11. Trusts for business protection and succession

Transcription

1 11. Trusts for business protection and succession 11.1 Introduction One of the last things on the mind of people involved in running a small business is what would happen to the business and the family if one of the owners were to die or suffer serious illness. Preferring to concentrate on profit generation, it is quite often the case that this subject is not even considered by the owners of the business (that is unless they personally know somebody who has died owning a business). However, the bare fact is that if this subject is not properly addressed, it can have catastrophic effects on both the stability and success of the business and the financial wellbeing of the deceased owner s family. Fortunately, these potential problems can be dealt with by the judicious use of: a suitable financial product; an appropriately drafted trust; an option agreement; and a suitable provision in each owner s will Implications of the death of an owner Different business structures Private businesses that are owned by two or more people can operate as partnerships, limited liability partnerships (LLPs) or limited companies. In what follows we will be looking at the planning possibilities for shareholders/directors of a private company that is a close company for tax purposes. In general, share succession planning for each of these entities will follow similar principles apart from in the following areas: It is generally not appropriate (or possible) for a partnership to effect a policy on the life of a partner. This may be relevant where there is a desire to implement business protection (keyperson) planning. In such cases a 185

2 policy in a partnership trust (see below) or a business succession trust may be more appropriate. A limited company can buy back (and cancel) its own shares. This is therefore an alternative strategy for a company in relation to share succession planning. This form of planning is not available to general partnerships or LLPs. An automatic accrual clause is sometimes a more appropriate share succession solution for partnerships particularly professional partnerships. This would typically involve the deceased s goodwill automatically passing to the surviving partners for no cost with compensation for the deceased s family being provided by a life policy written in trust. An automatic accrual clause would be very unusual in a limited company scenario Financial needs on the death of an owner On the basis that the shareholders/directors of a private company are made aware of the financial and emotional problems that can arise, they should be keen to take action to avoid such problems in the event of one of them dying or suffering a serious illness. The potential financial problems centre around: deciding who should buy the deceased s shares; agreeing a suitable purchase price for the shares to be purchased; dealing with the financial damage to the business, both from the standpoint of the loss of the value that the deceased shareholder/director gave to the business and the time the continuing owners will spend in dealing with this matter rather than running the business; and providing financial security for the deceased shareholder s family. They will therefore be very interested in ways in which they can set up an arrangement that: deals with who can buy shares in the event of the death or serious illness of any of the owners; 186

3 deals with how much should be paid for those shares; provides a means by which the purchase price will be made available; deals with any potential financial loss to the business arising from the death or serious illness of a shareholder; makes sure that all of this is dealt with in a tax-efficient and flexible way but in such a way as gives a degree of certainty. In essence, such an arrangement will enable: the surviving shareholders to keep control of the ownership of the business; the deceased shareholder s dependants to be financially compensated; and the business to cover any financial loss occurring because of the shareholder s death. Trusts can play a vital role in meeting these requirements The specific issues to address in planning In providing a share succession solution, it will be necessary to ascertain all of the relevant information as regards the circumstances and objectives of the owners. This will include details of the owners in the business and their respective shareholdings and confirming which shareholders will be party to the arrangement (i.e. those who are elderly, in ill health or who only have a minority shareholding may not be included) and ascertaining whether any existing arrangements for share succession exist. As regards business protection arrangements (i.e. keyperson cover) it will be necessary to obtain information on how the business might suffer financially in the event of an owner s death or serious illness Ascertaining the amount of cover needed Share purchase There will be a need to put provision in place so that cash will be available for shareholders to buy the shares of a deceased or seriously ill shareholder. This could normally be satisfied by a 187

4 suitable life assurance protection plan written to the shareholder s retirement age. Clearly, one of the key aspects to a successful business succession arrangement is to place a current value on the shareholding in the business. The valuation of shares in a private limited company is a complicated process (see below) but a good starting point would be to ask the current owners of the business how much they would currently sell the business for. This will give a good indication of the high end of its current value. If they cannot agree on this, an independent valuation could be taken from an accountant who is experienced in such matters. Keyperson cover This is the financial loss that the business may suffer as a result of the death or serious illness of a shareholder. This loss will extend not just to a reduction in profitability but also to the need to repay all or a part of any loans or overdrafts that the business may then have. For example, the directors/shareholders of Woolco Ltd may estimate that in the event of one of them dying there is likely to be a reduction in profits of 100,000 per annum. It will then be necessary to determine how long this loss is likely to last for (given that remedial action can be taken by the business) and, in this respect, the shareholders may believe there would be a loss of full profits for two years with a 50 per cent loss in year three. The loss of profits arising on serious illness will depend on the circumstances but frequently it would not be unreasonable to use a similar factor to that which applies on death. For Woolco Ltd there would therefore be a need for cover of 250,000 on each director/shareholder to cover the loss of two and a half years of pre-tax profits. The total business cover required for each director/shareholder should be determined by adding the shareholder needs to the keyperson needs. 188

5 Creating a suitable plan Business succession arrangement A successful business succession arrangement will be made up of a testamentary disposal of the business interest (i.e. shares in the case of a private limited company) via a will, an option agreement, a life policy and a trust of the policy. We will now look at these component parts in more detail: A will a suitable will provision is necessary to deal with the transfer of the shares on death. The will gives some degree of certainty over who will benefit from the shares or the proceeds of sale of the shares on death. It will also avoid any delays which could arise on an intestacy and give the opportunity for ongoing IHT planning by using a bypass trust (see below). A double option agreement this will deal with the purchase/sale of the shares on a business owner s death. Following the death of the shareholder his personal representatives will have an option to sell and the surviving shareholders an option to buy his shares. In the event of either side exercising their option, the other side will be bound. The option periods for buying and selling will be slightly different. If the position on serious illness is being covered, a double option agreement may not be appropriate because the seriously ill owner may not wish to sell. In such circumstances a single option agreement will often be used whereby only the seriously ill shareholder has the option to sell but if he exercises his option the other shareholders must comply. This means he keeps control and any decision made will reflect his intentions as to whether to remain involved in the business or not. By using an option agreement, inheritance tax business property relief will be secured, if otherwise available, on the shares on the death of an owner. This would not be the case if the shares were subject to a binding sale agreement on death as they would then be regarded as cash. 189

6 A life policy/serious illness policy on the life of each shareholder for a sum assured equal to the value of the shares. In this respect, it is important that only new policies are used. If trusts are declared of existing life policies, this could have the effect of making the policy proceeds subject to capital gains tax. A trust of the life policy/serious illness policy so that the proceeds of the policy can be paid tax efficiently to the continuing shareholders. This will enable them to purchase the shares from the deceased s estate or from a seriously ill shareholder. The trust would normally be a business trust on either a flexible (power of appointment interest in possession) basis or a discretionary trust basis. The named default beneficiaries would be the other current shareholders in the business but all the shareholders would be discretionary beneficiaries. This would enable the trust and the arrangement to cope with any future changes in shareholders. Any shareholders who are not participating in the arrangement (i.e. because they are minority shareholders or are elderly or ill) must not be a beneficiary under the trusts Tax implications The tax implications of the share succession arrangement are as follows: Policy trust Premium payments Premium payments are the collective responsibility of the directors/shareholders. No income tax relief will be available because the policies are on the lives of substantial shareholders and are part of the cost of raising capital. If the employer company pays premiums on the director s behalf, this will give rise to an income tax (and NICs) charge on the basis that they are additional remuneration. 190