Estate asset sold for less than market value

[colinefbarrett]

Hi

Very grateful if anyone could provide comment on the following query:

Some time ago my wife entered into a formal contract with a business partner to sell him ("the partner") a number of shares in her company. The Consideration for the sale of the shares was £1 (and this was written into the agreement).

Since then the company has been successful, and the partner's share is now worth in excess of £200,000.

In the share sale contract there is a clause which gives my wife the option to purchase the partner's shares from his Estate in the event of his death. The contract also states that these shares can be repurchased for the same Consideration (i.e. £1).

What I'm not sure about here are the tax implications of this. If the partner's shares are worth £200,000 at his death, then if the estate sells them for £1 is there not going to be some big tax bill associated with this?

Hope the query makes sense. Thanks for any comments.

CB

[pqtaxation]

I’m not an expert on UK rules on this specific point and if it does arise I suggest you should consult such an expert, but from reading your post I should expect that if the share sale agreement gave your wife the right to re-purchase the shares (call option) for a nominal price from his estate upon the death of the business partner and that call option was exercised by your wife then that nominal price will be their valuation within the deceased’s death estate.

If the call option was not to be exercised and the deceased’s estate sold the shares for £200k to your wife (or someone else) then that would be their valuation within the death estate; the shares might qualify for business relief from IHT. There would be no capital gains tax (CGT) on the uplift to that valuation in the death estate from cost.

The above may well be the taxation position for IHT/CGT but your wife may face a moral issue if the deceased leaves dependant/family who would not benefit because of the call option from the deceased’s undoubted contribution to the success of the business.

[colinefbarrett]

Hi

Just to clarify. The sale agreement (under which the shares were originally sold by my wife for a Consideration of £1) specifically states that she has an option to re-purchase the shares in the event of his death for the same Consideration for which they were originally sold (£1).

We're not so worried about BPR (or loss of it), it's the (possible) immediate tax implications of purchasing an asset from the deceased estate for considerably less than it's market value that is our main concern. Also, the specific circumstances mean that there are no moral/family considerations at stake here. Apologies for not clarifying where our specific concern lies.

Thanks again
CB

[maths]

Why would the partner buy shares for £1 knowing there was nothing in it for him/her as on death they could be bought back for a £1?

What would have happened if you wife had died first?

Could the partner have sold the shares to a third party whilst alive (presumably not) ?

Really don't understand the logic to the transaction?

[colinefbarrett]

Hi all

Much of the reasoning behind the transaction is personal between the two parties involved and it is very much the case that both parties are 100% happy with the spirit of the arrangement. I didn't want to spell it out here because all of "business arrangements" between the two parties are not at issue and I just wanted to focus on the specific area where we've got concerns.

At the time the original sale was made both parties engaged a national law firm to draw up a contract which provided a mechanism for the partner's shares to return to my wife in the event of the partner's death, and for there to be no material cost relating to this transaction. The mechanism the law firm came up with (and included in the contract) was this option for my wife to re-purchase the shares from the estate of the deceased partner for the same consideration as they were sold for (£1).

I do appreciate that the whole thing may look a bit strange, but it really is the case that this is what both parties want to happen. What we're trying to work out now is whether the mechanism included in the contract (option to purchase shares for £1) has indvertently created a potential tax bill - as a result of the shares effectively being sold by the estate for considerably less than their expected market value.

Thanks again for any comments!

CB

[colinefbarrett]

Hi, I've re-phrased this query and added some more info. I don't know if this helps clarify the query?

This is a private company with two Directors:
Director A owns 51% of the shares in the company, and Director B owns 49% of the shares.
The company originally belonged 100% to Director A, but about 4 years ago Director A sold 49% of the shares to Director B for £1.

If the Directors agreed to sell the company today, then it would probably fetch in the region of £500k.

Due to some quite unusal circumstances, Director B is not allowed to sell his shares to any 3rd party without first offering the shares to Director A.

If Director B does do this, then Director A has the option to buy back the shares for £1.

All this is set out in a legal document between Director A and Director B, and Director B is completely happy with this arrangement (as it is completely appropriate for the relationship between the two parties involved).

My question is this:
Even though the market value of the company is approx. £500k, are Director B's shares actually worth more than £1 given that if he tried to sell them they could always be purchased by Director A for £1.

The reason I'm asking is to try and understand what the probate valuation of Director B's shares might be in the event of his death. Would it be:
(a) £245,000 - as this is market value of his share should both directors agree to sell the company, or
(b) £1 - given that effectively Director B (or his estate) could never sell his shares for more than this amount unless Director A also agreed to sell (which Director A would definitely NOT want to do if Director B died).

Thanks for everyone's patience on this query, and thanks again for any comments.

CB

[pqtaxation]

Presumably the well-regarded solicitors who advised on and drafted the share sale agreement considered the taxation ramifications were your wife to exercise the call option either pre- or post-death of her business partner.

Why not just ask them for an updated opinion under current legislation to give your wife the comfort (and their professional indemnity insurance) you are seeking?

[maths]

The issue of valuation is, it seems, of importance for B's executors on his death.

As mentioned by pqtaxation, what advice was offered to B as to the IHT consequences of the arrangement on his/her death?

At the date of death B would appear to own the shares; A simply had an option to repurchase (ie A, prior to exercising the option, would not have a beneficial interest in the shares).

I'm still bemused about what seems to be anything but an arm's length arrangement but in short, on the death of B, the shares would be valued at their market value (ie not the £1) as it seems to me that IHTA 1984 s 163 suggests that any restriction on freedom to dispose of the shares is ignored as there appears to be no consideration for the restriction (s 163(1)(a)).

Perhaps others may disagree.

[colinefbarrett]

Thanks very much for these responses. They really are very much appreciated.

Unfortunately whilst the law firm who drew up the original agreement is a national firm, I couldn't say that they are well regarded!

We will go back to them, but understanding a little more about where the issue may lie is going to be very helpful in framing that conversation.

thanks again

CB

[maths]

Let us all know the outcome; I'm always prepared to learn.