The most often considered and important area for advisers with limited company clients is pension planning.
This could be linked with remuneration planning: how best to take money from the business for current or future expenditure in a way that minimises tax and National Insurance contributions and maximises benefit through retained funds.
For businesses doing well, there is also benefit to be derived from discussing how to tax-effectively invest retained corporate funds,
and the impact of cash or investments on inheritance tax business relief and capital gains tax entrepreneurs’ relief.
Subject to comfort in relation to risk, unit trusts and collective investments look impressive from a tax standpoint. Tax-free dividends and no tax on capital gains accruing until realised? Not bad. And, for a substantially trading company, there should be no detrimental impact on entrepreneurs’ relief if and when a qualifying share sale by the shareholders takes place.
A too often overlooked area of planning with limited company clients, though, is to test what the shareholders would want to happen to their shares on death against the reality of what the law provides would happen in the absence of any agreement.
Indeed, the absence of a ‘business will’ – a clear and regularly reviewed shareholder agreement covering share destination on death – will result in an effective business intestacy. And, for most shareholders, the consequences of such will not be something they will embrace.
To demonstrate just what this means, let’s have a look at some of the most common aspirations for share destination and rights flowing to the deceased’s spouse or other beneficiaries, and the legal reality if those aspirations are not clearly articulated in an appropriate agreement.
Aspiration: The right (for the surviving spouse/other dependants) to be appointed a director with accompanying rights to directors’ fees.
Reality: Directors are appointed by a majority of shareholders. So, if the shares of the deceased confer more than 50 per cent of the votes (a so-called ‘simple majority’), the aspiration would be realised; but, if less, then not.
Aspiration: The right, as a shareholder, to any dividends declared.
Reality: This aspiration would be realised but dividends are recommended by a majority vote of the board and agreed by a majority vote of the shareholders. So, a minority or 50/50 interest will have no power to force dividend declaration.
Aspiration: The right to call for the repayment of any outstanding directors’ loans.
Reality: These loans would normally be repayable on demand subject to any special terms in the agreement or any provision in the deceased’s will instructing the personal representatives not to call in the loan. If the deceased’s personal representatives are effectively compelled to call in the loan, this could cause cashflow challenges for the business.
Aspiration: The right to sell the inherited shares to the continuing shareholders and to force them to buy.
Reality: Standard Articles would not provide for this but there may be a right of first refusal given to the shareholders if any shareholder wishes to sell.
Aspiration: The right to sell the inherited shares to any willing buyer on the open market.
Reality: Generally speaking, this should be legally possible but subject to any provision in the Articles giving the continuing shareholders the right of ‘first refusal’ for a limited time in relation to any share sale.
There may also be a provision enabling the continuing shareholding directors to refuse to register a transfer of shares. However, such registration should not be unreasonably prevented. Or there may just be no provision whatsoever.
Importantly, even if a sale to a third party is permitted, there may well be a material commercial challenge in trying to secure a buyer willing to pay the required price. This could be especially so if the shares to be sold represent a minority interest.
Aspiration: The right to sell the inherited shares to the company and to force the company to buy (and cancel) the shares.
Reality: A corporate share purchase would not normally be prohibited under Standard Articles but there would be no compulsion. However, if the deceased had a majority shareholding and wanted a corporate share purchase to take place, this could then happen subject to satisfying the relevant company law conditions and, presumably, ensuring the transaction was treated as a capital transaction as opposed to a distribution for tax purposes.
While such a sale may be capable of being legally permissible and delivering the optimum tax outcome, it would be made more difficult in practice without available funds in the company at the time of purchase.
Aspiration: An obligation to sell the inherited shares to the company or to the continuing shareholders if requested.
Reality: This aspiration would not be realised without being specifically provided for in an agreement.
Putting arrangements in place
If what will happen as a result of having no specific formal agreement covering share succession on death is not aligned with the shareholders’ aspirations for what they would like to happen, it is essential they work with their adviser to put arrangements in place that reflect their wishes and those of their
co-owners and families/dependants.
The components of an effective solution are likely to be:
- A business share purchase/cross-option agreement
- Life insurance/critical-illness cover
- Business trust for the life policy(ies)
Given that the purpose of the life cover is to provide funds to facilitate a purchase of shares by the surviving shareholders, there would be no income tax relief on the premiums nor tax on the sum assured.
If the company paid the premiums, it would effectively be meeting a pecuniary liability of the shareholding director and so the amount payable, while normally being deductible for the company, would be assessable on the shareholding director.
A decent amount of care in calculating the amount of money required, and when it would be required, would be necessary if an (almost inevitable) premium equalisation strategy had been employed.
In most cases where premium equalisation is used, the total premiums for all of the cover would be added together to get a composite cost and then divided appropriately (as agreed between the shareholding directors) taking account of all the factors.
Sadly, the hyper tax efficiency of relevant life policies cannot be employed in share purchase arrangements. Arguably, RLPs could be considered if shares were to pass automatically to surviving shareholders on the death of a shareholder. The RLP could then be used to compensate family members who would receive no direct benefit from the shares.
Such an ‘automatic share transfer’ and ‘compensation’ arrangement could, however, be fraught with difficulty and, while theoretically possible, would be far from easy to implement so as to deliver the desired certainty of outcome and
tax efficiency that most would require.
Tony Wickenden is joint managing director of Technical Connection (a St James’s Place Wealth Management group company). You can find him Tweeting @tecconn