Will trusts can ease IHT burdens

11/07/2011

By Stuart Goodbody, Partner in Private Client. First published in New Model Advisor in July 2011.

Owner-directors of private companies can use discretionary will trusts to take advantage of the potential exemption from IHT of unquoted shares, and should review their wills now.

Unquoted shares can be eligible for up to 100% relief from inheritance tax (IHT). Owner-directors of private companies should review their wills to exploit valuable tax planning opportunities and avoid potential difficulties. 

Business property relief

In IHT legislation, ‘relevant business property’ comprising ‘any unquoted shares in a company’ qualifies for 100% business property relief (BPR) after two years of ownership. However, there are a number of important points to consider:

BPR is only applicable to trading companies, not investment companies. No relief is given if the business ‘consists wholly or mainly of dealing in securities, stocks or shares, land or buildings, or making or holding investments’. The wholly or mainly test provides an opportunity to secure IHT relief for assets brought into the company that might otherwise be unrelievable outside it, provided the conditions above are met and that no ‘excepted assets’ are involved.

Relief will be lost to the extent that share value is attributable to excepted assets, meaning assets owned by the company that are either used for personal rather than business purposes or are surplus to business needs. A high level of cash may be a problem, unless convincing evidence of its requirement for future business purposes can be produced.

BPR will be denied if on the director’s death their shareholding is subject to a binding contract of sale. This will include the situation where surviving directors are obliged to purchase the shares of the deceased. Directors should review their articles of association and any shareholder agreements to identify alternatives.

Avoid diminishing BPR unnecessarily by secured debt. Borrowings should be charged on the shareholder’s unrelieved assets, rather than on the shares themselves.

Where the land or plant used by the company is owned by a director, BPR at 50% will apply, and then only if the director has control of the company. For the asset to be sheltered 100%, regardless of control, steps can be taken to bring it within the ownership of the company, but the capital gains tax (CGT) and stamp duty land tax implications would need to be considered.  

BPR and wills

BPR is too valuable to waste, so directors should avoid the following in their wills:

• Making a specific gift of shares to a spouse who will benefit from IHT exemption in any event. If the spouse subsequently sells the shares, the unrelievable proceeds will form part of the spouse’s estate and be subject to IHT at 40%.
• Dividing their estate between IHT-exempt and non-exempt beneficiaries; for example, leaving a money legacy to a spouse and the remainder to children. Part of any BPR will be allocated to the legacy and the IHT position for the residuary beneficiaries will be worse than it could have been. 

The will should deal with company shares specifically, leaving them to beneficiaries who are not exempt from IHT. In a family context, the obvious choice will be children, but a direct gift may be problematic for the following reasons:

• It may leave the spouse insufficiently provided for;
• An outright gift to several children may be inappropriate because of a lack of involvement by some in the business or the implications for future management;
• The extent of BPR may not be certain, either because of the hybrid nature of the business or the existence of excepted assets.

Using a discretionary will trust

Will trusts can address these issues. A discretionary trust has enormous flexibility, since the chosen trustees can be given complete discretion over how company shares, and their income, are applied. There are clear advantages to this type of arrangement:

• A surviving spouse will not be cut out financially as they will feature among the potential beneficiaries.
• Loss of control will be avoided because the voting rights attached to the shares will be exercisable by the trustees.
• BPR will be tested if share values are such that IHT could be an issue. Wills should avoid using a nil-rate formula that discourages examination by HM Revenue & Customs and makes the availability of relief uncertain.
• If BPR is not available or only on a restricted basis, trustees can redirect shares for the benefit of a widowed spouse within two years of the death and secure IHT exemption retrospectively.

Where BPR-relievable shares are held within a discretionary will trust, a number of estate-planning opportunities can arise.

IHT mitigation

Shares may remain in a discretionary will trust and subsequently be allocated to children or other family members. In either case, the 10-yearly and exit charges for IHT associated with discretionary trusts will not apply so long as the BPR conditions continue to be satisfied.

Where the intention is to sell the shares or wind up the company, any proceeds retained in the trust will benefit from a more favourable IHT environment than if they were held by a surviving spouse. This is because the maximum IHT rate applicable to discretionary trusts is 6%. Since the trust fund can be administered for the benefit of the survivor without forming part of their taxable estate, this may facilitate gifts of unrelieved assets owned by the survivor to reduce residual IHT exposure.

If the spouse intends to continue in business, they may acquire some or all of the shares from the trust at market value, if necessary on an IOU basis. After the qualifying holding period, the purchased shares will be eligible for BPR and the value of the survivor’s estate for IHT purposes will be reduced by the amount owed to the trustees.  

Importance of executor choice

As with any planning involving trusts, the choice of executors and trustees is all-important. When assessing the merits of a particular course of action, the trustees need to keep in mind other taxes such as CGT and stamp duty.

Directors of owner-managed businesses should review their wills along with the company’s articles of association and any shareholder agreements. This will ensure BPR can be exploited effectively in the interests of their intended beneficiaries and provide an appropriate framework for succession.