If you own an interest in a business, it is essential to plan ahead. This is the case whether your business interest is in a limited company or a partnership or as a sole trader.
You may well intend, sooner or later, to give your business away to, for example, your children or to sell it and use the proceeds for your retirement. It is of course possible, however, that you might die before you are able to do this and therefore your business could still be owned by you at your death.
Who would you want to manage and inherit your business or its value in the event of your death? How can you ensure that your wishes are put into effect?
Inheritance Tax can be charged at the rate of 40% on the value of your business interest when you die. How can this be avoided?
It is very important to have a properly drafted Will in place to cover these issues. You should therefore take expert legal advice now on how to leave your business interest in your Will and how to make full use of the Inheritance Tax saving opportunities that are available.
Wills and Inheritance Tax advice for business owners
Why is it particularly important for business owners to have a properly drafted Will in place?
Everyone should of course have an up-to-date Will in place. This is even more important if you own an interest in a business.
A properly drafted Will can:
- Appoint the most appropriate people to act as the executors to deal with your business after your death.
- Give powers to those executors to continue to run your business to preserve its value until it can be passed over to your beneficiaries or to maximise its value until it can be sold.
- Ensure that your business interest is passed on to the person or people you wish to carry it on – perhaps a particular member of the family or a trusted employee – or that its value is inherited by the person or people you wish to leave this to.
- Make full use of the Inheritance Tax exemptions available so that your business interest can pass on to your beneficiaries tax-free.
If you don’t have a Will in place, there is no power to continue to run your business to protect its value after your death. It will be inherited in accordance with the Intestacy rules which may not be as you would want. The steps which need to be taken to ensure that Inheritance Tax is avoided may well not be put in place
What happens to a private limited company shares when the owner dies?
The company is owned by its shareholders and managed by its directors.
The shares you own in the company will need to be dealt with and either the shares or their value inherited when you die. How this is to be done will be governed by the company documentation and the terms of your Will.
You cannot leave your directorship to your beneficiaries by your Will. However, the shares you leave to your beneficiaries may entitle them to be appointed as directors if this is provided for in the company documentation.
You should have a Will in place which will appoint executors to deal with your company shares and name the beneficiaries you wish to leave these or their value to.
If you want your spouse or children to receive the income from your shares but don’t want them to play a part in running the company, you could leave your shares to pass into a Trust set up by your Will. This would allow the trustees you appoint who could, for example, be the other company directors to manage the business whilst your spouse or children receive the dividends from your shares.
It is vital to understand what the company documents have to say about how your shares are to be dealt with when you die. The Articles of Association and any Shareholders Agreement or Cross Option Agreement will be relevant here.
For example, these may provide that the company must buy your shares or that these are to be first offered for sale to the other shareholders in the event of your death. Insurance policies, which are often written in trust can be put in place to fund these purchases and in those circumstances, the beneficiaries of your estate would receive the cash value rather than the shares themselves.
To be effective, the provisions of your Will must be compatible with the company documentation. We, therefore, make sure that this is checked out either with your own advisers or with our Corporate Services team, as part of the Will making process.
What happens to partnership interest on death?
It is important to have a comprehensive and up-to-date partnership agreement in place as this should set out how your partnership interest is to be dealt with on your death.
For example, the agreement may provide that the other partners have the option to buy your interest before your executors sell or transfer it to anyone else.
Unless the agreement says otherwise, a partnership is dissolved on the death of a partner. The estate of the deceased partner is paid out and the other partners will then have to set up the partnership again.
You should have a Will in place which will appoint executors to deal with your partnership interest and name the beneficiaries you wish to leave this or its value to.
To be effective, the provisions of your Will must be compatible with the partnership documentation. We, therefore, make sure that this is checked out either with your own advisers or with our Corporate Services team, as part of the Will making process.
What often happens when the owner of a sole proprietorship dies?
If you are a sole trader, your business will usually die with you.
However, your business assets – including stock, monies owed to the business and perhaps goodwill – will need to be dealt with and these or their value will be inherited as part of your estate.
You should have a Will in place which will appoint executors to deal with the business assets and name the beneficiaries you wish to leave these to.
Your Will can enable the executors to continue to run your business until it can be inherited or sold. You may wish to appoint different executors to manage your business than to deal with the rest of your estate.
Your Will can set out how you wish your business or the value of its assets to be inherited. You may want to leave your business to a particular person who has an interest in carrying it on. Alternatively, you may prefer its value to pass with the rest of your assets to your intended beneficiaries.
Will my estate have to pay Inheritance Tax on my business interest?
If you own shares in a private limited company or have a partnership interest or are a sole trader, then generally speaking the value of your business interest will be exempt from Inheritance Tax on your death provided:
- You have owned this for at least two years at your death;
- Your interest is in a trading business;
- It is not subject to a binding contract for sale at your death; and,
- It does not consist wholly or mainly of dealing in securities stocks or shares, dealing in land or buildings or making or holding of investments.
So for example, shares in a company which owns and lets out properties to tenants is unlikely to qualify whereas shares in a company which buys land, build properties on that land and then sells these may well do.
There are also reliefs available to reduce the value of Inheritance Tax by 50% for land, buildings and equipment you own at your death which are used wholly or mainly by a company you control or a partnership you are a partner in.
Such Inheritance Tax exemptions and reliefs can be very valuable. However, the law regarding these is complex. It is therefore very important to get specialist legal and accountancy advice now to ensure that your eligibility to qualify for them is protected.
Your accountant will be able to advise you whether your business interest is likely to qualify for this Inheritance Tax exemption. If not, there may be steps you could take now to re-order your business affairs to qualify for this.
It is also vital that the terms of your Will and business documentation ensure that this Inheritance Tax exemption for your business interest is preserved.
How can I ensure that my Will is Inheritance Tax efficient?
If you are married and own a business interest which is exempt from Inheritance Tax, it may make sense to leave this in your Will to your children rather than to your spouse.
This is because anything your spouse inherits would be tax-free anyway due to spouse exemption. If the business interest was still owned by your spouse at their death and still qualified for the Inheritance Tax exemption at that time, this could be inherited tax-free by your children then. If, however, your spouse had sold your business interest or this did not qualify for another reason, the exemption would have been lost. For example:
- On Geoff’s death, his business interest qualifies for exemption from Inheritance Tax. His Will leaves all his estate to his wife Brenda. Brenda then sells the business interest and on her death leaves her estate to their children.
- No Inheritance Tax is payable on Geoff’s death as all his estate is inherited by Brenda and is covered by spouse exemption.
- On Brenda’s death, her estate is worth more than the Inheritance Tax-free allowances available to her. Her estate includes £200,000 from the sale of the business interest. £80,000 Inheritance Tax is payable on this alone.
- If Geoff had left the business interest to the children and the rest of his estate to Brenda, no Inheritance Tax would have been payable on his death because the business interest qualified for Inheritance Tax exemption and the rest of his estate was covered by his spouse exemption.
Then on Brenda’s death, the value of the business interest would not have been included in her estate and therefore no Inheritance Tax would have been paid on this.
You could leave your business interest directly to your children in your Will. There are however two difficulties with this. Firstly, we cannot be certain whether the business interest will qualify for Inheritance Tax exemption at your death or not. Secondly, we don’t know whether – notwithstanding the fact this may not be the most Inheritance Tax efficient course of action – your spouse may need to inherit some or all of the value of the business interest.
It would therefore be very common to include in your Will a gift of your business interest to a Discretionary Trust.
Essentially, the Trust would be controlled by the trustees you appoint who would, acting unanimously, decide how and when and to what extent the business interest or its sale proceeds are to be inherited by any one or more of the potential beneficiaries you name (these would usually include your spouse, children and grandchildren).
The idea here is that, after your death, if your trustees so decide:
- If your business interest is exempt from Inheritance Tax, some or all of this can be given to your children tax-free.
- If however, your business interest is not exempt from Inheritance Tax, this could be given to your spouse thereby qualifying for spouse exemption provided this is done within two years of your death.
- In the latter scenario, your spouse could then take advice as to how to deal with your business interest – for example, they could then gift this to your children if this was advantageous.
How Nelsons can help
Jane Sutherland is a Partner in our expert Wills, Trusts & Probate team.
At Nelsons, our team of experts will take you through the whole process from start to finish. We will work with your business accountant and, if appropriate, provide you with a free corporate law health check to ensure that the terms of your Will do not conflict with your business documentation.
If you would like any further information on any of the above, please contact a member of our team in Derby, Leicester or Nottingham on 0800 024 1976 or via our online form.