Malcolm Gunn highlights some pitfalls and planning points in connection with business property relief for inheritance tax purposes.
Once people hear about the 100% business property relief (BPR) from inheritance tax (IHT), which applies to shares in trading companies quoted on the alternative investment market (AIM), they often assume that such shares can easily be used for lifetime gifts.
For example, an individual (Biggs) might imagine it a good idea to buy these shares, hold them for two years, then give them away to his son (Tiny). He hopes that there is then no longer any need to worry about the seven-year survivorship period, which would otherwise apply.
It’s not that simple!
Unfortunately, of course, tax planning is never that simple. Although there will indeed be BPR available at the time of the gift, the IHT rules add further conditions which apply throughout the normal seven-year survivorship period. The main condition is that the asset given away must be owned by Tiny throughout the period beginning with the date of the gift and ending with the death of Biggs, or if earlier, the time of Tiny’s death. There are very limited provisions for replacement property, so Tiny could sell the shares and buy other similar shares, but at the time of whichever death occurs first, the shares held by Tiny must continue to be eligible for BPR.
A special rule applies to shares in unquoted trading companies, which qualify for relief at the time when they are given away. In this case, if the shares continue to be held by the donee, it is not required that the company concerned continues to qualify as a trading company. So, if the AIM shares given away qualify for BPR at the time of the gift, but not thereafter, this in itself will not affect the IHT relief.
So, let’s assume Biggs wants to help Tiny buy a property, but Biggs’ health is not good. He gives AIM shares worth £325,000 to Tiny after holding them for two years. Tiny immediately sells the shares in order to buy a property. Biggs dies within seven years of the gift. They hope that by this method, £325,000 has passed out of Biggs’ estate free of IHT.
Unfortunately, they will be disappointed owing to the condition that the asset given away must continue to be held by Tiny for the seven-year survivorship period, or until the earlier death of either Biggs or Tiny. Because Tiny sold the shares soon after the gift without reinvesting in other similar shares, the lifetime transfer ceases to qualify for BPR. It is, therefore, a lifetime chargeable transfer, using up the nil rate band on the death of Biggs.
Using a trust
If, however, Biggs had been better advised, the plan could have been made to work. What he could have done is to give the shares into a trust for his son, perhaps a trust in which the son has a life interest, after which the funds will pass down to the next generation. Once the trustees have the shares, they could then immediately sell them and buy a property for the son to use. Gains can be held over on this.
The same rules apply to a gift into trust as set out above, so that if Biggs dies within seven years of the gift, the BPR on the transfer to the trust will be withdrawn. That in itself does not matter because the gift is in any event covered by the nil rate band. But a careful reading of the IHT legislation (at IHTA 1984, s 113A(2)) reveals that there is only a recalculation of the additional tax chargeable on the gift, and no other IHT adjustments are to be made. That recalculation in fact produces no further tax because the nil band covers the transfer. The sub-section does not go on to state that Biggs’ cumulative total must also be restored to the figure of £325,000. The surprising result, therefore, is that Biggs still has his nil rate band available on his death within seven years, even if the trustees have sold the AIM shares and bought a property for Tiny to live in. HMRC accept that this is the case, and the planning is not in any way abusive.
The IHT nil rate band has been set at £325,000 since 6 April 2009, and as far as I know the government has no plans to change it. However, if the happy day ever arrives when the nil band is increased each year once again, there will be a further useful planning point for Biggs. This is that if he makes the transfer of £325,000 into trust, it is in fact the nil rate band as applicable on his death which will be available for the gift, and not the nil rate band at the time when he makes the chargeable transfer (IHTA 1984, Sch 2).
Practical Tip:
A lifetime nil rate band trust can be very effective for IHT planning with business property.
