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RALPH RAY FTII, BSc (Econ), solicitor, TEP looks at 'buy and sell' agreements and inheritance tax. GEORGE AND ABRAHAM are partners under a partnership agreement in the business of manufacturing widgets. They are both in their mid-forties. They are meeting their tax adviser, Richard.
RALPH RAY FTII, BSc (Econ), solicitor, TEP looks at 'buy and sell' agreements and inheritance tax. GEORGE AND ABRAHAM are partners under a partnership agreement in the business of manufacturing widgets. They are both in their mid-forties. They are meeting their tax adviser, Richard. 'We must be among your shrewdest clients', asserts Abraham. 'George and I have decided to enter into contractual arrangements now whereby on the death of either of us before retirement, his personal representatives become obliged to sell and the remaining partner is obliged to buy out the former's interest. Similarly, on an earlier retirement the same contractual arrangements will apply. Put it into effect straightaway, Richard, as we are confident that this is an excellent idea and we do not want to waste time or costs on unnecessary discussions.' 'Whatever you say', blurts out Richard, 'but may I please make some constructive suggestions?' (George says to Abraham sotto voce 'I warned you!')
A tax disaster!
Richard continues: 'At present a gratuitous transfer of a partnership interest (the same would apply to shares in a trading company) is a business asset to which business property relief can apply for inheritance tax and is therefore normally exempt. (A similar arrangement applies to agricultural property.) Therefore, when the first of you dies or retires, there should be no inheritance tax payable. What you are proposing, however, is an arrangement whereby you now convert the business assets into the proceeds of sale. The Revenue takes the view that such an agreement which entails this obligatory sale and purchase (not merely conferring an option) constitutes a binding contract for sale within sections 104 to 105 and 113, Inheritance Tax Act 1984 so that business property relief is forfeited. The Revenue issued a Statement of Practice in October 1980 (SP12/80) confirming its view that a 'buy and sell' agreement is a binding contract for sale so that business property relief will not be due on the business interest.
The better method
'The solution I suggest is to use the option method - a very similar intended effect is obtained if an appropriate put and/or call option is used and without sacrificing inheritance tax business property or agricultural property relief. Faced with the strict Revenue interpretation, the sensible reaction has to be to avoid buy and sell agreements. It is arguable that an automatic accrual arrangement as between the members of a partnership could be looked on by the Revenue as binding sale contracts, although this does not normally follow in practice. 'In any case, this difficulty does not occur with options and that route should be favoured. If cross-options are used, i.e. put and call options, it is better if they are successive in time.
Beneficial ownership
'Moreover, in law the effect of cross-options is still conditional on the exercise of one or other of you and until such exercise takes place, the transferor (or his estate) still has full rights of beneficial ownership in the asset itself. In addition, the mere fact that an individual(s) has an option does not mean that it will necessarily be exercised.' Richard had in mind here the Court of Appeal decision in J Sainsbury plc v O'Connor [1991] STC 318. In that case, put and call options were entered into in relation to the shares in a joint venture company. The Revenue argued that, as a result, Sainsbury ceased to be beneficial owner of the shares in that company, but the courts emphatically rejected this argument. As it happened, the option agreements were never exercised in any event, which all serves to underline the fact that both parties can walk away from the deal if they want to. George and Abraham have a long-term partnership agreement. It is unlikely to become a partnership at will. If it ever did, then there would be some grounds for arguing that business property relief still applied, notwithstanding any buy and sell agreement.
Satisfied customers!
'OK, you win, Richard', George reluctantly concedes. Ralph Ray is a consultant with Wilsons, Salisbury.
