Time for family “succession” planning – Better late than never

It is rightly said that failing to plan is planning to fail. This adage resonates further in case of family succession planning. If an individual fails to plan for his/ her succession, it can create havoc and chaos for the grieving family and for the business in general.

Family succession planning involves passing the wealth and the reigns of business to the next generation systematically and smoothly. It can be achieved by various means and modes, including by writing a “will” or creating a “private family trust.”

Traditionally, the will has been used to pass on wealth. However, a will offers the opportunity to pass on wealth only after one’s lifetime. This nature of a will creates disputes, as one can question the will’s authenticity. Sometimes a will is written under pressure and coercion, which makes things even more complicated. Therefore, some states have made it mandatory to get the will probated to execute the transfer of property from the name of the deceased to his/ her successor. Probating is a time consuming process and has financial implications. The probate fee is 3% of the fair market value of the property passing through the will. As many of the properties passed through will, may be illiquid, it can pose cash flow issues in the hands of the successor.

The transfer of the assets by way of will is neither taxable in the hands of the testator nor taxable in the hands of the persons receiving the assets.

However, a will is always vulnerable to challenge by kith and kin. Lately, we have seen eminent and well-respected families running big business houses in India fighting over the authenticity of the wills of their patriarchs.

Acknowledging the challenges related to succession through a will, many Indian entrepreneurs are leaning towards a more systematic and planned method of succession, by creating private family trusts.

A private family trust is created by a settlor, who hands over certain properties to trustees for the benefit of the beneficiaries. Generally, the trustees and the beneficiaries are the family members of the settlor. A trust runs like an institution governed by a trust deed, which is usually signed by both the settlor and the trustees. A trust deed defines who will run the trust, in what manner, what will be the beneficial interest of the beneficiaries, and when, how and in what manner the trust income/ assets will be distributed to the beneficiaries.

The settlor has the flexibility to create a discretionary private trust or a determinate private trust. In a discretionary private trust, the trustees have the discretion to distribute the trust income/ assets amongst the beneficiaries, whereas in a determinate private family trust, the ratio of the beneficial interest of the beneficiaries is pre-defined by the settlor.

As a private family trust runs like an institution and is usually institutionalised during the lifetime of the settlor, with predefined ways of decision-making, a private family trust provides the following benefits:

1. Greater transparency and certainty to family members

2. Dispensing the need to pass on wealth on death of a family member

3. Provides family governance rules

4. Interse arrangements amongst family members

5. Ring fencing of personal/ family wealth from business risks

6. Control of assets during one’s lifetime while passing its economic benefits amongst family members

One fundamental difference between a private family trust and a will is that the former kick starts the succession during the lifetime of the settlor.

The transfer of assets to a private family trust for the benefit of the family members of the settlor is neither taxable in the hands of the settlor nor in the hands of the private family trust.

If an individual fails to plan for his succession, the government-enacted laws provide how succession will occur in such situations. In case of a Hindu, Buddhist, Jain and Sikh, The Hindu Succession Act, 1956 provides how much of the assets will be passed on to which relatives. The provisions of The Hindu Succession Act, 1956 provides different rules of succession for males and females.

When an individual fails to make provisions for his succession, his heirs have to navigate through the labyrinth of laws and regulations to obtain ownership of the property. Many legal formalities have to be complied with, including obtaining a letter of administration and succession certificates from the court, which involves much time and money.

Therefore, it is imperative to plan for one’s succession. All of us spend substantial time and thought in earning wealth but it is equally important to plan, protect and pass it on in a systematic manner.

The views expressed in this article are personal. Article includes inputs from Sagar Narang – Assistant Manager – M&A Tax , PwC India