Kevin Read discusses planning opportunities for maximising business property relief and warns of some of the traps that can cause this valuable inheritance tax relief to be lost.
Business property relief (BPR) at 100% is available for inheritance tax (IHT) purposes if an asset, such as shares, constitutes ‘relevant business property’ (see below). The 100% relief means that the asset is effectively exempt from IHT. There are numerous conditions that need to be met, including that the transferor must usually have owned the shares for at least two years.
‘Relevant business property’ (IHTA 1984, s 105) excludes businesses that consist wholly or mainly of:
- dealing in securities, shares or land and buildings; or
- the making or holding of investments.
‘Wholly or mainly’ is taken as being more than 50% of the activities of the business ‘in the round’ (Farmer and anor (Executors of Farmer, dec’d) v IRC [1999] STC (SCD) 321). Factors to be considered include, inter alia, the capital employed, the time spent by the directors and employees, how turnover is split and the amount of profit derived from the investment and non-investment sides of the business.
Where this 50% test is likely to be failed, you should consider demerging the non-qualifying activities into a separate company, to protect the relief for the qualifying activities.
Care is needed with property businesses. Property development qualifies (i.e. it is not considered to be ‘dealing in land and buildings’) but property rental businesses are excluded from relief, in that they consist of ‘the making or holding of investments’. This even extends to furnished holiday lets, as confirmed in HMRC v Nicolette Vivian Pawson (Deceased) [2013] UKUT 050 (TCC), although the recent case Executors of M Vigne v HMRC [2017] UKFTT 632 (which may be subject to appeal by HMRC) did allow BPR on a livery business.
Excepted assets
Even where a company’s shares qualify, BPR is proportionately reduced where there are ‘excepted assets’ in the company. These are defined as assets:
- not used wholly/mainly for the business in the last two years; and
- not required for future use in the business.
HMRC will usually seek to restrict BPR where they believe excepted assets represent more than 5% of the total assets. Importantly, excepted assets include surplus cash, an issue central to Barclays Bank Trust Co Ltd v IRC [1998] STC (SCD) 125, where the judgment was that at the point of the transfer of the shares, there must be a reasonably foreseeable likelihood of the surplus cash being used. Thus, where a qualifying company holds a lot of cash, the directors should regularly discuss, and include in board minutes, likely uses of the cash, particularly if shareholders are elderly or otherwise have limited life expectancy.
Binding contract for sale
Where the relevant business property is subject to a binding contract for sale at the date of the transfer, no BPR is given, unless the business is being sold to a company wholly or mainly for shares and the purchaser will carry on the business, or if the sale is being made for the purposes of a reconstruction.
For example, BPR is not available if shares must be sold to existing shareholders in a company, either under the articles of the company or a separate shareholders' agreement.
A solution is to give the personal representatives (PRs) of the deceased shareholder an option to sell and the surviving shareholders an option to buy the shares. Either side can force a sale of the deceased's shares, but there is no binding contract for sale between the PRs and the survivors, so BPR is potentially available. See HMRC’s Statement of Practice 12/80, which deals with ‘double option’ agreements.
Rights issues
Where there is limited life expectancy, subscribing for shares under a rights issue can potentially save a lot of IHT, being a way of switching cash into BPR-eligible shares. As with capital gains tax, the rights shares are deemed to have been owned since the original shares were acquired. Thus, BPR may be available for IHT even where the rights shares have been purchased shortly before death, provided the original shares were purchased more than two years pre-death.
In Vinton (Executors of Duggan-Chapman Deceased) v HMRC [2008] STC (SCD) 592, Mrs. D was a shareholder in Wilton Antiques Ltd and also had an outstanding loan that was converted to shares, via a rights issue. She also made some other acquisitions, including via other shareholders’ renounced rights, before dying shortly afterwards. BPR was given on those shares acquired directly in the rights issue, but not on the other acquisitions.
Practical Tip:
The tax savings from this relatively simple strategy can be significant. For example, subscribing £200,000 for rights shares three months before an anticipated death (e.g. where there is a terminal illness) could save £80,000 of IHT, assuming 100% BPR is available on the shares.
