The OTS IHT review – Simplifying the Design of Inheritance Tax – Farms and Businesses
In this article I will consider the third key area considered by the OTS in their report- Farms and Businesses.
In my previous articles I have considered
Part 1 – lifetime giving and allowances
Farms and Businesses
It is generally understood that the policy rationale for both Agricultural Property Relief and Business Property Relief is to remove the need for sale and break-up of businesses and farms on the death of the owner. The reliefs ensure that farms and business can be passed on and continue from generation to generation.
I will set out below an overview of APR and BPR, before considering the recommendations within the OTS report.
Agricultural Property Relief (APR)
APR reduces the value transferred for inheritance tax purposes when assets such as farmland and farm buildings are either gifted during a persons lifetime or on death.
APR is given before any available annual exemptions, and is available at a rate of either 50% or 100%.
APR is available on the following types of property :
- agricultural land or pasture
- woodland or buildings used for intensive rearing of livestock or fish, where occupied with and ancillary to agricultural land or pasture
- cottages, farm buildings and farmhouses which together with the agricultural land or pasture are of a character appropriate to the property
The agricultural property must be located in the UK, Channel Islands, Isle of Man or an EEA state. This is in contrast to BPR which has no territorial restriction.
APR is primarily available in two situations:
- to a farmer who owns the land and buildings and uses these assets in his own business
- to a landowner who is letting out agricultural land or buildings to a farmer.
APR is calculated on the ‘agricultural value’ of the land. The agricultural value of the land will be different from the market value or development value. Generally land will be worth more if it is capable of being developed rather than if its use has been restricted to agricultural purposes only. The agricultural value is the value assuming it can only be used for farming purposes.
100% relief will be available where the owner farmed the land themselves, or it was let on a tenancy which began on or after 1 September 1995. The relief is 50% in other cases.
The property must have been held and used for agricultural purposes for 2 years where occupied by the owner or 7 years where it is let.
If agricultural land is sold and replaced with new agricultural land, the new land will qualify for APR provided that the combined period of ownership exceeds two out of the last five years where occupied by the owner. In the case of tenanted land, this is extended to seven out of the last ten years.
If a farmer runs a farming business, it is possible that he could receive both APR and BPR on the same transfer. If this is the case, APR will be taken in priority to BPR.
Business Property Relief (BPR)
BPR reduces the value transferred for inheritance tax purposes when relevant business property is either gifted during a persons lifetime or on death. BPR is given before any available annual exemptions, and is available at a rate of either 50% or 100%.
Relevant business property is :
- Shares in unlisted companies (including AIM shares) – any number of shares will qualify, there is no minimum holding (100% relief).
- A business or an interest in a business (100% relief).
- Shares in a quoted trading company where the owner had a controlling holding (50% relief).
- Land and buildings or plant and machinery owned personally by an individual and used either by his partnership or a trading company he controlled (50% relief).
To qualify for BPR the business must not consist wholly or mainly of holding investments. Shares in investment companies or property dealing companies will never qualify for BPR.
The general rule is that the donor must have owned the property for at least two years before the transfer. If this minimum ownership requirement has not been satisfied, the donor will not receive BPR on the transfer. If a donor sells business property and replaces it with other business property within three years, BPR will be available if the replacement asset is subsequently transferred. BPR will be given on the replacement property if the aggregated ownership periods, i.e. the period of time during which both the old and new property has been owned, totals at least two of the five years immediately preceding the transfer.
BPR will be restricted on a transfer of shares if the company holds ‘excepted assets’ on its balance sheet. An ‘excepted asset’ for IHT purposes is an asset that is not used for business purposes throughout the two years immediately preceding a transfer. An asset is also an excepted asset if it is not required for future use in the business. Excepted assets will typically include shares or securities held for investment purposes, or properties which are let and produce rental income. It could also cover large cash deposits held for investment purposes and not required for future use in the business.
Furnished holiday lettings (FHLs)
HMRC’s view is that FHLs do not generally qualify for BPR because they are investments. This view is supported in case law by HMRC v Lockyer and another, Personal Representatives of Pawson (deceased) and Anne Christine Curtis Green v Commissioners for HMRC.
However FHLs may qualify for BPR where there is a high level of additional services which means the property is not just an investment. In this case HMRC may accept that there is little or no distinction between a FHL and a hotel / bed and breakfast business. They say they will consider each case on its merits.
See the attached link to consideration of FHLS and the 2018 Graham case – https://www.etctax.co.uk/furnished-holiday-lets-business-property-relief/
The OTS Review
BPR – trading or investment?
The “wholly or mainly” test is generally considered to be a greater than 50% test. It looks at the main activities of the business and its assets and sources of income and profits.
For CGT purposes where a business is either given away or sold to a third party then gift holdover relief or Entrepreneurs Relief may be available. In relation to these reliefs the test is different and is whether there is “substantial” trading activity in the business. It is widely accepted, and suggested in HMRC guidance that substantial is 80% or more i.e. investment can be up to 20% in total. Generally when looking at this test the assets, income, expenses, time spent by employees will all be indicators which are considered.
The trading and investment tests are an areas where the interaction with CGT is important. The different definitions may have a distortive effect on the decision as to whether to transfer a business during life or on death. Also having tests which are aligned would be a simplification and be easier for taxpayers to understand.
Non-controlling shareholdings in trading companies
In practice, many joint ventures involve each JV partner having less than a 50% stake in the company with the balance of shares being held by a third party. Where these shares are held indirectly, for example in a holding company then they are likely to be treated as investments and not qualify for BPR.
Furnished Holiday Lettings (FHLs)
As noted above FHLs will in a vast majority of cases not qualify for BPR. It had been suggested to the OTS that confusion arises in this area particularly because if the relevant conditions are met that FHLs will be deemed to be trading for the purposes of Income Tax and Capital Gains Tax purposes.
The government should, as a package:
- consider whether it continues to be appropriate for the level of trading activity for BPR to be set at a lower level than that for gift holdover relief or entrepreneurs’ relief
- review the treatment of indirect non-controlling holdings in trading companies, and
- consider whether to align the Inheritance Tax treatment of FHLs with that of Income Tax and Capital Gains Tax, where they are treated as trading providing that certain conditions are met
Limited Liability Partnerships (LLPs)
LLPs, like other forms of partnership are generally treated as “transparent” for tax purposes. However the wording of the IHT legislation currently suggests that a corporate trading group that has an LLP rather than a company as its holding vehicle may not be treated as “trading” for BPR purposes. This is inconsistent and adds complexity to the rules.
The government should review the treatment of limited liability partnerships to ensure they are treated appropriately for the purposes of the BPR trading requirement.
APR – illness or infirmity
As noted above to qualify for APR the farmhouse or farm cottage must be occupied for agricultural purposes. Difficulties can arise where the farmer need to leave the farmhouse to received medical treatment or has to leave to go in to care. Whilst HMRC currently consider such circumstances on a case by case basis. The OTS believes that the tests for eligibility in these cases should be clearer and more transparent.
HMRC should review their current approach around the eligibility of farmhouses for APR in sensitive cases, such as where a farmer needs to leave the farmhouse for medical treatment or to go into care.
HMRCs guidance is clear when a valuation is required for probate, but less clear in relation to APR/BPR. An example is where it is clear that 100% BPR will be available respondents were unsure whether a valuation would be required and on what basis. HMRC explained to the OTS that it is sometimes necessary to establish the gross value of an estate, for example to establish whether the Residence Nil Rate Band will be available.
It would be helpful if HMRC guidance could set the circumstances in which a formal valuation of a business or a farm will be required specifically for tax purposes.
HMRC should be clear in their guidance as to when a valuation of a business or farm is required and, if it is required, whether this needs to be a formal valuation or an estimate.
If yourself of your clients require any assistance in relation to APR or BPR or inheritance tax and succession planning more widely, please get in touch with ETC Tax and one of our Chartered Tax Advisers will be happy to assist.