Inheritance Tax: The Expected Assets Trap

 

Many people assume that there will be no inheritance tax (IHT) bill on their owner-managed company – simply because it is a family business. Whilst this is true for trading companies, the activities of the company are the key factor in determining whether business property relief is due. Even when the company is trading, there is a nasty trap waiting to snare the unwary that needs considering.

 

Business property relief (BPR) is applicable at 100% of the value of ‘unquoted shares in a company’, which is the category of relevant business property that a family trading company will usually qualify under. This is given by IHTA 1984, s 105. 

 

A few short sections later, however, is section 112, which excludes any value pertaining to ‘excepted assets’ from qualifying for BPR at all. When working out the IHT charge, you therefore need to leave any such value out of the relief calculation. But what are excepted assets?

 

Section 112 defines excepted assets as those which are neither being used wholly or mainly for business purposes throughout the two years before the transfer (e.g. death), or are not so required for future use in the business. These are sometimes referred to as the ‘historic use’, and ‘future use’ tests.

 

It is immediately obvious, therefore, that the company owner’s house being transferred into the company would not be sheltered from IHT, as both tests fail in respect of it. In practice though, a real stumbling block that is encountered is surplus cash. This can either be by design – for example, where the owner has used the company as a kind of tax-efficient wrapper (or money box) to provide an alternative to a pension, or by accident – where the company just accumulates reserves over time which are then not distributed for whatever reason.

 

An active company needs some cash, so it is clear that having a positive bank account should not be an issue in and of itself. It is therefore possible to argue that cash meets the future use test, if it can be shown that it is in fact needed. For example, an amount equal to the usual working capital requirements on a year-to-year basis should not be an issue.

 

Case law has supported HMRC’s view that anything above the company’s normal requirements can be classed as excluded for the purposes of BPR. If you are going to try to rely on the future use test, the need for the excess cash has to be clearly evidenced – it can’t be speculative, or just as a safety buffer against a potential recession. Board approved plans to expand the business (e.g. by purchasing a larger warehouse) in the short to medium term on the other hand would potentially secure the relief, depending on the quality of the evidence. 

 

If there is excess cash due to the ‘moneyboxing’ strategy discussed above, it’s unlikely that the future use test can be met, so you will need to do something else to avoid incurring IHT. If you have other family members as shareholders, you could look at distributing profits in a way that takes advantage of multiple allowances, basic rate bands, etc. This may incur some income tax; however, with planning this could be less than the 40% IHT charge.

 

You could also consider renewing outdated plant and machinery, or paying off trade creditors early.

 

Another idea could be to invest in a side business using the cash. This could be say a trading LLP or an investment business. Shares in an investment business are not themselves excepted assets – however, you need to ensure the investment side doesn’t overshadow the company’s ordinary trade – or you might find no BPR is due at all. Specialist professional advice should be sought, if necessary.