Case Study – Directors Share Protection

Background

Whitefield Innovations (WI) is a marketing company. There are three shareholding directors, Mr Farndon with 51%, Mr Smith with 39% and Miss Farndon with 10%. WI is currently valued at £1 million.  As the company approached its 10-year anniversary, the directors began to think about the next 10 years and what would happen if one of them were to retire or die.

Challenges

• The directors wanted their share in the business to be inherited by their spouses, children or estate.
• A downside of this request was that the surviving shareholders would have to work with the new shareholder, who could have little or no interest in the business, or want to transfer their share of the business to their children to continue running it in the event of their retirement or death.

What Taylor Patterson did

To ensure that the surviving shareholders retain control of the business and any beneficiaries receive a fair value for their share in the business, we recommended that each shareholder take out a life policy written in trust using a director share trust and a cross option agreement.

The cross option agreement, sometimes called a double option agreement, leaves the surviving directors with an option to buy the deceased’s interest, and the personal representatives of the deceased have the option to sell. If either party exercises their option within a specified time frame the other party must comply.

It is significant that the parties to the agreement only have an option to buy and sell. This is to preserve business property relief. When a person dies, their whole estate will be liable to inheritance tax at 40%. The cash received by a deceased person’s estate would be liable to inheritance tax at 40%, however business property relief will still be available, because the options can only be exercised after death and the sale of the shares only became binding if either party exercises their option.

The Results

WI now have piece of mind, knowing a succession plan is in place in the event of the death of a shareholder.  For example, if Mr Smith dies the life policy pays out to the trustees (the surviving shareholder directors) the sum assured.  The sum assured is derived from a percentage of Mr Smith’s shareholding i.e. 39% of £1 million.  The trustees pay the sum assured to the surviving shareholder directors in WI, Mr Farndon and Miss Farndon.  Mr Farndon and Miss Farndon are then in a position to buy the shares from Mr Smith’s estate under the terms of the Cross Option Agreement.

As the shares do not form part of Mr Smith’s inheritance tax liability, the money is paid in accordance with his wishes and goes to the beneficiaries of his will, free of inheritance tax.