Tony Granger considers whether a business agreement is better than a will for the passing of shares on death and highlights some of the consequences.
The owner of a business interest (either company shares or a share in a partnership) may be a party to a shareholders’ or partnership agreement.
The shareholders’ agreement normally spells out the terms of the passing of the shares, usually to other shareholders. It is common for the shareholders to insure each other so that on the death of a shareholder, cash is available to buy the shares from the deceased shareholder’s estate. The use of a shareholders’ agreement enables the surviving shareholders to keep control of the business without new outside shareholders coming in. The alternative is for the shareholder to leave his shares to family members or third parties by will, thus introducing new shareholders in his place. If there is no will and no shareholder agreement, the shares pass on intestacy.
Shareholder agreements are broadly either ‘double option agreements’ or ‘buy and sell agreements’.
Double option/cross option agreement
Each party to this agreement has the option to sell and the option to buy shares on death or some other occurrence, such as severe disability or a critical illness. Once a party initiates the process, the other party must perform. If neither party exercises an option within a certain period, the status quo remains. In that case, shares may devolve according to the will of the deceased.
No inheritance tax (IHT) is generally payable on the shares passing under a double option agreement if business property relief (BPR) is available (see below).
Buy and sell agreement
Parties to this type of agreement must perform. Therefore, if shareholder A dies, the survivors must buy his shares and his estate must transfer the shares. Cash received for the shares sold may be subject to IHT.
IHT is generally payable on a taxable estate (after any reliefs, exemptions etc.) at the ‘death rate’ of 40%. There is no BPR for IHT purposes as the shares were subject to a ‘binding contract for sale’.
Agreement variations
Agreements do not have to be between all parties being shareholders. You may have a non-shareholder who wishes to become a shareholder on the death of one of them, and becomes a party to the shareholder agreement. This is obviously by agreement with the shareholders.
Shares passing by will
The shareholder may bequeath shares by will to his heirs. Subject to the shares meeting the BPR criteria, usually the shares will not be subject to IHT.
Shares passing by a will may or may not be very attractive, depending on the circumstances. For example, if a family member is reliant on dividends from the shares, the surviving shareholders may not declare dividends, leaving them without income. The death of a key shareholder may cause the shares to lose value. The shares would then be difficult to sell.
Practical Tips:
- The double option/cross option agreement is the most efficient type as shares are not generally inheritance taxable if BPR is available.
- By combining keyperson and shareholder life assurance, you can achieve the purchase of a deceased’s shares tax.
- Leaving company shares by will may be the least efficient way, as their value may not be realised; later sales of shares could only be to existing shareholders and not third parties; no dividends could be payable; and/or you may be a minority shareholder with no control.
