The ability for three hotel shareholders to buy and sell shares in a commercial arrangement allows them to maintain full ownership in the event of a business succession.
Platinum Luxury Hotels (UK) Limited owns and runs five high-quality hotels, situated in different locations across the UK. The current market value of the company is £7.25 million. It is owned and managed by three cousins.
The shareholders recently decided they would like to put a business succession arrangement in place. Should one of them die, the surviving shareholders would like to be in the position to buy the deceased’s shareholding from his personal representatives.
Buying the shares would allow them to maintain control and full ownership of the company, avoiding the shares falling into the hands of a third party. In turn, the deceased’s beneficiaries will receive cash to the tune of the market value of the shares.
The shares currently attract business property relief (BPR). The shareholders want to ensure the arrangement they put in place is efficient from an inheritance tax (IHT) perspective on their death.
The shareholders take advice and execute a double option agreement, giving their personal representatives the option to sell the shares and the surviving shareholders the option to buy these. As this is not a binding contract for sale, the shares should continue to attract BPR.
They each apply for an own life policy and place this in a business trust for the benefit of the other shareholders. Due to the reciprocal nature of this exercise, with each shareholder setting up a trust in return for the others doing the same, it is vital the arrangement is fully commercial to avoid invoking the associated operations provisions. If the arrangement does not qualify as an arm’s length transaction, it will be viewed as a gift with reservation. As a result, the value of the trust fund will form part of the deceased shareholder’s IHT estate on death.
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Each policy is issued to trustees from the outset. The ongoing premium payments will not be considered gifts, where the arrangement is fully commercial. The settlor is included as a beneficiary under the trust. This allows him to access the policy when he no longer owns shares in the company, as this might be at a time when he is otherwise uninsurable.
Generally if the settlor is a potential beneficiary under a trust and is paying the premiums to maintain a life policy, this would be classed as a gift with reservation of benefit. However, if the premiums qualify as exempt transfers due to the commercial nature of the arrangement, the IHT benefits of the arrangement should be maintained even if the settlor is a potential beneficiary.
Taking the following actions should help:
- The beneficiaries on the business trust should be limited to the settlor and other shareholders only. They should not include other family members unconnected to the company.
- The beneficiaries should be restricted to only those shareholders who are taking part in the arrangement and taking out similar cover in a business trust. This way there is no element of gifting taking place.
- They should make sure the level of cover is adequate and keep this under review. If the cover is too low, the other shareholders will have to fund the shortfall. If it is too high then arguably the shareholders stand to get gratuitous benefits or something for nothing. This could have a negative effect on the commerciality of the arrangement.
- Older shareholders and those in poor health pay higher premiums to maintain their policy, but stand less chance of receiving benefits. The shareholders should consider equalising the premiums they pay to make sure they each bear a cost proportionate to their likelihood of benefiting under the arrangement. The shareholders should make cash adjustments between themselves to rectify the position.
Elaine Cruickshank is tax and trusts manager at Aegon