18 Feb 2015 05:27pm

Diary of a tax advisor: Inheritance tax

This month, our Big Four tax advisor talks death, succession and giving appropriate advice

Imagine a bridge over a river. On one side is “personal”, on the other side is “corporate”. To what extent can a tax advisor cross that bridge? The reason I ask the question is in the context of business succession, family succession and inheritance tax (IHT) planning. As a business grows, the infrastructure around it – directors, employees and so on – also grows. The business owner needs to find the right balance between a successful business which creates wealth, and a successful family who will inherit that wealth, all the while making sure that key people in the business are appropriately incentivised.

The subject of succession inevitably leads to the subject of death, which is never an easy topic for discussion. On the one hand there is the owner and founder, whose business is both their livelihood and their entire life; and on the other hand there is the next generation, which wants more involvement and autonomy to take the business forward. In addition there are other stakeholders to think about, and good corporate governance is vital.

In thinking about succession, I am put in mind of a particular client of mine – an entrepreneur and founder of a successful businesses. Before a recent one-to-one meeting with him, I was advised that the key members of his board were likely to be the future holders of the equity. However, at the meeting my client made it very plain that while the board members would be well paid, they would never have any equity. The equity was his legacy to his family. Whilst this would be a disappointing blow for the key personnel, it was clear that their incentivisation will be by hard cash only.

So what about the legacy of equity for the family? One thing we discussed was his motivation. I asked, “Is the objective to make as much money as you can before you die?” He replied, “I have never thought about it. I just love doing deals.” Without simply embodying the grim reaper – or solely acknowledging his enthusiasm for the business – we still needed to focus on how the transition might one day take place.

It broadly boils down to two choices – doing something in lifetime or on death. In my client’s case his business should qualify for full Business Property Relief (BPR) on the assumption that conditions are still met when shares are transferred, either in lifetime or on death. If a lifetime gift of a business asset is made to a family member or to a trust, the taxpayer should be able to defer and transfer the capital gains to the recipient, known as holdover relief, and BPR should protect against IHT.

But there is a downside to lifetime gifts where holdover relief is claimed. If and when the asset is sold in the future, the recipient would pay capital gains tax on the amount deferred along with any increase in value since the gift was made. If the shares are transferred on death, there is a tax-free uplift to market value at that date. This is a double tax relief because IHT is prima facie due but is of course relieved by 100% BPR. That is, if the recipient subsequently sells the share, capital gains tax would be payable on the increase in value from the market value on death. Given the capital gains position, a transfer on death appears to be a clear winner.

While the tax issues are relatively clear, what about his family’s incentivisation and motivation? He has two sons who are actively involved in the business but he also has two daughters who are not in the business and never likely to be so. The next questions therefore are how, how much and when should his children take on his legacy. Such delicate issues cannot be resolved in one sitting, but this much is clear – the sons want an equity stake in the business in which they are now involved, and with the daughters indifferent, the debate about how much to who and when still has a long way to run.

I began this diary entry by asking to what extent the tax adviser can cross the personal/corporate bridge. What is clear is that to reach a solution acceptable to all of my client’s family, I will have to be the bridge – and be run over several times – as we work our way towards the solution.

Mike Walker, tax partner in the private client team at KPMG UK

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