Shareholder’s estate spared huge IHT liability by Hastings-Bass

Fri 12 May 2017

A company almost came unstuck when, under the guidance of their advisers, the Company adopted an inappropriate arrangement to remove the possible problem of having to repay a director’s loan account on death. The arrangement made, for non-tax reasons, would have created an IHT liability on an amount far greater than the loan itself. The case of Power Adhesives Ltd v Sweeney & Ors. ([2017] EWHC 676 (Ch)) concerned a director/shareholder (Peter) who owned 6,600 of the company’s issued share capital of £10,000, and was owed £490,000 by the company on his director’s loan account.

The facts

The Company was buoyant, with a balance sheet value of some £15m but the directors and shareholders had concerns about the possible detrimental effects to the Company should Peter die and the executors call in the loan: although the Company was prospering the directors considered that it might have difficulty funding repayment of the loan. Matters were brought to a head when Peter was diagnosed with cancer in December 2014 and as terminally ill in Spring 2015. Therefore, having taken advice, in April 2015 the directors arranged that the Company would issue to Peter new shares of a different class (“B” shares) from his existing shares with a nominal value of £490k, thereby cancelling the debt and removing the possibility of repayment being demanded on Peter’s death.

Peter died in July 2015 and only then was it realised that the effect of the debt to equity swap had been to:

·         create a very substantial IHT liability on Peter’s estate;

·         change substantially the relative interests of the Company’s shareholders (including two family trusts); and

·         make a value-shift from the other shareholders to Peter.

IHT liability

No valuation was made of the market value of the Company’s shares when the B shares were issued and it was not until probate was obtained that the likely scale of the impact was became apparent. The amounts involved are not given in the case report but the proportionate shift in value can be appreciated because before the B shares were issued Peter owned 66% of the issued share capital: after, he owned 496,600 of the issued share capital of £500,000, i.e. 99.32%. On a balance sheet value for the whole company of £15m, the value of Peter’s shareholding would have been increased by around £5m, for a cost to him of £490,000. If the Company’s market value was higher than that ‘balance sheet value’ then so, proportionately, was the value of the B shares.

No business property relief on the new shares

Although the Company was a trading company for business property relief (BPR) purposes, Peter’s new B shares did not qualify for BPR at the time of his death because of the way in which the issue had been arranged. His estate could not take advantage of the fact that he was already a shareholder So the B shares were all taxable in full on Peter’s death and their value was market value, not their nominal value.

Potentially exempt and chargeable transfers by the other shareholders

To the extent that the other shareholders’ interests in the Company were reduced they made IHT dispositions:

·         PETs in the case of individuals;

·         possibly chargeable transfers by the trusts.

The PETs may have been considered unlikely to fail and produce a liability, since the individuals concerned were much younger than Peter and in good health, while the transfers out of trust were covered by BPR.

Changes in interests of shareholders

As arranged, the B shares’ issue altered the interests of the other shareholders which created a company law issue. As majority shareholder Peter was exercising his power to diminish the interests of the other shareholders. The evidence presented to the Court was that this was not the intention of the directors, Peter included: the only purpose of the exercise was to replace the Company’s debt to Peter with a security of equal value that would not need to be liquidated on his death.

Value-shifting for CGT

Under the Taxation of Chargeable Gains Act 1992 (TCGA) where a person who controls a company exercises his control so that value is passed out of shares that he or a connected person owns, there is a CGT disposal to the extent that value has passed out of those shares. The other shareholders were connected with Peter, so they all made CGT disposals when the B shares were allotted because they did not receive new shares pro rata.

In this case the disposal, being of trading company shares could have been covered by gift hold-over relief (TCGA s 165) and so no liability was likely to arise. Gift relief requires a claim by transferor and transferee unless the transferor is a trust. HMRC guidance currently states that “Claims must be made by the taxpayer personally. If however the donor or donee is dead their claim is to be made by the personal representatives.” However, it is possible that HMRC may change their view following the Upper Tribunal decision in Peter L Drown & Mrs R E Leadley ([2017] UKUT 111 (TCC)) where personal representatives of the deceased were unable to make CGT negligible value claims on behalf of the deceased.

The solution

The legalities of the arrangement were all formally correct and there was no dispute about the transactions being what the Company directors and shareholders wanted, based on the advice given by their advisers. Therefore the share issue was legally valid and they could not argue that it was void ab initio.

Therefore the Company had to apply to the court for a legal declaration that the transaction was voidable because its directors (Peter and others), had not taken proper steps to uphold the interests of the minority shareholders, a situation similar to that seen in Futter v Holt and Pitt v Holt, the most recent cases (both heard together) on the tricky question of voidability of transactions.

The nub of these cases is that the Court has a discretionary power to set aside arrangements made by trustees or others who exercise a fiduciary duty where:

·         they have failed to take proper care in exercising their fiduciary powers;

·         the objects of those powers (e.g. beneficiaries or shareholders) would be unfairly disadvantaged; and

·         it would be unconscionable for others who may have benefited from the transactions to retain their benefits.

Failure of fiduciary duty

The Judge had to think carefully about whether the Company’s directors had failed in their duty as custodians of the Company for the benefit of its shareholders because, if they had taken all reasonable care he might have been obliged to deny them relief from the consequences of their actions. In this case the Judge concluded that, although the directors had taken professional guidance and were aware that their advisers had taken some trouble in advising them, they were responsible for taking more care, perhaps in the form of second opinions, before acting in reliance on the advice given (which, given that the advice contained errors at least as to the effects of the arrangements, was probably reasonable).

Disadvantage to the objects of fiduciary powers

That the objects of the powers suffered loss was relatively easy to see, since Peter’s estate would have been severely diminished by additional IHT liabilities had the share issue been allowed to stand and the other shareholders had lost out by the diminution of their stakes in the Company.

Denying the benefits of the transaction to other interested parties

The other interested parties in this case were the heirs to Peter’s estate and HMRC who were required to be notified of the Company’s application to the court and might have objected to the B shares issue being made voidable on the basis that it would give rise to a tax advantage (i.e. a considerable reduction in IHT on Peter’s estate). HMRC did not oppose the application but they would have certainly done so had they regarded the arrangement as a tax avoidance scheme and the court would not have granted relief if the only purpose had been to enable a tax avoidance scheme to succeed.

Avoiding the problem

The problem stemmed mainly from the way in which the B shares were structured and issued. There were other possibilities that would at least have avoided creating additional IHT liabilities over and above that arising on the debt, and might even have enabled the debt itself to be shielded from IHT. These issues should have been identified at the initial planning stage.