The lesser-known pitfalls surrounding business property relief may leave your business at risk of a very large and unexpected inheritance tax bill. Let the horror stories of Mr Wealthy and Ms Success be a lesson to those who think they are exempt from death and taxes…
Many major shareholders and business owners are under the impression that they will be able to avoid death taxes. This is because they believe that their company or business will be fully covered by business property relief, which exempts shares in qualifying companies and business from inheritance tax (IHT).
And many of them are right.
The problem is that there are no neon lights that start flashing when your business or company stops qualifying for business property relief (BPR). The vast majority of company and business owners will be surprised to realise that action they take could have potential IHT problems. These problems may not come to light until after the key individual has passed away leaving few opportunities to put things right..
Property held outside the company
Most businesses start life as qualifying trading businesses or companies for IHT. And in the early days of an entrepreneur’s career, avoiding IHT is unlikely to be on their radar. The problems come later as the business grows and acquires value.
The business owner may, for example, decide to incorporate to reduce their income tax liabilities. And the accountant may quite sensibly advise for the business premises to be retained outside the limited company.
If you own 100% of the business premises and more than half the company shares, you will get 50% business property relief on the business premises. So you only avoid IHT on half the value. If you control less than half of the company and you own the business premises personally, you may not get business property relief at all.
Well, is that it? What if you’ve held all your property in the limited company, would you get 100% business property relief? Not necessarily…
Property held in companies
Let me tell you a nightmare story. Mr Wealthy was a successful businessman who had built up two separate, successful companies, with one company being owned by the other and Mr Wealthy owning the much larger top company. When he sold the business in the top company the buyer offered him a premium price for the trade and assets, which left a nice pot of cash in the larger top company. Mr Wealthy fancied investing the proceeds in commercial property, so he did. His smaller subsidiary company kept trading as it had always done.
Then Mr Wealthy died unexpectedly – and IHT was payable at 40% on the full value of both Mr Wealthy’s companies. Why?
Because his commercial property company did not qualify for business property relief, as business property relief is not available for companies that have their main business as a property rental trade.
OK, so you might be able to understand that the Government only wants to give tax relief on genuine business activities; letting property is a bit more like an investment, so perhaps that makes sense. But Mr Wealthy’s trading company was subject to IHT, too.
“Not fair,” his family said. Not fair indeed, but because the larger commercial property company owned the smaller trading company, that meant that the whole group was disqualified under the tax rules from claiming business property relief.
Under different circumstances, a holding company containing investments including holdings in trading companies might have qualified for BPR in full provided that the holding company business consisted wholly or mainly in being a holding company of a trading company (or companies).
If only Mr Wealthy had obtained some IHT advice.
Cash balances in company bank accounts
Let me tell you another horror story. Ms Success had also built up a fantastic business and it had made a lot of money. She let the profits build up in the company bank account because she didn’t want to pay the higher income tax rate that extracting the profits would entail.
Sadly, Ms Success became ill and passed away – without doing any IHT planning. When the executors submitted the IHT account, HMRC asked them to pay inheritance tax on the £1 million bank balance that Ms Success had let build up in the company.
Her children were not impressed. They thought that the entire value of the company should be free from IHT. Unfortunately, the IHT rules say that if a company holds assets, including cash, that are not used in the company’s trade, that proportion of the company’s shares are subject to IHT.
In some cases, it is possible to claim business property relief where it can be shown that the cash is required for the trade or is being retained for future investment in the business, but it is not always possible, so it is best to obtain professional advice.
And the moral of this story is…
If there is a lesson to be learned from the above tales, it is this: ‘Do not assume that your business or company qualifies for 100% IHT relief’.
It is a good investment to ask your tax adviser to consider whether full business property relief is available on your business or company, and if not, to advise you on the best way to avoid IHT on your business.