My client, a widower, owns 100% of the shares in a trading company worth in the order of £1m. He has an interested buyer but is concerned that the sale of his shares will increase the potential inheritance tax in relation to his estate. He is happy to share the proceeds of sale with his children but is reluctant to make outright transfers, as he is worried that they may simply spend all the money. What are his options?
Answer
The starting point here would be to assume that your client’s shares could currently attract 100% business property relief (IHTA 1984 s 104), so that the potential inheritance tax liability in relation to the shares is currently nil. Following the sale, there would be no such relief in relation to the cash proceeds; therefore, assuming your client already has other assets in excess of his available nil rate band, his potential inheritance tax liability would indeed increase.
We can assume too that your client would be entitled to entrepreneurs’ relief on the sale of his shares, so let’s assume that he would receive somewhere in the order of £900,000 net of capital gains tax (at only a nominal ‘base cost’). His potential inheritance tax liability would thus increase to 40% of £900,000, or £360,000.
It would, of course, be possible for your client to give away his £900,000 proceeds of sale. If this were by way of an outright transfer to his children, it would be a potentially exempt transfer (IHTA 1984 s 3A) with no immediate inheritance tax charge arising. However, like many parents – and for a variety of reasons – your client is understandably reluctant to place £900,000 directly into the hands of his children.
The standard approach, when someone wants to retain control of the assets that they are giving away, is to make a gift to a trust of which the settlor is one of the trustees. The difficulty with this approach for your client is that – unless he was making a gift to a disabled person’s trust – a gift of the proceeds of sale to a trust would not be a potentially exempt transfer, and would therefore be immediately chargeable to inheritance tax. This would be calculated at: £900,000 less £325,000 less £6,000 (assuming two annual inheritance tax allowances) = £569,000, which at 20% amounts to £113,800. This may well be too high for your client to pay.
How then might your client proceed? It is a simple enough matter to avoid this immediate inheritance tax charge on a transfer to a trust: your client can transfer his shares to the trust before they are sold. Then, 100% business property relief would be available, any transfer would be at a nil value and no immediate inheritance tax charge arises. It should be noted too that although there are ‘clawback’ rules (IHTA 1984 s 113A), which broadly treat the gifted shares as being a gift of cash, if the donee (here the trustees) sells the shares, these rules only affect the position on the death of donor within seven years, and do not impose any retrospective lifetime charge in the donor’s lifetime.
The point at which the shares are treated as being sold for these purposes is the point at which there is a binding contract for sale in place. This is because IHTA 1984 s 113 denies business property relief to any asset subject to such a binding contract.
Thus, as long as the gift of shares is made before any sale becomes binding, the immediate inheritance tax charge on the gift to the trust will be avoided.
What though of the capital gains tax position?
A transfer of shares into trust would constitute a disposal for CGT purposes but ordinarily one would take advantage of ‘hold over’ relief under the provisions of TCGA 1992 s 260 and, in effect, any gains are passed on to the trustees. The problem with this approach in this case is that any held over gains would be triggered when the trustees sell the shares and entrepreneurs’ relief would not be available for at least a year – and then only if a ‘qualifying beneficiary’ holds at least 5% of the shares for a year (TCGA 1992 s 169J). Thus, if a sale is imminent, capital gains tax would be payable by the trustees at 20%, doubling the liability from £100,000 to £200,000.
The possible solution would be for your client to transfer 90% of his shares into trust without claiming hold over relief. Entrepreneurs’ relief would then apply in relation to that disposal – which, at 10%, would trigger a liability of approximately £90,000. When the sale of shares completes, your client would then make an additional disposal of his retained 10%, triggering a further charge of £10,000. His total liability would then be £100,000 but, having retained 10% he will have received £100,000, on the sale of his retained 10% share, and could meet that cost.
The trustees, meanwhile, will have received their shares with a base cost equal to their market value at the date of transfer; however, as they have received a 90% holding, any discount to pro rata value (and thus any gain in their hands, being the difference between this and the sale proceeds they receive) should be modest.
The one practical issue for your client is that as it is a condition that he makes the transfer into trust before there is a binding contract in place, there will remain the possibility that the sale will not complete, and your client will be left with a CGT liability in relation to the transfer to the trust, with no sale proceeds to meet it. In these circumstances, however, he would still have the option of falling back upon a hold over relief claim; and, of course, any decision on this would not need to be made until the end of January following the end of the relevant tax year, when the CGT liability would otherwise become due.
My client, a widower, owns 100% of the shares in a trading company worth in the order of £1m. He has an interested buyer but is concerned that the sale of his shares will increase the potential inheritance tax in relation to his estate. He is happy to share the proceeds of sale with his children but is reluctant to make outright transfers, as he is worried that they may simply spend all the money. What are his options?
Answer
The starting point here would be to assume that your client’s shares could currently attract 100% business property relief (IHTA 1984 s 104), so that the potential inheritance tax liability in relation to the shares is currently nil. Following the sale, there would be no such relief in relation to the cash proceeds; therefore, assuming your client already has other assets in excess of his available nil rate band, his potential inheritance tax liability would indeed increase.
We can assume too that your client would be entitled to entrepreneurs’ relief on the sale of his shares, so let’s assume that he would receive somewhere in the order of £900,000 net of capital gains tax (at only a nominal ‘base cost’). His potential inheritance tax liability would thus increase to 40% of £900,000, or £360,000.
It would, of course, be possible for your client to give away his £900,000 proceeds of sale. If this were by way of an outright transfer to his children, it would be a potentially exempt transfer (IHTA 1984 s 3A) with no immediate inheritance tax charge arising. However, like many parents – and for a variety of reasons – your client is understandably reluctant to place £900,000 directly into the hands of his children.
The standard approach, when someone wants to retain control of the assets that they are giving away, is to make a gift to a trust of which the settlor is one of the trustees. The difficulty with this approach for your client is that – unless he was making a gift to a disabled person’s trust – a gift of the proceeds of sale to a trust would not be a potentially exempt transfer, and would therefore be immediately chargeable to inheritance tax. This would be calculated at: £900,000 less £325,000 less £6,000 (assuming two annual inheritance tax allowances) = £569,000, which at 20% amounts to £113,800. This may well be too high for your client to pay.
How then might your client proceed? It is a simple enough matter to avoid this immediate inheritance tax charge on a transfer to a trust: your client can transfer his shares to the trust before they are sold. Then, 100% business property relief would be available, any transfer would be at a nil value and no immediate inheritance tax charge arises. It should be noted too that although there are ‘clawback’ rules (IHTA 1984 s 113A), which broadly treat the gifted shares as being a gift of cash, if the donee (here the trustees) sells the shares, these rules only affect the position on the death of donor within seven years, and do not impose any retrospective lifetime charge in the donor’s lifetime.
The point at which the shares are treated as being sold for these purposes is the point at which there is a binding contract for sale in place. This is because IHTA 1984 s 113 denies business property relief to any asset subject to such a binding contract.
Thus, as long as the gift of shares is made before any sale becomes binding, the immediate inheritance tax charge on the gift to the trust will be avoided.
What though of the capital gains tax position?
A transfer of shares into trust would constitute a disposal for CGT purposes but ordinarily one would take advantage of ‘hold over’ relief under the provisions of TCGA 1992 s 260 and, in effect, any gains are passed on to the trustees. The problem with this approach in this case is that any held over gains would be triggered when the trustees sell the shares and entrepreneurs’ relief would not be available for at least a year – and then only if a ‘qualifying beneficiary’ holds at least 5% of the shares for a year (TCGA 1992 s 169J). Thus, if a sale is imminent, capital gains tax would be payable by the trustees at 20%, doubling the liability from £100,000 to £200,000.
The possible solution would be for your client to transfer 90% of his shares into trust without claiming hold over relief. Entrepreneurs’ relief would then apply in relation to that disposal – which, at 10%, would trigger a liability of approximately £90,000. When the sale of shares completes, your client would then make an additional disposal of his retained 10%, triggering a further charge of £10,000. His total liability would then be £100,000 but, having retained 10% he will have received £100,000, on the sale of his retained 10% share, and could meet that cost.
The trustees, meanwhile, will have received their shares with a base cost equal to their market value at the date of transfer; however, as they have received a 90% holding, any discount to pro rata value (and thus any gain in their hands, being the difference between this and the sale proceeds they receive) should be modest.
The one practical issue for your client is that as it is a condition that he makes the transfer into trust before there is a binding contract in place, there will remain the possibility that the sale will not complete, and your client will be left with a CGT liability in relation to the transfer to the trust, with no sale proceeds to meet it. In these circumstances, however, he would still have the option of falling back upon a hold over relief claim; and, of course, any decision on this would not need to be made until the end of January following the end of the relevant tax year, when the CGT liability would otherwise become due.
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