Mark McLaughlin highlights a potential pitfall for inheritance tax (IHT) business property relief purposes.
For individuals who own businesses or an interest in them, business property relief (BPR) is a valuable relief from inheritance tax (IHT). BPR potentially provides relief at 100% (or 50%) on ‘relevant business property’ (e.g., shares in an unquoted company carrying on an eligible activity).
However, BPR is subject to certain conditions. Failure to satisfy them can result in business owners or shareholders losing out on BPR.
‘Binding contract’ trap
An anti-avoidance rule which sometimes goes unnoticed is that BPR is generally denied if there is a ‘binding contract’ for sale of the business property at the time of transfer (IHTA 1984, s 113).
However, this BPR trap is subject to two statutory exceptions:
- Business incorporations where the binding contract is for the sale of a business (or business interest) to a company which is to carry on that business, and the consideration is wholly or mainly the company’s shares or securities (but not cash).
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Sales of company shares or securities for the purpose of reconstruction or amalgamation.
Care is needed where business property is gifted shortly before a sale. For example, if a chargeable lifetime gift of shares (on which BPR is claimed) is shortly followed by a sale of the company, HM Revenue and Customs (HMRC) might check the position carefully (see HMRC’s Inheritance Tax manual
at IHTM25291).
Watch out for ‘buy and sell’ agreements
A potential trap for partners or shareholders is ‘buy and sell’ agreements (see HMRC’s Statement of Practice 12/80).
HMRC's view is that ‘buy and sell’ agreements constitute a ‘binding contract’ for sale broadly where the arrangements provide for:
- an agreement for the partnership interest or shares to pass to the personal representatives (PRs) of the deceased partner or shareholder;
- a requirement for the PRs to sell the partnership interest or shares to the surviving partners or shareholders; and
-
an obligation for the surviving partners or shareholders to buy the asset under the terms of the agreement.
Where these conditions apply, BPR will not be due on the business interest or shares.
The Inland Revenue published an article in the Law Society Gazette in May 1981, which included the following example:
Example: Binding contract for sale
“Partnership continues and partnership share falls into deceased's estate but partnership agreement provides obligation for executors to sell and for surviving partners to buy partnership share either at valuation or in accordance with formula.”
What can be done?
Fortunately, arrangements can be structured in such a way that BPR remains available. For example, agreements may include the following:
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Accruer clauses, i.e., the deceased’s interest passes to the surviving business owners, who are required to pay the PRs a particular price (commonly an arm’s length valuation).
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Options, i.e. the deceased's business interest falls into his estate, but with an option for the survivors to purchase it.
HMRC accepts that the above types of arrangement do not constitute binding contracts for sale), and therefore do not prevent the business interest qualifying for BPR (IHTM25292).
Practical tip
If a company's constitution requires the deceased shareholder’s personal representatives to offer his shares for sale to the company, other shareholders or directors, BPR restriction does not apply provided there is no obligation on the survivors, etc. to buy the shares (see HMRC’s Shares and Assets Valuation manual at SVM111120).
