sale went ahead on 31 Jan 2007; Mr Swain died on 17 Feb during the hospital procedure.

IHT on the estate was greater than it would have been if the sale had been deferred, because BPR was lost. CGT was also incurred that might have been avoided. Mr Swain’s daughters sued the solicitors, arguing they should have advised delaying the sale until after the operation. The solicitors argued that they were not instructed to advise on what might happen in the event of death soon after the completion of the sale. They also argued that the risk of death during the procedure had been


negligible, and that Mr Swain had not asked their advice on the issue that had caused the loss.

The decision Having lost at first instance, the solicitors were successful in having a retrial ordered by the Court of Appeal. Arnold J examined carefully the extent of the solicitors’ retainer and whether they had excluded tax advice as to the effect of the disposal. He held that they had, but only by the narrowest margin, because the letter could have been more specific about IHT and CGT. The Court of Appeal upheld this decision, ordering the daughters to pay 60% of the solicitors’ costs.

Practical points • An engagement letter should state which areas of advice are not covered, as well

as stating those which are.

• The practitioner should keep in touch with the client, being alert to circumstances that might change and have a bearing on the timing of a transaction.

• Even in a commercial case, private client issues may be relevant, and one should be alert to the significance of all taxes.

It has been noted, in legal publications, however, that solicitors who are sued should not necessarily ‘throw in the towel’. There may be scope for defending the claim, even though this will still not necessarily lead to an entirely satisfactory outcome for all/ any parties involved!

Partners—active and inactive

S.105 (1)(a) allows BPR in respect of property consisting of an interest in a business. There is no requirement that the owner of that interest should be actively concerned in the furtherance of the trade.

This can lead, in practical terms, to a conflict of interest within a partnership. If an elderly partner leaves a business, the younger partners may be more able to move the business forward, modernising it as the ‘younger generation’ may think fit. However, the older partner may have substantially more capital in the business than the younger partners, and this would have to be addressed if he were to leave.

So long as the older partner’s capital remains true capital (remembering the excepted asset rules etc.) then BPR will be available; in this context he will also need to avoid his capital being converted into a loan, as loans to a partnership are not part of the business. The old partner would usually be wise to stay on.

‘Wholly or mainly the holding of investments’

A business which wholly or mainly holds investments will usually not fall within the ambit of BPR. The nature and structure of a client’s business should be reviewed with this in mind. The possibility of ‘tweaking’ activities undertaken to make a claim


for BPR workable should be considered e.g. involvement of the owner of land under a grazing agreement. A time may come, however, where it is safer to hive off a part of the business that is very likely to fall foul of this restriction on BPR, so as to avoid tainting the rest of the business.

Pilot trusts

HMRC’s GAAR guidance, at D26.1, noted that, ‘Settled property may be chargeable to IHT under the relevant property regime. A charge to tax will arise on the value of the settled property on every tenth anniversary of the settlement and a pro-rata charge will arise whenever property comprised in a settlement ceases to be relevant property. In determining the rate at which tax is charged on settled property, the value of all the property in settlements established by the same settlor on the same day – ‘related settlements’ – is taken into account.’

The case of Rysaffe v CIR [2002] STI Issue 23 concerned a scheme to settle shares in a private company using ten discretionary settlements, five made by each of two settlors in the same form on consecutive days. The issue of related settlements, and associated operations, arose in connection with the ten-year periodic charge on the settlements. The settlers had argued that each settlement stood alone for the purposes of the calculation of the charge; HMRC argued that, on the contrary, there was in relation to each settlor only one settlement. The Special Commissioner originally found in favour of HMRC, but the decision was overturned on appeal.

It was initially thought that a similar scheme, implemented today, would probably fail because of GAAR. The GAAR guidance, however, gives the practitioner reason to feel more optimistic. It sets out an example at D26.2.1:

‘C wishes to leave his estate in trust for his 7 grandchildren. He wants to ensure that these settlements are not subject to IHT after his death. C establishes one settlement per day over a period of 7 days, settling £100 on each. He revises his Will so that he leaves a specific legacy of £250,000 free of tax to each settlement. Following his death, his executors pay the legacies to each of the trustees.’

The taxpayer would have taken this action in the belief that each settlement will have its own nil rate band after his death. D26.5.1 confirms HMRC’s understanding that

‘Settlements that are established on the same day are related settlements and the value of property, immediately after they commenced, in related settlements is taken into account in determining the rate of tax that is charged on each settlement. Because the settlements [in the example here] were created on consecutive days, they are not related settlements and so the rate of tax is calculated without reference to the other settlements, notwithstanding that the substantial addition of funds came about as a result of a single event—C’s death.’

The guidance states at 26.5.3 that, “The practice was litigated in the case of Rysaffe Trustee v IRC [2003] STC 536. HMRC lost the case and having chosen not to change


the legislation, must be taken to have accepted the practice.” The next paragraph of the guidance (26.6.1) concludes that, ‘The arrangements accord with established practice accepted by HMRC and are accordingly not regarded as abusive.’

This was good news for a settlor. Sadly, the Finance (No.2) Act 2015 contains provisions which attack the use of these ‘pilot trust’ arrangements by relating settlements together through ‘same day additions’. ‘Same-day additions’ (as defined in s.62A IHTA 1984) are to be added to the supposed transfer of value for the purpose of calculating the periodic charges under the relevant property regime. From 18 November 2015 (Royal Assent of the Summer Finance Bill 2015), same day additions will be taxed on trusts created on or after 10 December 2014 and those created before 10 December 2014 unless the addition is made to a protected settlement, i.e. one made before 10 December 2014 and to which funds are transferred (under a Will executed before that date) on the death of the testator before 6 April 2017. C. The implications of ss.39 – 42 IHTA 1984 Where a testator makes exempt gifts by Will to, for example, his spouse or civil partner and the remainder of the estate is not exempt, because it is left to his children, and the testator owns assets which qualify for BPR, the amount of the advantage gained from the relief depends on the way you write the clauses in the Will. A common mistake when trying to juggle the interests of surviving spouses and civil partners with those of issue is to create a Will where the surviving spouse or civil partner takes a large legacy tax free; and then the residue is left to the issue, so it contains the relievable assets – unfortunately, then, you have a gift of partially exempt residue and the provisions of ss.39 – 42 IHTA 1984 kick in. BPR operates to reduce the value transferred by a transfer of value before any exempt parts are deducted. Thus, where an estate is partially exempt the transfer of value then has to be allocated between exempt and non-exempt gifts under ss.36-42 IHTA 1984. It is s.39A IHTA 1984 which determines the allocation of any BPR between exempt and non-exempt gifts and it is complex. s.39A(2) provides that specific gifts of relevant business property are reduced in value by the relevant BPR relating to that property, whether or not the gift is to an exempt or non-exempt person. With the result that the chargeability of non-exempt gifts will be reduced; whereas the relief is wasted in respect of exempt gifts since it reduces them too. If the gift of the relevant business property is not specific, such as when it falls into the residuary estate, the relief does not go to reduce the value of the relevant


business property but is apportioned rateably between the exempt and non-exempt gifts - s.39A (3) & (4).

Example Fred Widget has a business valued at £2,000,000 attracting 100% relief, a business property valued at £800,000 (attracting 50% relief), and other assets totalling £200,000, making a total estate of £3,000,000. Under his Will he leaves the interest in the business property to his daughter Justine, subject to any tax thereon, a £800,000 legacy to his widow, Eileen and the residue to his son, Phillip. The reduced value of the specific gift to Justine is £400,000. The appropriate fraction of the value of the gift to the widow is calculated in accordance with the formula: £600,000 (VT) - £400,000 (RVG) = £200,000 = 1 £3,000,000 (UVT) - £800,000 (UVG) £2,200,000 11 Where VT = value transferred in the estate after deduction of relief RVG = reduced value of any specific gifts after relief UVT = the value of the estate before relief is deducted UVG = the unreduced value of any specific gifts of any relievable property The gift to the widow is therefore multiplied by the appropriate fraction, ie £800,000 x 1/11 = £72,727 The tax is then calculated as follows:

£ £

Total estate 3,000,000.00

Less relief on the business & business property (2,400,000.00)

Value transferred 600,000.00

Value attributable to widow’s legacy 72,727.00

Value attributable to Justine’s gift 400,000.00

(472,727.00)

Attributable to the residue in favour of Phillip 127,273.00


Tax is then paid on the total of the gifts to Justine and Phillip i.e. £400,000 + £127,273.00 =£527,273. If the gift to Justine was not made subject to tax it would be assumed to be made free of tax with the result that it would have to be grossed-up! s.42(1) IHTA 1984 defines “specific gift” for s.39A purposes as any gift other than a gift of residue or a share of residue. Gifts payable out of business property are not for the purposes of s.39A specific gifts of that property. Gifts of business property should therefore be dealt with in isolation from the rest of the estate. It is therefore preferable to make specific gifts of property having the benefit of the relief to non-exempt beneficiaries. Hence, the clause in par. 1.2 in section C of the notes above.


Case study 1

Adrian Widget is 63. He had a heart by-pass operation 2 years ago but is fully recovered. Mrs Amanda Widget is 58 and in excellent health. Adrian owns 40% of Widget Mouldings Limited. Amanda owns 30% and the remaining 30% is owned by Primus Investments Plc - a quoted company.

Widget Mouldings Limited is a manufacturing concern worth £4 million and apart from the usual trading assets it owns a portfolio of quoted securities worth £300,000 and a villa in Spain worth £200,000 used exclusively by Mr and Mrs Widget for entertaining their friends - proper returns have been made on the P11D.

Under the terms of the deal whereby Primus acquired its shareholding there is a full shareholders’ agreement providing that on 31 December 2027 or the earlier death of Adrian, Primus will acquire 25% of Adrian’s 40% shareholding i.e. leaving Adrian with 15%. This will increase the Primus holding from 30% to 55%. The Articles of Association contain detailed provisions protecting minority interests following the acquisition of control by Primus.

Adrian’s son, Michael, is aged 36 and is managing director of Widget Mouldings Limited. He is employed on a 5 year rolling contract at £50,000.

Mr and Mrs Widget have generous pension scheme provisions and they jointly own the premises worth £500,000 and occupied by the company at an annual rent of £50,000.

Adrian’s great pride is his £200,000 boat which was purchased last year with the aid of a loan secured on Mr and Mrs Widget’s shareholding in Widget Mouldings Limited.

Adrian and Amanda’s daughter, Susan, is not involved in the company. She is aged 30 and is married to a clergyman. They have 2 young children.

About 4 years ago, Adrian took out a whole of life unit linked insurance policy at an annual premium of £5,000 a year. The policy has a current surrender value of £22,000. The matrimonial home is jointly owned as joint tenants and is worth about £400,000.

Mr and Mrs Widget would like to do something for their children partly to reward their son for his efforts and partly to provide for their grandchildren. Adrian is minded to give 5% of his shares to his son and Amanda would like to put 5% of her shares into trust for the grandchildren.

Adrian’s thoughts on his Will are that Amanda should retain the matrimonial home, Michael would have the proceeds of the sale of the shares in Widget Mouldings Limited as well as the other 10% holding (assuming he has already transferred 5% to him during his lifetime) and Susan should have the life policy with the residue split equally between Michael and Susan.


Amanda thinks she would like to give Michael the remaining 25% in Widget Mouldings Limited, after the 5% has gone into trust for the grandchildren. Similarly, the matrimonial home would go to Adrian with the office premises. Anything else will go to Michael and Susan.

How will you advise the Widgets?

Case Study 2

Harry is the patriarch of the family business, Cars R Us. He is the sole director and majority shareholder. All the other shareholders are members of the family. Harry has had a stroke and lost his mental capacity. Alan and Jane, Harry’s son and daughter, are also shareholders and employees in the family business. In the past few years Harry has taken a step back from managing the family business and Alan and Jane have taken on more managerial roles. Although no formal plan has been put in place the assumed natural progression would have been for them to have become directors of the company and inherited Harry’s shares in due course. Catherine, Harry’s wife and the mother of Alan and Jane is not involved in the business and has only a few shares in the company. She is just about coping with looking after Harry.

a. What information is required to be able to advise thoroughly? b. What steps need to be taken? c. How could the position have been improved if action had been taken before

Harry lost capacity?

Documents

Succession planning for business clients - The Law Society · Succession planning for business ... often outline how they want a son or daughter to succeed to ... Since 6 April 2013