Readers' forum - A literary legacy

We act for an author who also writes material for the stage and films as well as books. He has a well-established portfolio, which produces a significant stream of royalty income. This has lasted for many years and looks set to do so for the future.
Most of our client's activities are carried on through the medium of his limited company, which he owns with his wife, who has the significant minority shareholding, but there is no untoward significance in that. Our client has a slave contract with his limited company, but it actually expired many years ago and nothing has been done about it since. He has just carried on as before, putting all royalty income through the company.
He has another limited company which carries on in a similar fashion and deals with a relatively minor aspect of his work. Then finally, on a desultory basis, he does some work — personal appearances and such like — in his own name, and paying tax on a self-employed basis.
Our query concerns inheritance tax. The simple question is whether readers think that business relief is available on the shareholdings in the company enjoying the copyrights. A lot of reading on the subject has failed to elicit a firm view and because there could be very considerable sums involved we do not want to leave it until after the fatal day to find out.
Query T16,725 — Thinking ahead.

Reply by Kalonymous:

It is assumed that the client's shares are unquoted. It is generally assumed that business property relief is available on trading assets. However, the rules do not even mention the word 'trade' or any derivative word. The test under the legislation is whether (in the case of company shares) the business of the company 'consists wholly or mainly of making or holding investments' (see IHTA 1984, s 105(3)).
These provisions were considered by the Court of Appeal in George & Loochin (Stedman's Executors) [2004] STC 163 (a caravan park case) where the ultimate decision in favour of the taxpayers was down to the particular facts of the case. Therefore the two companies will have to be considered separately — if there was a significant reason for two different companies being used (or a difference in the way they were used), this might lead to the shares in one qualifying as business property and the other not.
The first company was previously a slave company. Therefore, historically, its main function was to exploit the services of the client in return for royalty receipts. Had the company not been used for such purposes, the income would have been treated as earned (rather than investment) income by the client.
Thus, originally, the company's business would not have consisted wholly or mainly of making or holding investments. Provided that the client continues to operate this company as a personal services company, I would have no hesitation in concluding that the company remains eligible for business property relief. This is the case even though the original slave contract has expired.
However, if the company has not distributed its profits, the accumulation of undistributed profits might mean that the company's main activity is holding these cash investments and relief would be precluded.
Additionally, the value of the relief might be curtailed by IHTA 1984, s 112. It would be necessary to ascertain the value of the shares and then how much of it relates to 'excepted assets'. These are those assets not used by the company for the purposes of its business in the two years before the date of the transfer. If there are some old copyrights that continue to generate income, it is arguable that these are no longer being used in the company's business — they just continue to provide income to the company. If the income streams for each right are more short-lived, then this would be less of a worry. What needs to be determined is how the value of the company is made up.
These issues would be more of a concern if the client were to retire (either by choice or circumstance) some time before his eventual death because the business of the company would no longer be exploiting the client's writing but merely the receipt of income streams.
We are told less about the second company — in particular we are not told whether it was party to a slave contract. The above issues would be equally relevant and ultimately its status would depend on the particular facts of the case and the circumstances in the two years before the client's death.  

Reply by Inverclyde Racer:

We are not told who holds the copyright assets; however, I would suspect that the author has assigned the royalty income to the company. The limited company and slave contract are then used as a vehicle to reduce the rate of tax.
Problems occur for any business property relief claim when we look at the business activity. IHTA 1984, s 105(3) identifies what is not relevant business property, stating the making or holding of investments as an example.
The company does not have a trade of its own and it is likely that the principal activities will make reference to the slave contract held to generate investment income from the royalties. More than 20% of the income and assets held by the company are for investment purposes and so the company will be an investment company, as defined at TA 1988, s 130. On this basis business property relief will not be available.
As the concern is inheritance tax, an alternative would be the use of a discretionary trust. We are not told the age or health of the author or the level of assets or income involved; however, the author should plan to use his full inheritance tax nil rate band by making a transfer to a discretionary trust every seven years. After each seven-year period, the last transfer will fall out of the author's accumulation period and will not be subject to inheritance tax. It must be remembered that discretionary trusts are subject to ten-yearly inheritance tax charges and an exit charge.
If the author has grandchildren, then an accumulation and maintenance (A & M) discretionary trust should be considered.
An A & M trust is considered an 'inheritance tax friendly' trust that will not be subject to principal and exit charges. Trusts are very effective in that they allow the author to determine the succession direction of the income and finally the assets. Care should be taken not to set up a settlor-interested trust, which would then be included in the author's estate at death.
The disadvantage of an A & M trust would be that the transfer will be chargeable to capital gains. If a non-A & M discretionary trust were used, a hold-over claim under TCGA 1992, s 260 would be available.

Extract from reply by Brumus:

It seems to me that the key to the question is the contract between the author and his company. This should specify which of them owns the copyright. I would guess that it actually is the company, in the same way that a, say, publishing company will probably own the copyright to material produced by its employee 'in-house' writers. Copyright subsists for the life of the author and another 70 years after death and it would seem logical that an asset potentially producing income over such a long period is likely to be an investment asset and not eligible to business property relief.
If the author purports to give the copyright to someone else in such circumstances — in an attempt to reduce the eventual inheritance tax liability on his death — this would seem to imply that (if my assumptions above are correct) that the company will have made a gift of the copyright to him with attendant potential corporation tax liability on the gain. Perhaps the author could achieve a similar result by gifting shares in the company; the settlements legislation should not apply as the company owns a capital asset rather than simply being reliant on the future earning power of the director.

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