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Business succession planning

A case study

The trust and taxation-related article in the previous issue highlighted the key points to bear in mind in connection with business protection trusts used in business succession planning.

In this article we review the steps to be taken by a limited company that wishes to set up a business succession arrangement to ensure that, on death or serious illness of a shareholder, the surviving shareholders have the opportunity to purchase the shares of the deceased/ill shareholder so that the control of the company remains with them.

We review the position in the form of a case study involving Bass Fishmongers Ltd.


Bass Fishmongers Ltd was established in 1991 by Alf.  Alf gradually diluted his shareholding by making gifts to his son Mike and selling shares to Pete and Steve.  By 2016, the shareholdings in the company are as follows:-

Mike - 40%

Alf (Mike's father) - 10%

Pete - 25%

Steve - 25%

Alf is no longer actively involved in the business and is not interested in acquiring more shares in the company eg. on the death of a co-shareholder. 

All four shareholders are keen that they personally and the business do not suffer the financial difficulties that can arise on the death or serious illness of a shareholder.  The current value of Bass Fishmongers Ltd is £2.5 million which is mainly goodwill.  The company does not currently pay a dividend. 


The directors/shareholders have stated that they wish to establish a financial plan which can help them to overcome any financial difficulties that could arise in the event of any of them dying or suffering a serious illness.  In particular, they wish to deal with a tax-efficient transition of shares to the surviving shareholders on death.

In order to organise this, it will be necessary to:

(1)        Identify the need for cover and quantify it.

(2)        Consider a suitable plan to provide for share purchase (business succession) using, where appropriate, life assurance policies, trusts, share purchase agreements and Wills.  This plan would need to take account of Alf's position as regards his 10% shareholding.

(3)       Consider any appropriate planning that they will need to undertake with regard to their Wills to accommodate a share purchase arrangement. 

Identifying the need for cover and quantifying it

In any share purchase arrangement, there is a need to put cover in place so that cash will be available for shareholders to buy the shares of a deceased shareholder.  This could normally be satisfied by a suitable life assurance policy written to the shareholder's retirement age.

One of the key aspects to a successful share purchase arrangement is to place a current value on the shareholding in the business.  The valuation of shares in a private limited company is a complicated process.  A good starting point for this would be to ask the current owners of the business how much they would currently sell the business for.  This will give a good indication of the high end of its current value. If they cannot agree on this, an independent valuation could be taken from an accountant who is experienced in such matters.

In this case, Mike, Pete and Steve have put a value of £2.5 million on the business.  The value of Alf's smaller minority shareholding will be hugely discounted and it is therefore likely that this will only be worth about £50,000.  This means that if a straight proportion of the residual value is used, Mike, Pete and Steve's shares are worth £816,666 each.  In practice, the market value of a minority holding will always carry a discount and the parties will need to agree a value between themselves.

A suitable plan

A successful share purchase arrangement will be made up of four limbs - a testamentary disposal of the shares via a Will, a cross option agreement, a life policy and a trust of the policy.  In more detail each will comprise of the following:

  • A Will - a suitable Will provision is necessary to deal with the transfer of the shares on death.  A Will gives some degree of certainty over who will benefit from the shares or the proceeds of sale of the shares on death. It will also avoid any delays which could arise on an intestacy and give the opportunity for ongoing inheritance tax (IHT) planning by using a by-pass trust.
  • An option agreement - this will deal with the purchase/sale of the shares on a shareholder's death.  Following the death of a shareholder their personal representatives will have an option to sell and the surviving shareholders an option to buy the deceased shareholder's shares.  In the event of either side exercising their option, the other side will be bound.  The option periods for buying and selling will be slightly different. 
  • A life policy on the life of each shareholder for a sum assured equal to the value of the shares.  This provides the cash to fund the purchase. 
  • A trust of the life policy ensures that the proceeds of the policy are paid tax efficiently to the continuing shareholders to enable them to purchase the shares from the deceased's estate.  The trust would normally be a business trust on either a flexible (power of appointment interest in possession) basis or a discretionary trust basis. The named default beneficiaries would be the other current shareholders in the business but all the shareholders would be discretionary beneficiaries.  This would enable the trust and the arrangement to cope with any future changes in shareholders. Alf will not be participating in the arrangement and so will not be a beneficiary under the trusts.

Tax implications

The tax implications of the share purchase arrangement are as follows:-

Policy trust

(i) Premium payments

Although there will be a distinct premium payable on the policy of each director, total premium payments are the collective responsibility of the director/shareholders. No income tax relief will be available. If the company pays premiums on the director/shareholders' behalf, this will give rise to an income tax (and NICs) charge on the basis they are additional remuneration.

Premium payments will not give rise to gifts for IHT purposes provided the arrangement is commercial.

(ii) Sum assured

On the basis that the policies in question are protection policies, so have no surrender value, then in the event of the life assured's death there will be no chargeable event gain - even if the policy is a non-qualifying policy. 

The payment of the policy proceeds to the trustees of the trust will not give rise to income tax or inheritance tax.  Whilst the later distribution of the proceeds by the trustees to the surviving director/shareholders could give rise to an IHT exit charge, this is very unlikely.  For such a charge to arise, there would have needed to have been an IHT charge at the last ten-year anniversary (or when the policy was placed in trust) and this would only have been the case if the life assured had died before or was in serious ill health at that ten-year anniversary.

The IHT gift with reservation rules will not apply provided the arrangement is on a commercial basis.  The income tax pre-owned assets tax (POAT) rules could, in theory, apply but should have little impact unless a claim arises and money is held within the trust. 

Double option agreement

(i) Establishing the agreement

Provided the amount payable under the double option agreement equates to the current market value of the shares, there should be no IHT/ CGT implications at that time.  

(ii) Exercise of the option

The purchase of the deceased's shares would give rise to a disposal of the shares for CGT purposes. However, as those shares will be revalued at their market value on the deceased's death, and the purchase price is likely to be for a similar amount, it is unlikely that any taxable capital gains will arise. 

The Will

The deceased shareholder's shares will normally pass to the beneficiary under their Will free of IHT because of 100% business property relief.  A double option agreement does not count as a binding contract for sale and so business property relief should still be available.  There would be no CGT at that time because of the revaluation of the shares on death.

Alf's shareholding

Given that no dividends are being paid, and he no longer actively works for the company, Alf's shareholding probably represents more of an emotional link that he has to the company following his earlier involvement rather than an actively managed investment. 

The company does not pay a dividend and, given the size of his shareholding, Alf could not compel them to make a dividend payment. Therefore, this shareholding has little value in his hands.  Given that Alf is not to be directly involved in the future of the company, he should not be included in any share purchase arrangement.  Indeed, to ensure that he cannot benefit as a shareholder under the trusts and policies of his co-shareholders, the trust should restrict beneficiaries to only those who are taking part in the share purchase arrangement.

Now may therefore be a good time for Mike, Pete and Steve to consider making an offer to buy Alf's shares and so acquire ownership of the whole company between them.  

How this could be achieved will depend on the financial position of the company and the amount Alf would want for his shareholding. If a personal purchase was likely and they had to borrow money to achieve this, any interest paid on the borrowing should qualify for income tax relief.

If the company has cash available it could buy back the shares and cancel them leaving the other three shareholders with a proportionately larger interest in the company.

The valuation of shares

As mentioned previously, this can be a difficult area because the valuation of shares in a private company can be a very subjective issue.  If the shareholders cannot agree on a price then they could consult an accountant (with share valuation experience) for a valuation.  The valuation will dictate the level of life assurance cover required under the life policies.

The initial value of the shareholding (as confirmed by the double option agreement) will indicate the initial level of cover required.  But the arrangement needs to be able to cope with changes in the value of shares. This would normally be dealt with in the double option agreement.  Two approaches are possible, either:-

  • the valuation is based on the market value of the shares; or
  • the double option agreement is based on a fixed value that needs to be confirmed by the shareholders from time to time and which, if it is not confirmed, reverts to market value

A fixed valuation gives the benefit of certainty - as it gears up the life cover required, although it can lead to CGT and IHT implications if the fixed value gets seriously out of line with the real market value.

Business protection

If it was desired to include an element of business protection (e.g. keyperson cover) within the arrangement, the level of cover could be increased on each shareholder/director's life.  On a director/shareholder's death the surplus funds (i.e. over and above that needed for share purchase) could be lent to the company by the surviving director/shareholders.  Once the company had resumed normal trading, the company could repay those loans without any tax liability on the director/shareholders. 

Serious/critical illness

The arrangement can also be tailored to deal with share purchase or business protection on a director/shareholder suffering a serious/critical illness.  The major difference here is that in order to give the ill director/shareholder maximum security, any purchase of shares should be governed by a single option agreement in favour of the ill director/shareholder i.e. they should not be forced to sell against their will.