On 18 September we delivered a webinar to business owners about Business Relief.
The key tax points that we covered in the webinar are explained in this article. The webinar also discussed an investment vehicle that can be used by investors (both personal and business investors) to obtain Business Relief. Whilst the details of this investment vehicle are not covered in this article you can find out more about it by watching a recording of the webinar by clicking on this link here: Webinar
What is Business Relief?
Business Relief is a valuable inheritance tax relief available to owners of shares in limited companies or interests in partnerships. The Business Relief legislation provides 100% freedom from inheritance tax on the value of shares in an ‘unquoted’ trading company or interest in a partnership on the death of the shareholder, so long as the shares have been held for at least 2 years prior to death and are still held on the date of death.
The term ‘unquoted company’ refers to a company not listed on a recognised stock exchange.
Business Relief qualification rules
Business Relief applies to ‘trading businesses’ but not ‘investment businesses’. It is important to understand the difference between these definitions.
An investment business is typically one that rents out property or holds an investment portfolio of quoted stocks and shares.
A trading business is one that sells goods and services.
The Business Relief legislation was established with a view to protecting jobs, which is why it is targeted at trading businesses (which typically employ people) and doesn’t apply to investment businesses (which tend not to require many employees).
However, it can get complicated where businesses have a combination of trading and investment activities. Do they qualify for Business Relief?
The current legislation states that Business Relief is not due where the business carried on consists wholly or mainly of the making or holding of investments.
HMRC normally interpret ‘mainly’ as over 50%. So this means that over 50% of the activities of the company need to be trading activities.
Trying to pin down whether a company that has a mixture of trading and investment activities qualifies for Business Relief can be complicated and unfortunately HMRC will not give advance clearance on the subject.
Do we think that Business Relief will survive the current Labour government?
It is always helpful to understand the historical context of legislation with a view to determining its ongoing relevance, or otherwise, in today’s world.
The Business Relief legislation was introduced in 1976 by a Labour government. Which is interesting in itself given concerns about what adverse changes the present Labour government might make to inheritance tax.
The reason for the introduction of the legislation was to ensure that after the death of a major family shareholder, a family-owned business could survive as a trading entity, without having to be sold or broken up to pay off the inheritance tax liability. Such a breakup or sale could put jobs at risk which was a major concern during the economic stagnation of the 1970s.
Clearly we are all unsighted at this moment in time as to what tax increases Labour are going to announce in October and whilst there has been plenty of speculation, we are none the wiser as to what might actually transpire.
Labour have made noises about wanting to be seen as business friendly and if they do want to last more than one term in power, they will need to be able to demonstrate economic competence.
Small and medium sized owner managed businesses make up the vast majority of employers in the UK and any attack by Labour on Business Relief would in our view be unwise. They could make changes to the legislation, for example extending the qualifying period from 2 years to a longer period. Or they might require that much more than 50% of a business’ activities are trading activities (e.g. increasing this to say 80%).
But we would be highly surprised if Business Relief were to be abolished outright.
Mitigating the loss of Business Relief on sale of a trading business
When you sell your business you lose the protection of Business Relief immediately.
The cash proceeds sitting in your bank account would be subject to inheritance tax at 40% should you die.
However, you have the opportunity to benefit from something called ‘replacement property relief’. So long as you replace the asset which previously qualified for Business Relief with another asset that qualifies for Business Relief within 3 years, you immediately obtain Business Relief on the value of the newly acquired asset.
If you don’t manage to replace the asset within 3 years with another asset that qualifies for Business Relief, but instead at a subsequent date, you will have to hold the new asset for 2 further years before it will qualify for Business Relief.
Pre-sale planning opportunities
Prior to selling your business you might choose to put some of your shares into a discretionary trust in favour of your family members.
The gift of the shares into trust can be effected without any immediate tax implications (you can hold over any gains tax that might otherwise be triggered by the gift) and up until the time that the business is sold, there will be no further tax implications for the trust if no dividends are paid on the shares (if dividends are paid on the shares the trustees will need to pay tax on this income).
Once the shares are sold, the trustees of the trust will have to pay gains tax on the gain in value of the shares (they will inherit the original base cost of the donor’s shares).
To the extent that that the sale proceeds are retained as cash or held in assets that don’t qualify for Business Relief, a tax charge will fall for payment by the trustees every ten years of up to 6% of the value of the trust assets. Alternatively, if the proceeds are reinvested into assets that qualify for Business Relief this ten year tax charge can be avoided.
Excepted assets
Even if your business qualifies as a ‘trading business’ for the purpose of the Business Relief legislation it is possible that not all of the value of your shares (if a company) or your interest in the business (if a partnership) will qualify for relief from inheritance tax.
The reason for this is that the legislation precludes inheritance tax relief applying to what are called ‘excepted assets’. The simplest example of an excepted asset would be cash that is surplus to working capital requirements. If you have a business that has a working capital need of £1M but you hold £1.5M of cash, there is a risk that HMRC could argue that £0.5M of the cash is an ‘excepted asset’. In this example, if we assume that you are the 100% owner of this business, on your death your executors might have to pay inheritance tax at 40% of the value of the £0.5M surplus cash (i.e. £200,000 of inheritance tax).
Peter Glenton
If you are holding excess cash with the intention of deploying that cash in the near future you should have at least annual board minutes documenting this. For example, a farming partnership might hold excess cash with the intention of buying some neighbouring land should it become available. During the ‘waiting period’ the partnership minutes should note what land they are looking at buying, what bids they have made in the last year if any, etc.
Any questions
If you would like to explore any of the points raised in this article with us, please do not hesitate to get in touch with your regular RG contact and they will introduce to one of the team who specialises in advising on Business Relief.