Trusts are Tax - Efficient and Curb Property Wars..!

Building Trust while Planning for Succession.!  

By Hiten Kotak & Jinesh Shah

For most family held businesses, planning for succession is one of the toughest & most critical challenges.

Family Business Owners Checklist..!

There are good reasons why succession planning is one of the most challenging to-dos on a family business owners checklist

Some key reasons are continuity &  growth of the business and also protecting the economic interests of all family members.

Both these objectives could be conflicting at times. So, it is essential that preparation for succession planning is initiated well in advance.

Protection of economic interests of all the family members often results in distribution of wealth that may essentially involve holding of shares of the company by each of the family members directly. This may prove detrimental to the interests of the business for various reasons. One of them is that all the family members may not be inclined to run the business.

Another reason is that one of the family members owning a significant stake may dispose off his holding to an external party, thus leading to loss of control over the firm. Since all the family members are not inclined to run the business on a day-to-day basis, it would be essential to split the management & operating roles from the ownership, which entails a fresh challenge. You may want to give exactly equal shares to everyone, but those who work in the business may feel they are entitled to more.

Likewise, those who dont work in the business may feel the same way about their own shares. After all, they may reason, they are not drawing salaries, so they should get a bigger share of dividends & profit-sharing. There have been instances where the absence of succession planning has resulted in bitter fights amongst the siblings & family members.

It is therefore important to derive a structure that helps to distinguish between equity ownership and managerial roles.

Legal Will..!

Historically, a business and its assets were passed onto future generations by way of a legal will in order to ensure a smooth transfer.

However, considering the various complexities detailed above &  more so in the current economic, social &  legal structures, family business owners want more than just a smooth transfer of wealth & thus, succession planning is not limited to a will.

Succession planning involves discussions around financial, tax & business issues of the family business owners estate.

Interests of Spouses..!

An important objective is to ensure that the interests of all family members are  safeguarded.

Family business owners are concerned about the interests of their spouses post their demise,a dispute among siblings over the wealth & the leakage of the familys wealth as a result of a litigious divorce or / family fights.

To avoid disputes over property and achieve tax efficiency, conditions are attached to the assets, their distribution & utilisation. This is done by creating a trust as a vehicle of succession planning. Trusts are now being used for creating separate vehicles for various family members which engage in carrying out investments into stocks, mutual funds and insurance policies for family members.

Types of Trusts..!

There are various types of trusts & they can be chosen and executed depending on the objectives the settler wants to achieve.

Sometimes the choice of trust structure is also influenced by regulations that govern the asset class being settled into a trust. These differ depending on whether the assets held by the trust include listed company shares or / a private company, land and property, cash,etc.

A trust is not a legal person but merely a legal obligation, wherein the assets are held in the name of the trustee for benefit of the beneficiary.

A trust is a pass-through entity & its taxability is determined by the way in which the trust is organised. These are fiscally transparent entities whereby the obligation to pay tax is on the trustee (as a representative assessee).

Though the income generated through the trust is taxable in the hands of the trustee, the burden of tax is effectively borne by beneficiaries to the trust. A trust in its own capacity can borrow money, own & dispose assets and it can hold offshore assets.

Succession Planning..!

A trust can also be an effective tool for separation of economic & controlling interests. But other issues such as tax, stamp duty, the proposed General Anti Avoidance Rules, liquidity, legal issues etc., must be assessed ahead of succession planning by way of trusts.

Finally, succession planning is not something you can do once and forget.

To be a persistent family business leader, you have to continually revisit your plan, reviewing and updating it to reflect changes around you, be that in the business, economy, and your own health as well as the abilities &  passion of the people you plan to pass it on to.

About the authors..!

The authors Hiten Kotak & Jinesh Shah are Co-Head - Tax and Director M & A, Tax, KPMG - India. Views are personal.

  

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