Michael runs a successful turnkey shopfitting business with his cousin Ben. They are equal shareholders. The business has been running for 25 years and is worth £3 million. It employs 10 staff. Michael is married to Jane. He has a basic will in place that passes everything he owns to Jane while she is alive, and if she is not, everything would go to his three children.

Although Jane likes the idea of inheriting 50% of the business, she doesn’t have a clue how to run it. Ben doesn’t think it would be sensible to have her as a new business partner as he is concerned it could affect business continuity.

Both Michael and Ben agree that Jane inheriting the entire value of Michael’s shareholding wouldn’t be appropriate. They understand that it would be better if Jane was compensated with a cash sum equivalent to the value of shares she would have inherited. However, if this happens Michael understands that when Jane in turn passes away, her estate would have to pay inheritance tax on the cash sum she had inherited in lieu of the shares. Jane could also be left with minority shares to allow her to retain dividend rights in addition to the receiving the life insurance proceeds – it really depends on the value of the business and the sum assured.

ADL Estate Planning puts in place appropriate shareholder protection trusts (populated with the insurance proceeds) and business trusts (populated with the Michael’s shareholding) means that any cross-option agreement when exercised on death means that the life insurance proceeds which the surviving Director, Ben, uses to buy Jane’s inherited shares remain outside of her estate but still allow her to benefit from them.

Michael’s shares fall into a business trust, while the life insurance falls into the shareholder protection trust.

The trustee of the shareholder protection trust would be the surviving director – Ben – and he buys the shares from the trustee of the business trust which is Jane – so cash goes into the business trust and Michael’s shares go into the shareholder protection trust. Jane (and Michael’s children) can benefit from the cash in the business trust without it ever forming part of Jane’s estate.

Michael is looking for a tax-efficient solution which will allow Jane to benefit without adding to her estate, thus avoiding inheritance tax on her death so that their three children can be left with more wealth. Michael also wants to ensure business continuity following his death for the sake of Ben and the employees.

Michael could put in place generic planning involving a cross-option agreement with a life policy owned by the company so that when he passes away, the life policy pays out to the company.

Ben, as director, could use that money to buy Jane’s inherited shares. Jane would receive the cash sum, but it is taxable in her estate and is open to all third-party threats. It solves part of the problem, which is finding the money to buy out Jane, but not all of the problem, as the inheritance tax liability on Jane’s estate still remains. If she had inherited the business shares, provided the business was still trading on her death, there’d be no inheritance tax to pay on the value of it.

Furthermore, it’s often not a good idea that the company owns the life policy. Although this could save on corporation tax, it would mean the Michael’s shares would be cancelled when the company buys back the shares, thus losing the opportunity for Capital Gain Tax (CGT) efficiency should Ben decide to sell the company in the future. This because the entire gain would be laden on his shares, whereas, if Michael’s shares weren’t cancelled, but passed into the Shareholder Protection trust following the execution of the Cross Option agreement, at least 50% of the business would’ve receive an uplift in value for CGT purposes on Michael’s death.

Therefore, when Ben comes to sell the business, it’s only his directly owned shares (50% of the company) that would be pregnant with gain since inception. The other 50% resides in the Shareholder Protection trust for his and his families benefit and there may not be much gain on those shares since the date of Michael’s death.

Michael can solve his problem only via advice from an experienced and qualified professional. The solution outlined above must be identified by someone who is competent in areas of regulated finance and trust planning and who understands the business model and shareholder relationships.

Download our Cross Options strategy document for business owners.

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