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Five inheritance tax traps for business owners
Business property relief (BPR) is a valuable relief that can exempt relevant business property such as shares in a trading company from inheritance tax.
If you own a business therefore it might appear that no further inheritance tax planning is required. Wrong!
We outline below five common traps.
Property used for the purposes of the business may also qualify for business property relief.
If the property is held outside the company or partnership, the relief is restricted to 50% of the value of the property. However, if the property is within the business, then the rate applying is 100%. For a valuable commercial property, the difference could be significant.
This can be a particularly complex area in relation to partnerships where, especially for family partnerships, there may be uncertainty as to whether assets are held inside or outside the partnership. The ownership of assets should be confirmed sooner rather than later and, if the property is partnership property, a suitable partnership agreement should be prepared.
There may of course be advantages to retaining the property outside of the company or partnership too and full advice should be sought to balance the potential inheritance tax advantages with other considerations.
Business property relief is not available where there is a “binding contract for sale” at the time of the relevant inheritance tax event.
This commonly arises in arrangements for partners and shareholders in their wills.
Partnership and shareholder agreements typically provide for the sale of the deceased’s partnership interest or shareholder interest to the remaining partners/shareholders.
If incorrectly structured, such a provision could be treated as a binding contract for sale and as a result valuable inheritance tax relief would be lost on the value of the business interest in the deceased’s estate.
Provided the problem is identified in time, it can be addressed. For example, HMRC does not consider cross-option agreements, which provide the executors with the right to sell, and the other partners/shareholders with the right to acquire, the deceased’s partnership interest/shareholding to be binding contracts for sale.
If the business holds assets which have not been used in the business for the two years before the relevant inheritance tax event and are not required for future use in the business, HMRC may restrict the value of the business property relief given.
Such assets are referred to as “excepted assets”.
One common example is excess cash held on the balance sheet which has not been earmarked for future use.
Other examples include shares held by a company for investment purposes or an investment property in which a shareholder lives.
If there is excess cash on the balance sheet, this may taint the availability of BPR.
Such assets not required for business use may be denied on the basis that they are “excepted assets”.
Businesses with seasonal trades may generate significant cash balances at particular times of the year; however, in such instances it should be relatively straightforward to demonstrate that the cash held was required to meet future expenditure.
More challenging is the situation where a business, anticipating economic headwinds, decides to retain cash as a buffer. While it might appear that such amounts are for the future use of the business, HMRC’s position is that unless there is evidence that the cash is held for a specific future purpose, it is likely to be an excepted asset.
While shares in a trading business may qualify for 100% BPR, once that business is sold, BPR is no longer available on the proceeds of sale.
Many business owners, particularly if they have received a significant sum, may then look for steps to take to mitigate their newly increased inheritance tax exposure.
While there are options available, including acquiring other assets potentially qualifying for BPR, forward planning before the sale provides other options. For example, while the transfer of a significant cash sum into trust would be an immediately chargeable lifetime transfer to the extent that the transfer exceeded the available nil rate band, if shares had been transferred into trust prior to sale, then no charge would have arisen on the basis that BPR was available. Provided the transferor survives at least seven years, then even if the company has then been sold, the trustees would have acquired a sum without incurring any inheritance tax liability.
Such steps need to be balanced against the potential loss of the ability to claim Entrepreneurs’ Relief on the shares held by the trustees (although in certain instances, it may still be possible to make a claim).
The overdrawn loan account is the more familiar headache for advisers of SMEs, with associated s455 charges, etc.
However, positive DLA balances can also create problems to the extent that on death they are not treated as BPR assets.
While shares may qualify, the DLA, even if introduced for the purpose of supporting the trade, will not.
For director/shareholders with significant DLA balances and therefore potential inheritance tax liabilities on their deaths, it may be appropriate to convert the DLA balances into share capital. For example, the DLA balance might be converted into redeemable preference shares which, subject to the usual 2 year holding period, would qualify for BPR. However, the shares could be redeemed to facilitate repayments to the shareholder, subject to the company having sufficient realised profits.
BPR is a valuable relief but shouldn’t be taken for granted.
To ensure that it is available, and its value is maximised, shareholders and partners should keep their position under review rather than assume that the relief will be available.
For more info on BPR please contact our helpful team of tax advisers or be sure to read more about SME tax related matters below…