Inheritance Tax and Business Property Relief Pitfalls
Carly Drummond · July 28th 2023 · read
Firstly, a quick Inheritance tax reminder…
Inheritance tax (IHT) may be imposed on a taxpayer’s worldwide assets after their death. This is subject to certain conditions like domicile and the terms of their Will. The standard rate of IHT is 40%, however there are planning opportunities to minimise the tax exposure, with some reliefs reducing the IHT payable on certain assets to nil. Where a taxpayer has a business or business assets within their estate for example, then these may qualify for Business Relief (BR).
What is Business Relief?
Previously known as Business Property Relief (BPR), Business Relief (BR) reduces the value of a business or its assets for the calculation of IHT. The assets which qualify for 100% relief include:
- a business,
- an interest in a business (such as a sole proprietorship or partnership), or
- unquoted shares.
The assets which qualify for 50% relief are:
- controlling shares in a listed company (i.e. more than 50% of the voting rights),
- land, buildings, and machinery owned by the taxpayer and used predominantly in a business they controlled or were a partner in, or
- land, buildings, and machinery used in their business and held in a trust that it has the right to benefit from.
It is crucial that the two-year ownership requirement is met, whereby the assets or business must have been owned for at least two years prior to the date of death. There are situations where these rules are relaxed, for example the replacement asset rules, which may allow a qualifying asset or business to be disposed of and replaced with another without needing a two-year ownership period for the new asset.
Business Relief is primarily available for businesses carrying on a trade. Where the business’ primary activity involves securities, stock or shares, land or buildings, or in making or holding investments for example, then Business Relief would not be available. If there are several income streams, we would be concerned with the activity the company is ‘wholly or mainly’ undertaking, which is defined in the current legislation as more than 50%. This would be determined based on a number of factors, but if a company is found to be 51% trading, then Business Relief would apply.
Groups can add to the complexity, especially where there are trading entities and investment businesses. Where a group owns both investment and trading subsidiaries, then Business Relief on the shares of the holding company will be restricted because of the investment subsidiary. There is a special allowance for holding companies of trading groups, which we can take advantage of, and can assist with restructuring to carve out qualifying BR business from non-qualifying ones.
Once it is determined that a business or assets are qualifying for Business Relief, then care must be taken to preserve the treatment. Here are the top pitfalls that we have seen from our clients:
- Binding contracts for sale Some partnership and shareholder agreements might include clauses whereby the partnership or company would buy back their business or shares upon death. This would be a binding contract and is as good as holding cash. By entering into this contract, the taxpayer no longer has a potentially BR qualifying asset but rather will be taxed on the guaranteed cash which will be received, at 40% - a costly oversight! We can help with the wording of partnership and shareholder agreements to avoid this common pitfall.
- Lifetime gifting If an individual makes a gift and survives for a period of seven years, this will not be brought into their estate for IHT purposes. However, it is important to consider the circumstances under which these lifetime gifts are made. Even if a gift qualifies for BR, it can be subject to reconsideration if the seven-year requirement is not fulfilled. If the recipient sells the gifted asset and the donor does not survive the seven-year period, then the previous planning to mitigate IHT would fail, meaning IHT at 40% may be due! There are steps that can be taken to protect against future actions of the recipient which we can assist with.
- Spousal exemption It is quite common for a taxpayer’s primary beneficiary to be their spouse. Generally, where assets are passed on death to a surviving spouse, they will be exempt from IHT. Where businesses or assets that qualify for BR are passed to the spouse on death, there is a risk that on the death of the spouse these assets will no longer qualify for BR and IHT will be due. This could be a risk if we listen to the longstanding rumours that the BR test could move to being 80% trading in line with capital gains legislation. This could mean that a previously qualifying BR business no longer qualifies and in this case we ought to have banked the BR on the death of the first spouse. We therefore recommend looking at the future of your business and identifying whether planning should be undertaken sooner rather than later.
- Excepted assets An asset is excepted if it has not been used wholly or mainly for purpose of the business during the last two years, or which the business does not require in the future. Even if a business qualifies for BR, if there are excepted assets then these will be liable to IHT. Large cash balances are most at risk. Whether these balances are there for future use of the business, or have just not yet been extracted, considering them early on and understanding the implications is key. The team at MHA Caves, our Wealth Management offering, are on hand to assist with investment advice for cash balances, which could help ensure businesses currently with excepted assets obtain full relief for BR.
- Property structure The final pitfall in this insight is all about control. Whether BR is available is, in some cases, contingent on who controls the business. For IHT purposes this is defined as voting rights and can be aggregated with a spouse. If a business is diluting shareholdings through any wider restructuring or planning, then they will need to be mindful of maintaining control, especially where there are assets held outside the business which are relying on the 50% BR. Again, we are here to help with this type of planning with the IHT and wider tax considerations with bringing assets into the business, and that partnership/shareholder agreements, business financial statements, and Wills are all aligned.
Planning is key!
We advise business owners to ask themselves the following:
Do you have a business which might qualify for Business Relief?
Do you own any assets which may also qualify?
Have you got any potentially excepted assets?
Have you got a Will, and are business assets being left in the most tax efficient way?
Have you considered setting up a Lasting Power of Attorney?
Are you expecting beneficiaries to rely on a deed of variation to obtain the most tax efficient treatment of business assets?
Are you holding significant cash deposits or investments in taxable assets?
Finally, IHT planning does not stand on its own. Steps taken as a part of an IHT review will likely have other tax implications so we would need to understand the chargeable gains, stamp duty, and stamp duty land tax positions, in addition to whether there are income or corporation tax, or VAT consequences prior to implementation. In some instances, there may be reliefs available for these other taxes, so it is worth discussing these in advance.
Get in touch
Please get in touch with our Private Client Team to find out more.