How to Use Business Property Relief to Reduce Inheritance Tax
"One day all this will be yours…well at least 60% of it!”
Many entrepreneurs have an exit strategy that involves selling their business during their lifetime, but for others, the plan is for it to pass down to the next generation of the family. If the business is going to stay in the family, you need to consider inheritance tax.
Inheritance tax (IHT) is charged on the value of your estate (broadly, all your assets less all your liabilities) when you die. It is also charged on certain types of lifetime gifts. The first £275,000 of your estate is free of tax (the “nil rate band”), but all the rest is charged to IHT at 40%.There are certain reliefs which will reduce the value charged to IHT, and one of the most important for family businesses is Business Property Relief (BPR).
BPR reduces the value of “business assets” for IHT. For some assets, the reduction is 100%, so the asset is effectively exempt from IHT. For others, the reduction is only 50%.
100% BPR is available for:
· A business (that is, a sole trader’s business) or an “interest in a business” (typically, a partnership)
· Shares in an “unquoted” (not traded on a Stock Exchange) company – note that shares traded on the AIM or USM are treated as “unquoted”. This is the relief that can apply to family companies.
50% BPR is available for:
· Land, buildings, machinery and plant used by a business run by a partnership of which the owner is a partner, or by a company in which he owns a controlling interest.
Do not assume your business will qualify for BPR
Most owners of family businesses are aware that BPR exists – the danger is that they will not appreciate the potential problems that may mean their business gets less BPR on their death than they may have expected. Here are some of the commonest pitfalls:
What is a “business”?
There are some exceptions to the rule that a business qualifies for BPR. The following businesses do not qualify:
A business or company will not qualify if more than half of its business involves:
· Dealing in stocks and shares, or
· Dealing in land or buildings, or
· Making and holding investments
This means that, for example, a business involving investment in property, or property dealing, would not qualify for BPR. Confusingly, a property development business would qualify – the distinction is between merely buying and selling land (no BPR), and buying land, building on it, and selling the land and building (BPR). If your business involves a mixture of these activities, it is important to get expert advice on whether or not BPR will apply to it.
Businesses involving furnished lettings, caravan sites, boarding houses, and so on are right on the borderline of “holding investments”, and a tax adviser should be able to tell you whether they will qualify for BPR or not – and possibly advise you how to move the business to the right side of the line if at present it does not qualify.
“More than half”
The actual wording in the law is “wholly or mainly”, and this is taken to mean “more than half”. There can sometimes be a planning opportunity here if, for example, a family trading company owns one or two investment properties, then in some circumstances 100% BPR will be available on the whole value of the shares in the company, whereas if the investment properties had been owned outside the company, no BPR would be available on them.
BPR is also not available on the value of certain assets owned by a business:
1 If an asset is used mainly for the benefit of the proprietor of the business or his family, it will not qualify for BPR – for example, the private living accommodation above a pub or shop, if it is occupied by the proprietor and/or his family
2 If an asset is not used for the business, it will not qualify – a typical problem here is surplus cash retained in a company, and if the company has significant amounts of cash, advice should be taken on how to reduce the risk of it being excluded from BPR. If it can be shown that the cash is required for future use in the business, it may qualify for BPR after all
Directors’ loan accounts
There is a trap here, that is often not appreciated by the owners of family companies.It is quite common for a director/shareholder to have loaned significant sums to his company – indeed there are tax planning strategies when a business is transferred to a company which involve deliberately creating a large loan account, because it offers a way of extracting profits from the company without suffering income tax.
The problem is that in the hands of the director, the value of his loan account is an asset (that is, he is owed money by the company), but it is not an asset that qualifies for BPR. Too often, this goes unnoticed, as the loan account is regarded as part of the shareholder’s interest in the company and it is assumed that BPR will be available.
Binding contracts for sale
Property that would otherwise qualify for BPR will get no relief if at the time of the owner's death it is the subject of a “binding contract for sale”.
Shareholder’s agreements or partnership agreements often contain provisions for the surviving owners of the business to take over the deceased owner’s interest in the business. These agreements need to be checked, to make sure they do not create a “binding contract” for the deceased’s share to be sold to the survivors. It is quite simple to word such agreements so that they achieve the desired effect without creating a “binding contract”, but I still occasionally come across agreements that have the wrong wording and could prevent BPR from being available.
Property Used by the Business
It is not unusual in family businesses for some of the business assets (most typically, the business premises) to be owned outside the business. For example, the children may have shares in the company, or be partners in the business, but the business premises are owned by mother and father as individuals, and the business pays them a rent for using them.
There are good tax planning reasons for a structure like this, but one point which is often overlooked is the rate of BPR that will be available. Look back to the start of this article – where the property is owned outside the partnership or company, the rate of BPR is only 50%, so half the value of the premises will still be chargeable to IHT on the parents’ death. It can be even worse – note that even the 50% relief is only available if the owner of the property used by a company had a “controlling interest” in that company – that is, more than half of the voting shares were held by him (or by him and his wife together). If this is not the case, no BPR will be available and the whole value of the property will be chargeable to IHT.
BPR is an extremely important tax relief for family businesses – but don’t take it for granted.
General Tax TipThere is no inheritance tax on a legacy to your spouse or civil partner, is there? Oh yes there is, if the surviving partner is not “domiciled” in the UK only £55,000 of the legacy is exempt, and lifetime planning will be needed to avoid IHT on the rest.