Surviving succession
The survival of a business does not always depend on its profitability; sometimes failing to have a succession plan in place can lead to its downfall.
As businesses brought in the New Year, thoughts will have turned to getting affairs in order. Sole traders and main shareholders in private companies especially, will have (hopefully) turned to their solicitors to plan for succession.
Otherwise, a death of a main shareholder could have an enormous impact on the continuation or future success of a business.
Partnership agreement
Interests in a business are be treated as part of an estate and dealt with by a will - or in the absence of that, an intestacy. It is possible to appoint specialist personal representatives as executors. They can have extra powers in a will to enable them to manage the business properly, and manage any pressure from competing beneficiaries with different interests in the estate. It can also allow other assets to be used to help keep the business running until it is sold.
If the business is structured in a partnership, there needs to be an agreement in place to cater for the death of a partner, as well as other contingencies. Otherwise, the death of a partner may cause the partnership to simply dissolve. A properly drafted partnership agreement can allow the surviving partners to purchase the deceased partner's share from the personal representatives of the estate. However, the partnership agreement must not create a binding agreement to sell in the event of death as this could have adverse inheritance tax (IHT) consequences.
Inheritance tax and business property relief
Businesses will also be planning succession for the purpose of minimising IHT due on their estate. Some business interests qualify for business property relief (BPR) from IHT on death, receiving a 50 per cent or 100 per cent reduction on the IHT payable. BPR does not apply to a business which only generates investment income, and practitioners should establish whether the business is a trading company.
If the business buys and sells property, it must be held onto for at least two years before it qualifies. This will be a significant issue to bear in mind when combing accounts and establishing a client's position. However, significantly, BPR can be lost if, for example, the whole estate passes to a surviving spouse or civil partner. Such transfers are exempt in any case.
It was widely thought in the run up to November's autumn statement that George Osborne would be shaking up BPR in the face of criticism that instead of supporting small businesses, it was being misused as a tool in inheritance tax minimisation schemes. Although BPR remained unchanged, practitioners should be aware that major alterations could be on the chancellor's agenda in the near future.
Trusts
It may be more tax efficient to arrange business assets that qualify for BPR to be left to a discretionary trust, rather than to a spouse or civil partner. The surviving spouse or civil partner can be a beneficiary of the trust but the trust assets do not form part of their estate and will not be included in it when they also die in due course.
A further refinement would be for the trustees of the trust to sell the assets back to the surviving spouse or civil partner subject to an IOU. Provided the assets remain business assets and the spouse keeps them for at least two years, they will become eligible for BPR. Then they can be gifted by the spouse to the children and provided he or she survives for seven years from the date of the gift, it will be free of IHT. On the other hand, this complicates family arrangements and may give rise to other tax liabilities under the ten yearly charge to IHT.
A further option would be to arrange to gift the business assets to one or more of the adult children in the family. They could then sell the assets back to the surviving spouse in return for an IOU, in a similar way to that set out above for a trust.
An advantage of this would be the absence of the ten yearly charge to IHT, though a major disadvantage in this scenario is the lack of control this could bring. A change in family circumstances such as a child's divorce or bankruptcy could place the business at risk, and practitioners need to bear this in mind.
Catherine Robson is a solicitor in the wills, trust and probate department at SA Law LLP