How To Arrange The Passing Of Business Shares On Death
The passing of business shares on the death of a business partner who is not a spouse requires careful planning. If you are considering selling business shares to a non spousal partner this area requires experienced advice.
To avoid business shares falling into a person’s estate and the surviving owners losing control of a business, many business owners set up share purchase agreements. The usual objective of agreements for the sale and purchase of a share in business between the owners in the event of the death one of them is that the beneficiaries of the deceased sell their share to the surviving partner. Unfortunately, using the wrong type of share purchase agreement can result in the surviving business partner being denied business property relief. However, the terms of this should not be obligatory.
Historically HRMC has regarded this kind of agreement as binding, as and such made the transfer of shares on death ineligible for business relief, for IHT purposes. Equally, for IHT purposes, the transfer of the share could be passed into a trust.
It is worth noting that HMRC will accept that in the passing of business shares a double option agreement is not a binding contract for sale (Statement of Practice SP12/80) and this will not prejudice business property relief.
Interestingly, this is despite the fact that the double option agreement states that if one party decides to exercise their right to buy or sell, the other party is bound to comply. If both parties decide not to exercise their options, the practical effect of the agreement is the same as a buy and sell agreement. In this instance, eligibility for business relief is retained.
The wording of these agreements is obviously crucial. HMRC gives specific reference to a double option agreement entered into under which the surviving partners have an option to buy (call option) and the beneficiary has an option to sell (a put option), such options to be exercised within a stated period after a partners death.
If the option periods for the purchase and the sale are not identical (e.g. the option to buy for three months and the option to sell for six months from the date of death) this does not affect how HMRC views the agreement.
In Spiro v Glencrown (1991) the decision provided authority for an option to be a contract for sale, which resulted in no business relief being available. Early in 1996 HRMC (then the Capital Taxes Office) confirmed there had been no change in its opinion regarding Statement of Practice SP12/80 and the case wouldn’t be cited as authority for an option constituting a binding contract for sale.
More recently the 2000 case Griffin v Citibank Investments provides a much stronger argument that an identical terms buy and sell option together do not constitute a single bilateral contract. This did not concern an arrangement for a share purchase between partners but it did involve 2 identical options and is of particular relevance for this reason.
In December 1994 Citibank Investments Ltd sought an investment that would generate funds in the form of capital gains rather than as income liable to corporation tax. It purchased 2 FTSE linked options on terms that all transactions entered into on reliance of the purchase agreement formed a single transaction. Corporation tax was then assessed for 1994, 1995 and 1996 on the gains arising from the two option contracts.
On appeal to the Special Commissioners, Citibank Investments Ltd contended successfully that the gains arising from the options fell to be treated as capital gains rather than as profits or gains chargeable to tax under Schedule D. HRMC appealed the decision but conceded that each of the two options, if taken separately would be a qualifying option within the meaning of section 128 ICTA 1988 and accordingly any gains would have been exempted from a charge to tax.
However, if the two options fell to be treated as one composite transaction by the operation of the Ramsay principle (in essence the court should not confine itself to the method of assessing the tax consequences of each individual transaction in a composite transaction but instead should look at the composite result and consequences) as was the Revenues contention, that would fail to satisfy the statutory definition of a qualifying option within the meaning of section 128.
As all the above indicates, setting up these agreements is best done using advice from an experienced IHT and business adviser.
Please call us if you own a business with a person who is not your spouse for help in the passing of business shares.