Business Property Relief to Offset Inheritance Tax Bills
In the wake of the Covid-19 pandemic, and with the ongoing energy price crisis, it is natural that some companies will look to build up cash reserves to help protect against further shocks. However, doing so can give rise to an inheritance tax (IHT) problem for smaller companies.
Inheritance tax relief for business assets, informally known as business property relief (BPR) or simply business relief, works by reducing the value of qualifying assets (which can include company shares) in a death estate. The relief is not capped.
BPR is given at either 100% or 50%, depending on what the asset in question is. Full relief is given for interests in unincorporated businesses, such as trades or a share in a partnership. It is also given for unquoted company shares.
Quoted company shares can qualify for BPR, but only if the shareholding represents a controlling interest. Relief is restricted to 50%. This partial rate of relief is also applicable to land, buildings or machinery which is used by a business the deceased had a qualifying interest in (the precise requirements differ with the type of business).
We’re considering unlisted shares, so it is the 100% BPR rate that is relevant.
Naturally, there are qualifying conditions to satisfy. The shares must have been owned by the deceased for a continuous period of at least two years, ending with the date of death.
The shares must not be subject to a binding contract for sale at the time of death. This can occasionally cause problems if the shareholder, or other, agreement compels the estate to sell the shares to any remaining shareholders, but this is easily overcome with a cross-option agreement.
IHTA 1984, s105(3) excludes shares from qualifying for BPR if the business carried on by the company is wholly or mainly ‘dealing in securities, stocks or shares, land or buildings or making or holding investments’.
HMRC’s view, which has been upheld in various court cases, is that deriving income from property, eg, from a letting business, is passive income from holding investments. However, it has also been established that where substantial services are provided, or where the rental business is a small part of a larger composite business, BPR can apply.
This is not considered here, and we will assume that the company is currently trading for simplicity.
There are some subtle differences between the requirements for BPR and business asset disposal relief.
Perhaps most strikingly is that a furnished holiday letting business is deemed to be a trade for BADR, and so can qualify as long as the other conditions are met. There is no similar deeming provision in the BPR legislation, and so relief will not apply automatically.
It would need to be shown that non-investment activities were the dominant part of the business. This was considered in HMRC v Lockyer & Anor (for Pawson dec’d) (2013) where the Upper Tribunal overturned the First Tier Tribunal’s decision to grant BPR on a furnished holiday letting business.
The value of any ‘excepted assets’ will also need to be excluded from a BPR claim by virtue of s112 . Assets will be excepted if they have not been used wholly or mainly by the business (for business purposes) throughout the two-year period ending with the date of death, or if they are not required for future business purposes.
This can be a complex area. If a company is operating a hybrid business, eg, mainly trading but it has some rental properties, the properties will not be excepted assets because they are being used for business purposes.
The fact that these are used by the investment part of the business will be irrelevant, as long as that part is not the dominant side (the wholly or mainly test).
On the other hand, if a company holds assets that are, in reality, merely owned for the purposes of providing a private benefit – such as a boat, aircraft or a house – these cannot be said to be used for the purposes of the business, and so will be excepted.
Perhaps the most contentious asset type is excess cash on deposit. By its nature, cash cannot be said to have been used for the two-year period ending with the date of death, and so it must be demonstrated that any significant cash balance, above what would normally be expected to satisfy the company’s working capital requirements, is required for future use.
This was considered in Barclays Bank Trust Co Ltd v CIR [SC 3107/97]. In particular, a point of note from this case was the contention that HMRC dismissed the argument that s112 does not place any time limit on the ‘future use’ test, as well as noting that the term ‘was required’ (in the future use test) implies that there must be an imperative that the cash is needed for something palpable. In short, holding money indefinitely ‘just in case’ is likely to mean the test is failed.
A minority shareholding is unlikely to be significantly affected by excepted assets. However, in a family company where there are only a handful of shareholders, the effect will be more pronounced. There are some strategies that could be adopted to reduce the level of cash in the company bank account.
Firstly, bringing forward creditor payments might be an option, eg, settling purchase contracts early. Of course, this may mean that cash levels will gradually build up again due to the reduced regular outgoings. Consideration would also need to be given to any early settlement charges, etc.
Another option, particularly in a family company, could be to use the cash to make bonus payments. Of course, there would be income tax consequences of this.
A better option might be to use the cash to begin a secondary activity. This could even be an investment business, as long as it did not overshadow the trading activity. As an example, the company could consult a financial adviser to make investments with a view to generating an income stream, which could then be used to grow the portfolio. Rental properties could also be considered.