Inheritance Planning and Partnership Capital Account Balance

nunez125

I am in a business partnership with my parents and they hope to pass the business to me as a gift or as an eventual inheritance. They also want to put a small amount of the value of this business aside for my 2 siblings, as the eventual inheritance for those siblings (my parents have other assets that those siblings will also get, separately from this business).

My parents have a large balance in their partnership capital account in the business, and I was wondering if it is it possible for them to use this balance to provide the amount they aimed to provide for my siblings future inheritance, since it is large enough for that job.

They could presumably use this balance to withdraw an amount of cash from the business partnership over time while still in the partnership, or after retirement, that would satisfy their desired amount as future inheritance for my siblings, and thereby leave me owning the business alone, after this capital had been removed.

The alternative is for them to leave a part of the business to my siblings (particularly a share in the property / premises), but that leaves us in a joint ownership situation, which none of us want to be in.

As far as I know it, any balance in my parents partnership capital account is treated like a loan from them to the business if they retire, and is therefore an amount that I might be due to repay anyway in the future from the business, and so I wonder could it easily be employed for the purpose of balancing the future inheritance a bit.

I am also wondering what happens to any unpaid balance in their partnership capital account when they retire or later die? Is it effectively an asset that forms part of their future estate and must also be divided in any inheritance? They do plan to leave the business partnership wholly to me, so perhaps that also includes this balance?

nunez125

Thank you so much for all of this information. We will definitely take professional advice, but I am very glad that you have made me aware of all of these issues, before I go into that process. Mostly because I would like to be able to know if the preferences that I have are feasible from an IHT and CGT standpoint. Thank you again for taking the time to respond.

If you do not mind, I will fill in some of the blanks that you have raised, just in case it might lead you or others to any more conclusions. First, there is no formal partnership agreement, and so it sounds like this would be very important to set up. Perhaps it all hinges on this agreement, and I was not aware of that. Thank you again.

You asked would the siblings become partners on the death of my parents. The answer is that as it stands, my parents just own the business property separately from the partnership, and in their names, and it is mortgage free. They might have preferred the simplicity (for them) of making my siblings joint owners of part of the building (25% each) in their will, so that they did not have to get my siblings involved on the business partnership itself.

They would also be able to retain ownership of the building during their lifetime if they did it this way, and perhaps charge me rent if they retire from the partnership. However, this option seems less suitable from my perspective, as it creates a shared ownership of the property down the line, which I hoped to avoid. My parents understand now that although this is an obvious option for them, it is not the ideal one for me in the long term.

I hope that the property being separate from the ownership of the building does not make either the business or the property ineligible for BR. If it does, they would almost certainly try to fix this by combining them somehow (combining the property into the partnership, or by incorporating).

Since the business partnership and the property are both mortgage or debt free, this would make it easy to incorporate if we wanted to (as far as I understand it), but I am not sure if this step is necessary, or advantageous to my dilemma of the attempt to avoid shared ownership with my siblings. Right now, by having 4 partners in the business (my parents, myself and my wife), the income is split 4 ways, and so the income tax bill is not a huge problem (I know high income tax bills for partnerships are often a major reason for incorporating, so there is no need to incorporate for now).

Whether the property remains separate from the partnership, or the property is added to the partnership, or either property or business or both, are incorporated, my concern, is how best to portion off some equity or value or cash (or a promise of cash from future earnings) to my parents or siblings, without doing it in a way that leads to including them in the formal business structure in a way that creates future difficulties for me.

Some of my worries if my siblings end up as part owners of the premises include loss of control of important decisions or the development of the business premises, differing priorities about the future of the site, being forced to buy one or more of them out at an inconvenient time, or them selling a share to a third party if I can’t afford to buy it at the time they want to sell, or them being locked out of selling due to their CGT liability, or them selling before my parents death and losing IHT relief from BR, or difficulties in me borrowing money against the property since all partners are jointly and severally liable for the repayments (as I understand it).

The particular business is the type that needs upgrade or development work occasionally, which would be the building owners responsibility. If myself and my siblings did own the building jointly, that means it would presumably be a joint cost, which in the very long run, might cause problems getting everyone's agreement to spend the money, or what to spend it on. It's a headache and a constant ongoing communication and paperwork exercise that I don't think any of my siblings would want.

You asked if the partnership has a lot of cash (in terms of BR). It only has an amount that is needed for day to day running (about £50k), so I am assuming that means ‘not a lot’. Is it the wrong type of business for BR? Not as far as I know - the accountant has mentioned in the past that it is eligible for this, at 100% relief as far as I know.

So there should be no IHT cost, but my concern is that if part of the property goes to my siblings, then they will get it without IHT thanks to BR, but as far as I know, rollover relief would have to be used to transfer my parents base cost to them (and me). As it happens, this base cost is very low, and therefore leaves them (and me) with a big CGT liability.

I do not mind the big CGT liability on my portion since I do not intend to sell, but I worry that a big CGT liability on their portion might discourage or even block them from ever selling their share to me. Hence me wondering if I should aim to try to be gifted the property alone, and find a different way to get them a ‘cut’.

As far as I know from reading about BR, it only applies if you hold the asset and continue on the business in the form that it was running at the time of the gift, for entire lifetime of the person giving the gift. If my parents gift a share to my siblings as well as me, do my siblings have to hold it for the rest of my parents lifetime, or risk undoing the BR and creating and IHT liability? If so it would again prevent a sale of their share to me for the entirety of my parents lifetime?. Again it makes me worry that I need to be gifted the property alone to avoid this.

All of it leads me to wonder if the only obvious option is for me to aim to borrow enough money to buy out the share that my parents might have kept for my siblings, before they ever give it to them. I would be 100% owner and the business would have those borrowings, and my parents can keep that cash as my siblings future inheritance. However, this feels like a bit of a 'nuclear option', when none of them are demanding or expecting any money 'now', and are happy with it down the line.

My Dad has said he would prefer to try to find a way to do it all without me having to borrow money, to avoid putting extra pressure on the business. My ideal, better than me borrowing a lump sum to buy out the share that would have been my siblings inheritance, is that my parents simply gift me the whole business premises and leave myself and my wife as the sole partners, and I have some sort of provision that I have to owe my parents whatever amount they need, to give to my siblings in their inheritance, to make it all fair.

I had hoped that I could somehow just do this repayment over a long time period, like 20 years, from the profits of the business. I have other income and am not relying on this business entirely, so I hope to be able to afford to do this. My siblings probably wouldn’t mind either, getting the money down the line like this. My Dad is just happy to be able to continue working in the business as he enjoys it.

Your answer makes me think that maybe the above is possible, simply if the partnership agreement states it. I am worried that if I do go down the route of asking to be gifted the whole business but owing my parents / siblings money over time to compensate them, my parents or siblings would need to feel some assurance that it was a formal agreement and that they would definitely get this money over time. I just don’t know the best way to set this up in a way the makes everyone feel secure. Writing it into a partnership agreement seems pretty feasible though. As far as I now they would all be happy as long as the get their cut somehow.

One other option is that I am imagining is that it would be possible for the partnership agreement to make the property part of the partnership, and then the siblings would actually have to become partners in the overall business to get a share of the equity. Again it could presumably be written into the partnership, what their capacity is there, and perhaps limit it in a way that does not create problems down the line, and makes it easy for me to buy their share out when i do have the money. This kind of thing seems less ideal to me, but that’s a guess.

I do not think that my parents are aware that their capital account balance even exists (we are a small family business and they didn't to get too involved in the accounts over the years), nor that there might be an obligation for me to pay that amount to them or their estate on retirement. It is something that they have not accounted for in their inheritance plans, but it is a large balance, that as it stands looks like it might be something of a problem for me (unless the partnership agreement passes it to me somehow in the long run).

Ideally the remainder of the capital account balance would belong to me once the amount that they want is paid off. I am still not sure what you think of my idea in the original post, of using the balances of my parents capital accounts as the easiest way to get the money over time to my parents (for my siblings inheritance)? It would be paid over time from the operating profits of the business partnership, to my parents, who would have to make a gift of the cash to my siblings, as a potentially exempt transfer, and then live 7 years afterwards, or leave that cash to them in a will.

If the partnership agreement has it in writing that I owe a certain amount to my parents for this purpose, and the balance exists in the capital account to pay it, and I would pay it gradually as soon as cash accumulates in the business, then presumably this is enough reassurance for everyone involved. I have other assets aside from this business (also mortgage free) that my parents and siblings might be able to view as a form of security, for peace of mind that I will likely have the cash over time, or there might be something to ‘recover’ their money from if it all went wrong somehow.

In terms of IHT liability on the cash that my parents get from the business via this above mechanism, it would be liable for income tax, and then would also form part of my parents estate for IHT, which would fall oil my siblings and not me, and therefore be unfair. So yes, as you have pointed out, it perhaps becomes tax inefficient for them to give their other children money this way, as opposed to just gifting them part of the business, and receiving 100% IHT relief via BR.

From this perspective, you might say that I might be stuck with no other option than to end up joint owners with my siblings in an inheritance situation, and then try to proceed from there by borrowing the money to buy my siblings share, and just hope that they will sell and take the hit on CGT.

nunez125

Two additional comments - I considered doing the repayment to them over a long period like 20 years because the business has been in the family for over 100 years, so 20 years into the future doesn't feel that long for us. However, that creates tax liabilities for them at the other end.

The second comment - the 'nuclear option' of me borrowing money to buy the share that would have gone to my siblings, might have the disadvantage of creating a tax liability for them, as far as I know. The cash might have to be gifted immediately to my siblings as a potentially exempt transfer, and hope that both parents live for 7 years afterwards.

nunez125

We are a retail business, and yes the property is used for the business. There is a small commercial unit attached that is rented to a separate business, which I imagine complicates the BR case, as that unit is not technically part of the ‘main business’. However, it is small and maybe only 20% or less of the value of the main premises, so not a huge issue. Do you think that it would be excluded from BR?

To respond to your points:

1. Currently all 4 partners are active, no one has retired yet. I am not sure exactly how the £1m/50% BR limit will affect this situation (I think the value of the interest in the partnership is under £1m, so I am assuming it is not an issue?). What is the effect of the new £1M/50% BR limit on this situation in your opinion? Is it any reason for me to be trying to rush anything before the 5th April?

3. Why is the property only eligible for 50% BR, not 100% like the interest in the partnership? I know there are specific conditions to each of those 2 brackets. Thank you for the info about rent being charged invalidating the 50% relief, or if the owner is no longer a partner. I would remain partner, and joint owner of the property, so the second point may not be relevant, but it is highly relevant that my siblings cannot charge me rent without losing their 50% BR. It might mean that a stake in this property could be the wrong choice as their inheritance, if some other way can be found. This is the sort of issue I was wary of.

4. An LLP sounds like a good idea. I will have to read up on that. Thanks for the info that incorporating may not be an advantage.

5. Thanks for clarifying this. As I understand it, the stake in the property that I could get as a gift (presumably 50%) comes to me at my parents original low base cost, but the stake that I buy (presumably also 50%) will come to me at market value. My pooled base cost (assuming it is done this way), would be the average of the two, so a lower CGT liability than if I had been gifted it all. I don’t intend to sell, so it’s not hugely relevant to me, but the reason that I am curious about this is that if my siblings also get gifted a stake from my parents, and employing s165 holdover relief, my siblings stake will have the original low base cost, but full market value for any subsequent sale to me. They will get a nasty CGT bill (23% I assume?), vs the 10% CGT bill my parents would get under BADR if they sold to me directly. This is the point where I fear that my siblings’ own accountant might say don’t sell, rent it to him. But if they rent it to my partnership, they will lose their BR through which they received tax relief on the original gift. So it seems fairly useless to them to have this stake. This is one reason why I wondered should the property be added to the partnership (if this is possible, but I think that it is), not as a company, but as an LLP. It would mean that the business and property are a single entity. It could also include the separate but adjacent rental unit, thereby bringing it into the relief from BR where it might have otherwise been excluded? Have I got this bit wrong? If the property and the business were both in the same LLP, maybe there is no great advantage, and it might be difficult to avoid then making those siblings partners in that new LLP is some way (which is something that I wouldn’t choose, as they have no actual involvement in the business). Perhaps that can be indicated in the partnership agreement, to limit the extent of their overall involvement in the partnership. However these things can easily be changed later as I understand it, so it could be a slippery slope adding them as partners at all?

When you say my parents are eligible for BADR, I assume you are reffing to the fact that whatever parts of the business that they sell to me (if I try to borrow and buy that stake that they intended for my siblings inheritance) only attracts 10% tax for them, which is fairly tax efficient vs the tax rates on other forms of income or gain / disposal. I am guessing that cash does then become part of their estate for IHT, even though it came from the sale of an asset that would otherwise have been excluded from IHT if gifted (their main business, and so qualifying for BR)? If so, the sale of the stake does become more costly for them, than simply gifting it to those siblings directly if I am not mistaken. I think they are close to the IHT threshold and might have to try to gift this cash right away to my siblings. So it’s not particularly tax inefficient for them to sell the stake to me, that they intended to give to will to my siblings, pay only 10% tax thanks to BADR, and then either keep the cash for my siblings to inherit, or gift it immediately, as a potentially exempt transfer. All of these gifts at once create a lot of risk of a failed potentially exempt transfer, which could encourage us all to just stick to a will, and forget gifts. Again, not my preferred choice.

6. Interesting.

8. Apologies for using the term ‘profit’ where ‘cash’ was appropriate. So you are saying that ‘If you want to go down this route of ensuring that profits are used to buy back your parents' capital interests then and they are a material amount then incorporation may be worthwhile’. Is there any chance that you could elaborate slightly on this? it sounds important, but I don’t know the underlying reasons.

nunez125

Thank you so much for all of this information. You are very generous to share all of your expertise, and I feel like maybe I have used enough of your time.

I am at least able now to go forward with some insight into the main issues, so thank you again for your time.

It feels like from your answers, I have taken some of the following conclusions. Perhaps incorporation is unnecessary, a partnership agreement is essential, a general partnership is should not include my siblings as partners, an LLP is a possibility, though the LLP possibly should not include partners uninvolved in the running of the business either, and the LLP could include the business property if we desired.

Despite all of your great explanations, the issue of what to do about my parents large capital account balance in the partnership is still grey area to me, in terms of whether it can be a vehicle for funding my parents retirement / siblings later inheritance, rather than them keeping their stake in the property to do so.

If you have any parting comments on that, I would be very grateful, but if not, thank you again for all of your helpful insights.

I will also seek further professional advice before doing anything more.

Thanks again for all of your help.

nunez125

Thank you so much for laying all of this out so clearly, you have really helped me. They really should teach this sort of stuff in school.

This last answer seems very comprehensive, and it does make all of the possibilities a lot clearer.

Thank you again, and you are very kind for helping me out.

Sending good Karma your way!