The reduction can be 50% or 100%.
Alan is the majority shareholder in a limited company that manufactures furniture which he started 20 years ago. He dies, leaving his home worth £400,000, investments worth £100,000 and his company shares worth £750,000 to his daughter, Olivia.No Inheritance Tax is payable on his £1,250,000 estate. The gift of the property and investments is covered by Alan’s Nil Rate Band and Residence Nil Rate Band allowances (the latter gives Alan £175,000 on top of his standard £325,000 allowance, since he is leaving his home to a direct descendant). Alan’s shares in the company are not listed on a recognised stock exchange and he has held them for more than 2 years, so full Business Property Relief applies.
For Business Property Relief to apply, certain conditions must be met. These are:
- The asset must be ‘relevant business property’
- The asset must satisfy the length of ownership requirements
- None of the automatic exclusions must apply
Relevant business property
The relief will be 100% where the type of property is classed as ‘relevant business property’. Relevant business property means:
- A business or interest in a business (such as a partnership share)
- Company shares that aren’t listed on a recognised stock exchange
The relief will be 50% where the business property is:
- Company shares listed on a recognised stock exchange where you had voting control of the company immediately before death
- Land, buildings, machinery or plant that you own personally which are used for business purposes by either a company (quoted or unquoted) of which you had voting control or a partnership of which you were a member.
For these purposes, voting control means the ability to exercise over 50% of the votes on all resolutions. Any clause within the Company’s Articles of Association that prevents control in relation to certain matters would mean the relief did not apply. However, sometimes a spouse or civil partner’s shareholdings can be taken into account.
Note that if any loan is charged on the business asset, Business Property Relief will only be available on its net value (Section 162(4) Inheritance Tax Act 1984).
Length of ownership requirements
In addition to the business property being of the right type, there are further requirements as to the length of ownership of the property.
The property must have been owned by you for at least two years at the time of your death or must be a replacement for relevant business property where the combined period of ownership is two years. An example of replacement property would be if you were a sole trader or partner and you decided to incorporate your business as a Limited Company.
If you inherited the property from a spouse or civil partner, you are deemed to have owned the property from the date it was originally acquired by your late spouse / civil partner.
In addition to the above requirements regarding the type of property and the length of ownership, the business asset must satisfy the following – otherwise it will be automatically excluded from Business Property Relief.
- The business must have been carried on for gain
- The business must not have consisted wholly or mainly of the following prohibited activities:
- dealing in securities, stocks or shares;
- dealing in land or buildings; or
- making or holding investments (Sections 105(3) and (4) Inheritance Tax Act 1984)
Shares in property development companies will usually be eligible for relief.
Note the words ‘wholly or mainly’ above. The fact that a business carries on some of these activities does not disqualify it from qualifying for Business Property Relief. ‘Mainly’ means ‘more than 50%’ – so if the activities of the business predominantly qualify, Business Property Relief will be available for the whole value of the Company’s shares. HMRC will look at the overall context of the business, capital employed, employee time, turnover and profits when deciding whether activities qualify or not (Farmer & Anor (Executors of Frederick Farmer dec’d) v IR Commrs (1999) Sp C 216).
Other points to note
If the terms of the shareholder or partnership agreement require that the continuing shareholders or partners will buy your shares on your death (a “buy sell agreement”), it is HMRC’s view that the interest will be in the cash proceeds and not in the property itself. With this type of agreement, a ‘binding contract has been entered into at the time of the transfer”, so Business Property Relief will not be available (Section 113 IHTA 1984 and para IHTM25292 HMRC Tax Manual).
An option to buy the shares is not the same, and does not prevent the relief being available. This provides the solution where a company wants to prevent the shares being sold outside of their circle. The PRs can be given an option to sell the shares, and the surviving directors or partners can be given an option to buy the shares. Either party can exercise the option, achieving the same effect as the buy-sell agreement.
Where Business Property Relief is wasted
Business Property Relief is an incredibly valuable Inheritance Tax allowance. It allows those who have worked hard to build a family business, to pass this on to future generations without the potential 40% Inheritance Tax charge. However, it is very easy to waste the allowance and cause problems for your children down the line.
David owns 100% of the family business which he established 10 years ago, a private limited company which manufactures doors. His shares are worth £900,000. He also owns 50% of the family home which is worth £700,000 and £50,000 investments. On his death, he leaves everything to his wife Maria. There is no Inheritance Tax to pay on his death as all of the gifts are ‘spouse exempt’.
Martha is elderly and decides to sell the business to release some cash for a more comfortable retirement. Her estate is now worth £900,000 (proceeds of company shares) + £700,000 (family home) + £50,000 = £1,650,000. By the time of her death, her assets have increased in value to £2,350,000.
Business Property Relief will not apply as she has converted the shares to cash. The Residence Nil Rate Band is not available as her estate is over £2 million and tapering has reduced this to zero. She therefore has her nil rate band and David’s unused nil rate band. Inheritance Tax will be payable at 40% on everything else, reducing the amount that her children inherit by a staggering £680,000.
What David could have done in the above example is to leave the business in a discretionary trust with his wife and children as potential beneficiaries. If business property is left in a discretionary trust, HMRC will make a decision as to whether it qualifies for Business Property Relief. They would not normally make this decision if the surviving spouse or civil partner inherited the business, because the spouse exemption means no Inheritance Tax would be due (regardless of whether the business qualified for the relief or not). HMRC only makes a decision where there is a possibility that tax could be do.
This decision from HMRC is valuable as it allows for future estate planning by the survivor.
If HMRC rules that the business qualifies for the relief, it will be available to benefit both the surviving spouse and children going forward. Whilst the property does qualify, there are no ongoing Inheritance Tax charges. The business or a part of it can be given to any of the beneficiaries whenever it is deemed appropriate. If the survivor decides to sell the business to release some of its value, the majority of the proceeds can remain in the trust and do not need to form a part of the survivor’s estate. Whilst the proceeds will begin to attract ongoing Inheritance Tax charges (maximum 6% every 10 years) they are often preferable to a 40% charge on the survivor’s death.
If, on the other hand, HMRC rule that the business does not qualify for Business Property Relief, the trustees can distribute the business to the surviving spouse or civil partner within two years of the first-to-die’s death. The effect of this is that the gift is ‘written back into the Will’ as if this is what the first-to-die intended all along – and the gift then attracts the spouse exemption (Section 144, IHTA 1984). The survivor would then need to consider other ways to reduce the Inheritance Tax bill that will be charged on their estate.
When a director is owed a debt
Business are sometimes financed by loans from their shareholder directors. However, a credit balance on a directors’ loan account (or a current account) will not be eligible for Business Property Relief. It is sometimes therefore beneficial to convert these balances to share capital. This is illustrated by the case of Vinton v HMRC (2008).
The Deceased owned 750,500 shares in Wilton Antiques Ltd which benefited from 100% Business Property Relief. The Deceased also was owed £300,000 by the Company by way of a director’s loan. Director’s loans do not qualify for the relief.
A few days before their death, the Deceased took up a rights issue under which they were allocated 300,000 further company shares, to satisfy the Director’s loan. As a consequence of the share reorganisation rules, these new shares were equated with her original holding therefore attracted full Business Property Relief on her death, even though they were owned for less than one week.
This shows that where appropriate, it may be beneficial to convert a Director’s loan into share capital to benefit from the relief.