Many business owners will be aware of business property relief (BPR) for inheritance tax (IHT) purposes, and some might assume that the value of their business interest will be sheltered from IHT by BPR.
However, BPR (at the rate of 100% or 50%) is subject to various conditions and restrictions. This article outlines a selection of traps and pitfalls, which could result in a loss of BPR. The list is by no means exhaustive, and the BPR requirements should be considered carefully in every case.
The ‘right’ business
A business (or business interest) and unquoted company shares are not eligible for BPR if the business, or the business carried on by the company, consists wholly or mainly of dealing in securities, stocks or shares, land or buildings or making or holding investments (IHTA 1984, s 105(3)). These BPR exclusions are subject to relatively limited exceptions, such as in relation to group holding companies (see s 105(4), (4A)).
The exception from BPR for businesses wholly or mainly of making or holding investments means that (for example) the shareholders of a family or owner-managed company operating a rental property business (and nothing else) would generally not be eligible for BPR in respect of their shares.
All or nothing?
The above ‘wholly or mainly’ exclusion from BPR in respect of investment businesses etc. is an ‘all or nothing’ test. For example, shares in an unquoted company with activities comprising 51% qualifying trading and 49% investment business may qualify for BPR in full (although in practice it would probably be difficult to measure the respective activities accurately). On the other hand, the company’s shares would be eligible for no BPR at all if its business activities were 49% trading and 51% investment.
It is therefore vitally important that the company does not breach the ‘wholly or mainly’ excluded activities test, by ensuring that the company’s investment business activities do not predominate over its qualifying trading activities (see HMRC’s Inheritance Tax manual at IHTM25265, and Shares and Assets valuation manual at SVM111150). Otherwise, BPR may be lost in its entirety.
A separate potential BPR problem is an anti-avoidance provision for ‘excepted assets’ (IHTA 1984, s 112). An asset is generally an excepted asset if it was neither used wholly or mainly for the purposes of the business in question throughout the two years (or such shorter period as the company owned the asset) immediately preceding the transfer of value, nor required at the time of the transfer of value for future use for the purposes of the business.
If ‘caught’ by the excepted asset provisions, the effect is broadly that BPR is restricted by the value attributable to the excepted asset. Only that part of a transfer of value which relates to ‘relevant business property’ is reduced by BPR; the other part relating to the excepted asset is not reduced by BPR, and is chargeable to IHT as normal.
Thus (for example) using an unquoted trading company as a ‘money box’ for surplus cash (i.e. cash not required for present or future trade use) is unlikely to shelter those funds from IHT, as cash which is an excepted asset will generally restrict BPR on the shares. HMRC does not consider that holding surplus cash on deposit constitutes an investment business activity (see HMRC’s guidance at SVM111220).
Following a partner’s retirement from a partnership, if a financial interest is retained in the former partner’s capital account, it will generally attract no BPR, on the basis that the retired partner is a creditor of the business (Beckman v IRC  STC (SCD) 59; see IHTM25250).
If a trading company shareholder makes a straightforward cash loan to the company, there is generally no prospect of BPR for that investment on the individual’s death. However, where funds are used to subscribe for additional unquoted shares in the company, BPR may become available once the shares have been held for at least two years (subject to the other BPR conditions being met). Alternatively, if the additional shares are acquired under a rights issue, the effect of the ‘replacement property’ rule for BPR purposes is that the normal two-year ownership requirement does not need to be met for those shares to qualify for BPR (IHTA 1984, s 107(4)).
Don’t get ‘tied up’
Avoid ‘binding contracts’ for sale for BPR purposes (e.g. ‘buy and sell’ agreements on a trading company shareholder’s death before retirement). As a general rule, BPR is denied if there is a binding contract for sale of the business property at the time of its transfer (see IHTA 1984, s 113). Consider arrangements under which the deceased’s interest passes to the surviving business owners, who are required to pay the personal representatives a particular price (commonly referred to as ‘accruer clauses’), or options to purchase instead (see IHTM25292 and SVM111120).
The above article was first published in Business Tax Insider (December 2018) (www.taxinsider.co.uk).
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