Inheritance Tax and property-based businesses
Most readers will be aware of business property relief (BPR) which provides relief from inheritance tax for ‘relevant business property’.
For these purposes relevant business property includes:
- property consisting of a business or interest in a business (100%);
- any unquoted shares (100%);
- land, buildings, machinery or plant which, immediately before the transfer, was used wholly or mainly for the purposes of a business carried on by a company of which the transferor had control or by a partnership of which he then was a partner (50%).
Given the potential to wholly relieve the value of such relevant business property from inheritance tax, it is an extremely valuable relief.
While it is an effective exemption from inheritance tax for business, it is challenging, but not impossible to obtain the relief for certain property-based businesses.
So what is a business?
‘Business’ is not defined for the purposes of the inheritance tax legislation but takes its ordinary meaning, i.e. a trade or profession carried on for gain. As such a business for these purposes excludes ‘hobby businesses’ that are not carried out for gain.
This definition of a business will include a sole trader’s business as well as a partner’s share in a partnership carrying on a business. As clarified in the Trustees of the Nelson Dance Family Settlement v HMRC  STC 802, it can potentially apply to the transfer of a business asset, whereas previously it was thought only to apply to the transfer of a business interest.
Not all businesses will qualify.
BPR is not available where the business consists wholly or mainly of:
- dealing in securities, stocks and shares; or
- dealing in land or buildings; or
- making or holding investments.
Property-based businesses can encompass a wide range of activities from buy-to-let through to hotels and care homes. Nonetheless the treatment of these activities may be very different for the purposes of BPR, with some benefiting from the relief, and others denied it. The latter two exclusions mean that businesses that are property-based can be particularly problematic.
Making or holding investments
Regarding the ‘making or holding investments’, there are two tests to be applied here:
- whether the activities carried on constitute a business;
- if they do constitute a business, is BPR precluded because that business was one of ‘wholly or mainly holding investments’?
For the purposes of this test ‘wholly or mainly’ is defined as over 50%.
While this test would appear to be straightforward there are challenges in applying it in practice as the following illustrate.
Furnished Holiday Lets
For other tax purposes, furnished holiday lets (FHLs) are treated as trading and benefit from reliefs such as Entrepreneurs’ Relief but they may still be denied BPR on the basis that they are deemed to be businesses primarily consisting of the holding of investments and therefore little different to other residential or commercial lettings.
There have been a couple of important case law decisions in relation to claims for BPR relief on holiday lettings.
The Upper Tier Tribunal in HMRC v Pawson  UKUT 50 denied the taxpayer relief because of the low level of additional services being provided as part of the holiday letting business. Following that decision, it was thought that FHLs might potentially qualify for BPR provided sufficient ancillary services were offered. However, subsequently in the more recent case of The Executors of Ross v HMRC  UKFTT 507, the First Tier Tribunal also denied BPR on FHLs despite services provided being more than in any other FHL case heard to date. In Ross, the taxpayer in that case had an agreement with a hotel allowing the holiday let guests to make use of the hotel’s services. Nevertheless, the First Tier Tribunal ruled that the services were incidental and that the reason the guests chose to stay there was to enjoy the holiday property exclusively with the result that it was in fact an investment property. BPR was therefore denied.
In light of the Ross decision it would therefore appear unlikely that most FHLs will qualify for the relief, but each case should be considered on its merits.
Over the last couple of decades there have been a variety of cases concerning property-based businesses and, in most cases the taxpayer’s claim for BPR has failed, unless there has also been a significant trading element.
These have included cases involving caravan parks and commercial buildings as well as FHLs. Whereas these cases have denied relief in the case of commercial buildings and FHLs, it is generally accepted that hotels will qualify and there have also been successful claims in respect of caravan sites.
Among these decisions the one in Trustees of David Zetland Settlement  UKFTT 284 reinforced the point that the use of sound business principles, while changing the activity from a mere passive investment to that of running a business, nonetheless did not change the fact that the business itself was still one of holding investments and therefore BPR should not be available. Additional services may not therefore bolster a claim for BPR if the underlying business remains an investment one.
Nevertheless, the recent decision in Executors of M Vigne v HMRC  UKFTT 632 where the taxpayers ran a livery yard with the provision of some ancillary services was decided in favour of the taxpayers and BPR was successfully claimed. The First Tier Tribunal rejected HMRC’s argument that the business was nothing more than holding investments, describing HMRC’s analysis as wholly artificial and stated that no informed observer could have concluded that the business was one of holding investments.
Following Pawson, HMRC has focused on whether additional services provided are of such a nature and extent that they prevent the business from being an investment. The First Tier Tribunal in Vigne rejected this approach, saying this was the wrong test. Rather, the First Tier Tribunal stated that the proper starting point should be to make no assumption one way or the other but instead to establish the facts and determine whether the business is wholly or mainly one of making or holding investments. This was only a First Tier Tribunal decision and it remains to be seen whether HMRC successfully overturns it on appeal; however, it may give some hope for other property-based businesses and emphasises that it is important to pay close attention to the facts.
Some holdings of land and property will include elements which potentially qualify for BPR and others which will clearly not such as residential properties let to third parties.
The owners of such mixed holdings might be concerned that properties let to third parties (for example) might taint their overall holding to such an extent that it is deemed to be a business the nature of which is wholly or mainly the wholly of investments and result in the denial of BPR on everything.
Such landowners might consider restructuring their holdings to separate out those elements that will qualify from those that will not. However, even in the absence of restructuring there are tax cases which support the argument that not only should BPR be available on individual elements but the entire mixed holding.
To this end both Farmer (Farmer’s Executors) v IRC  STC (SCD) 321 and Brander (representative of James (deceased), Fourth Earl of Balfour)  STC 2666 established several tests to establish whether the investment element represents more than 50% of the whole. The tests include considering the income, profit, time spent, capital used and, standing back, the overall look and feel of the business. Such arguments may be particularly valuable (as they were in the Balfour case) to larger landed estates which include a range of activities from farming in-hand to the letting of residential properties.
Property development businesses
The BPR exclusions above include businesses of dealing in land or buildings. Does this mean that a property developer would be excluded from qualifying? Not necessarily.
A business of dealing in land would be one that acquired land with a view to selling it on after it has increased in value, for example, after it had sought and successfully obtained planning permission for the construction of new homes. While such a company would be treated as trading for tax purposes, it would not qualify for BPR. However, a company that builds and sells properties, whether residential or commercial for sale will potentially qualify for BPR.
BPR would extend to land and property held by the business, e.g. plots of land awaiting development provided these are held as trading stock.
While it may be an uphill struggle to obtain BPR for many property-based businesses, it should not be dismissed automatically, and, in the right situations, this extremely valuable relief may be available.
This article was in published in our May 2018 enewsletter. To be added to our mailing list, click here and submit your contact details on our sign up form.