New restrictions on business property relief may bring a significant rise in inheritance tax (IHT) liability for some, so make sure you review your tax position.
In the Budget on 20 March 2013, the Chancellor made some shock announcements about his intention to restrict the availability of business property relief (BPR) where borrowing is used to fund the BPR qualifying investments.
What does this change mean for individuals?
From the date of royal assent to the Finance Bill 2013 (expected mid-July 2013), business property relief will be restricted if the relevant BPR asset was acquired using debt.
For example, Mr Smith, who is single and has already used his nil rate IHT band, has assets worth a total of £1 million and borrowings of £250,000.
Included within Mr Smith's assets are his company shares, now worth £500,000. Mr Smith bought these shares for £250,000, having raised the funds by borrowing against his £500,000 home. His unquoted company meets the BPR criteria of being a mainly or wholly trading company, which doesn't own any investment assets, and he has owned his shares for over two years. On this basis he will qualify for 100% business property relief.
Until the new legislation, essentially the debt in this example would be set against the chargeable assets other than the shares (ie the house) for IHT calculation purposes leaving the value of his shares covered wholly by the BPR available. His IHT liability is therefore £250,000 x 40% = £100,000. This is made up of £1 million of assets, less £250,000 debt, less £500,000 BPR.
How does the change increase IHT liability?
Following the introduction of the new restrictions, Mr Smith’s potential IHT liability will be £500,000 x 40% = £200,000 – double the amount. This is because the debt is set against the asset it was actually used to purchase – in this case the shares. So whereas previously the BPR was worth £500,000 to Mr Smith, he will in future only receive BPR of £250,000 leaving the house subject to IHT in full.
Even if the arrangements were made before the new rules will be introduced, Mr Smith will have an increased potential IHT liability of £100,000.
Borrowing purpose is key
Had Mr Smith had a mortgage secured against his home and used other cash to acquire the shares, he would be unaffected by the change in rules – the key is the purpose of the borrowing and being able to clearly demonstrate that purpose.
BPR is a valuable relief but is a complex area with many pitfalls, more of which are highlighted in our previous article: Beware avoiding inheritance tax with business property relief.
There are a number of IHT planning options available to Mr Smith to mitigate his increased IHT exposure but the key will be taking early advice and planning ahead.
If you own assets that you believe qualify for BPR, it is a good idea to have your current position reviewed against the new restrictions to check the impact on your inheritance tax position.