Succession Planning
Parents who are considering the transfer of wealth to their children generally want to ensure that they safeguard the value of assets and businesses, maintain family wealth levels, and pass wealth on in a tax-efficient manner. The following points should be considered by a taxpayer who is preparing to pass on a valuable asset to family members.
It is important to establish if an interest in a business can avail of tax reliefs such as CGT retirement relief, CAT business or agricultural relief.
It may be advisable to consider re-organising corporate structures in order to reduce the level of non-qualifying assets held in businesses that may prevent the company qualifying for tax relief and to split businesses and value across several companies if a parent wants to pass the value on separately to individual children.
Valuations may need to be obtained for private companies to consider the likely exposure to tax. In addition, a valuation of the underlying assets in a company can assist in establishing if investment asset levels will preclude relief. For example, CAT business relief is not available where a company is wholly or mainly an investment company (i.e. more than 50% of its value comes from investments).
Any possible exposure to foreign tax should be considered. For example, if foreign investments are held (such as UK assets) there will be an exposure to UK inheritance tax at 40% once the estate threshold (currently Stg£325,000) is exceeded.
Residence planning may be considered to avoid the imposition of Irish inheritance tax, especially in the case of a non-domiciled person.
The transfer of pension funds into ARF structures means that the capital value can be preserved for the family and consideration should be given to who should receive the ARF.
If a taxpayer wants to pass on the value of a company but retains control of the business, the voting rights can be retained in a separate class of shares, so that the remaining shares and value are passed over but the voting control is retained.
Key Documents
Certain key documents need to be considered when advising on an inheritance plan.
Will
A testator should appoint an executor to manage the estate and run the business. He needs to give the executor sufficient powers to act and sufficient protection to ensure that the executor is willing to act.
Shareholders’ Agreement
Where the estate includes shares in a company which has other key shareholders a Shareholders’ Agreement is a good idea as it ensures that all affected parties focus on the needs of the business, and of the surviving family early on, and agree the best method of securing the value of the business for the family without damaging the viability of the business.
Keyman Policy
Frequently the best option in a shared business is for the surviving owners to buy out the estate’s interest in the business. This is likely to give rise to funding problems (especially if the business is incorporated). A keyman policy which provides funds for the purchase of the estate’s interest can provide a solution.
Enduring Power of Attorney
If a client who is running a business suffers a premature stroke (or other medical condition), or is involved in an accident giving rise to mental incapacity but not resulting in death, he cannot legally make decisions or transfer control of his assets, and no-one can step in to replace him.
If an EPA has been signed, it can be registered once the donor is incapacitated, so that assets can be dealt with for his benefit.
The Use of Trusts
The classic use of a discretionary trust is a Will Trust set up to protect young children, or to make provision for children who have special needs and will need assistance with their financial affairs in the future.
The main disadvantage of a discretionary trust is discretionary trust tax (“DTT”). However, DTT does not arise while a principal object (i.e. the spouse or children of the disponer) is under the age of 21.
In addition, there is an exemption from DTT where the trust is set up for a named beneficiary who is not a principal object (i.e. a spouse, child or minor child) and who is under the age of 18. This can protect a trust set up for grandchildren from DTT. It should be noted that if there are other beneficiaries named in the trust deed who are over 18 years and one beneficiary is under 18 years, then DTT will be triggered by the fact that there is a beneficiary over 18 years of age, where there are no principal objects.
CAT does not arise for the beneficiary until assets are received from the trust, so the payment of gift/ inheritance tax is deferred.
Protective Trusts
In some cases, a client will see the tax issues as secondary and will be more concerned with protecting the assets or the beneficiary than with minimising tax. If a family member has a substance abuse problem, or a mental illness, or another incapacity he may be particularly in need of assistance in dealing with assets. A settlor or testator whose child has special needs will typically want to set aside a proportion of his estate for the benefit of that child. A discretionary trust offers flexibility and if the trust is protective, set up solely for that individual because he is incapable of managing his affairs due to incapacity there is an exemption from discretionary trust tax.
Generation-Skipping Trusts
Where a family has very substantial wealth and children are wealthy in their own right (and will never need the assets that can be passed down by parents) a “generation-skipping” trust may be considered. Instead of passing assets to children (subject to CAT), with the children ultimately passing on to grandchildren (another layer of CAT), the grandparents may set up a trust for the grandchildren, skipping the intervening generation.
A fixed trust can be used if the DTT cost will be high. The trust will be subject to DTT (if it is discretionary) but if it is set up for named minor grandchildren DTT should not arise until the eldest is 18. If there is a wide age spread among the grandchildren consideration might be given to setting up separate trusts for each grandchild (so that the DTT only arises as each child reaches 18 years).
A generation-skipping trust may also be considered if children have run into severe financial difficulties, to the extent that any assets passed down by parents are likely to be absorbed by creditors. In such a case the family position may be better if the assets can be left on to the grandchildren, skipping the insolvent child.
The CGT cost of a generation-skipping trust also needs to be considered.
Interest in Possession Trusts (e.g. Life Interest)
Interest in possession trusts provides a beneficiary with an interest in the income of an asset for a fixed period, or for life. However, the capital value is retained in the control of the settlor and passes to a selected remainderman. For example, a testator who is married to a second spouse can give a life interest in the family home and an investment fund to the spouse so that the spouse can continue to live there and would be entitled to any income from the investment fund. However, the capital value will pass in due course to the children of the first marriage.
Trusts can be a useful planning tool in the context of succession planning, and consideration should be given to the benefits of passing assets via a trust.
Capital Acquisitions Tax (known as “CAT”) is a tax on gifts and inheritances, payable by the person receiving the asset.
CAT generally arises when a benefit is taken by (or from) a person living in Ireland, or consists of Irish assets, such as Irish land, cash in an Irish bank account, or shares in an Irish company.
There is provision for a tax-free threshold below which no tax is paid, and there are 3 categories of threshold [class (a), class (b) and class (c)]. The tax-free threshold depends on the relationship between the person giving the benefit and the person receiving it, and the closer the relationship the higher the threshold.
For example, if a parent gave a benefit to a child on 14 October 2019 the threshold would be €335,000 (class (a)). By contrast, if a parent received a benefit from a child on the same date the threshold would only be
€32,500 (assuming no exemptions apply) as a gift received from a child falls into the class (b) threshold.
Benefits are cumulative, so all gifts or inheritance received since 05 December 1991 (a cut off date set by legislation) which fall into the same class threshold, will be added together, and will use up part of the available threshold. CAT will be payable at a rate of 33% (since 06 December 2012) on the excess of the value of the benefit over the available threshold. If a child were to receive a gift of €100,000 from a parent in 2019 then this would use up €100,000 of the class (a) threshold of €335,000 and the available threshold to shelter future benefits would be €235,000.
There is no CAT between spouses so the focus of most CAT planning is passing wealth to the next generation.
A parent will generally want to plan the transfer of wealth so that children are given assets on a phased basis so that they learn to deal with financial issues and manage properties and other assets before substantial wealth passes. In some cases, planning may be required to ensure that the value of a business is protected in the course of a transfer from a successful founder to the next generation.
CAT Inheritance Planning
A gift allows a person to make provision for family members during his own lifetime, so he can benefit from a more structured and tax efficient transfer of wealth. However a gift may give rise to stamp duty and CGT costs (neither of which arise if an asset passes on death) so the potential tax costs of a transfer need to be established.
The advantages of gifts to children are:
Any rise in value after the date of the gift accrues directly to the child, building up his wealth, and reducing the level of the estate the parent will eventually pass on.
The beneficiary will have assets which he can borrow against, or sell, to fund any gift/inheritance tax on future benefits.
Benefits received since the cut-off date (now 1991) are aggregated together to reduce the tax free threshold. If the cut-off date is brought forward again a gift made now may not affect future gifts or inheritances.
Most family transfers are taxed based on the market value of the asset. In the current climate values are depressed, so a taxable gift in 2017 may result in a lower tax cost than a future inheritance of the same asset (if values or tax rates rise).
The rate of CAT (33%) may rise in the future so benefits passing now may attract less tax than future benefits.
Transferring Wealth by Gift
There are a number of measures available that can be used to facilitate the transfer of wealth without a prohibitive tax cost. The following reliefs may be used to reduce CAT:-
Dwelling House Relief
This relief applies if assets pass by inheritance but the relief is no longer available on gifts unless the beneficiary is an incapacitated relative or a relative aged 65 or over. In general, the disponer needs to live in the property up until his date of death and the beneficiary must live in the property for at least 3 years prior to taking the inheritance.
If the disponer or beneficiary moves out of the dwelling as a result of mental or physical infirmity this is treated as occupation of the dwelling for the purposes of the relief.
The beneficiary must not be entitled to an interest in any other residence and must retain the dwelling as a principal residence for 6 years unless the beneficiary was 65 or over on taking the inheritance (subject to certain provisions for replacements).
In general, the ownership of any other residential property in Ireland or abroad (for own use or as an investment) will prevent the beneficiary from claiming the relief.
If a second dwelling is taken in the same inheritance, the ownership of the second dwelling prevents the relief applying to the dwelling which may otherwise qualify for dwelling house relief.
Business Relief
The taxable value of the qualifying business property may be reduced by up to 90% when it is passed on to a beneficiary.
The value of the relief will be reduced if part of the value of the business comes from investments, and if the investments make up over half of the total value of the business relief will not be available.
This relief can be used to pass a business or shares in a trading company or group on to the next generation.
It could also be utilised to invest in a child’s business with a view to passing the shares or business interest on in due course.
It should be noted that to secure relief the parent must hold the business interest or shares for 2 years before an inheritance of 5 years before a gift.
There is a clawback provision so the beneficiary must retain the business for 6 years (10 years if the asset was development land), and must ensure that the business is run in such a way that it remains a qualifying asset for business relief during that 6 year period.
Agricultural Relief
The value of qualifying agricultural property may be reduced by 90% when it is passed to a “farmer”, i.e. a person whose assets are substantially (80% or more) in the form of agricultural property.
If the asset passed consists of woodlands the beneficiary does not have to meet the 80% assets test to be a “farmer” and to get relief on the value of the woods.
The beneficiary must actually farm the asset, or lease them to someone who actually farms them for 6 years.
Agricultural relief also has a clawback provision so the beneficiary must retain the agricultural property for 6 years (10 years if the asset was development land), In addition, he must remain resident in Ireland for the 3 years following the year in which the benefit was received.
Annual Small Gift Exemption
A person can receive a gift of €3,000 per annum from any number of individuals. Two parents could give a combined gift of €6,000 per annum to a child, building up an investment of €30,000 over 5 years.
Reliefs
Many parents want to transfer value without transferring total control to children, especially if children are young adults who may not have any experience of dealing with valuable assets.
In general, it is difficult to provide absolute legal barriers to the realisation of assets as the beneficial interest (i.e. the real ownership) must transfer to the child if a gift is to be effective for CAT purposes.
However, a parent can install practical safeguards to minimise the likelihood of an ill-judged disposal of assets.
The options set out below may be of interest.
Charges
To reduce the risk that the child will dispose of a benefit and dissipate the proceeds a parent can gift most of the value of a property, but require a payment left outstanding on the property as a charge in favour of the parent.
Alternatively, a parent with a strong banking relationship might look at a commercial mortgage on the property which can be paid by the child (possibly funded by renting a room) and which may be secured by a parent’s guarantee (not a gift unless called by the bank).
If a parent gifts a property which is already owned by him and charged to a bank, the child’s gift is the value of the equity. It should be noted that if a commercial loan is involved the bank may have issues in relation to the security offered.
Co-ownership
A parent could acquire or retain a small interest in a property (say 5%) as a co-owner so that most of the value passes to the child. With the parent on the title, it will be difficult for the child to sell the property or charge it without co-operation from the parent (or court order).
Private Company Shares
Control of a private company tends to vest in the person who holds the voting rights and it is possible to carve the voting rights of a private company out into a separate class of voting shares; so that the children can be given value (in the form of ordinary shares) but the parent retains control via the voting shares.
Family Investment Partnership
A family investment partnership is a mechanism to increase overall family wealth while retaining control of decisions in the hands of the managing partner. The partnership agreement can be structured so that control of major decisions relating to the assets, and distributions are in the hands of one particular partner (generally the parent).
The structure allows the family members to participate in the returns from partnership assets, without passing on decision-making control to the children.
It also allows for economies of scale, and increased investment levels as family wealth are pooled for investment purposes.
The transfer of a share in the partnership from a parent to a child, or the “seed capital” to start the investments, would be subject to CAT at the date of transfer.
However the parent can use the tax-free threshold to pass the investment “seed capital” to the child, without a tax cost, and the growth in the investment would accrue to the child.
Child Protection Trusts
If it is clear that a child or other family members will need ongoing protection and should not be given outright control of assets a discretionary trust may be appropriate to secure the benefit (but not the burden) of assets for that child or family member.
There can be a tax cost associated with discretionary trust protection for adult children, but an exemption may be available if Revenue can be satisfied that the trust is required to protect an incapacitated or improvident child.
Asset Protection: Keep Control
If it is clear that CAT will arise it is possible to insure against CAT using a “Section 60” life policy. The parent pays the premiums and when the life company pays out the proceeds of the policy on death they are exempt from CAT to the extent that the policy is used to pay CAT.
Insurance
These notes are intended as a general guide. Fortress Financial Planning has endeavoured to provide an accurate commentary but the notes cannot cover all circumstances. Fortress Financial Planning strongly recommends that formal tax & legal advice be obtained before any steps are taken.