Welcome to the fourth and final part of our series on planning for Inheritance Tax (IHT). The series covers everything you need to know to ensure good IHT preparation in all areas of your life.
So far, we’ve looked at the implications of Inheritance Tax for all of your personal affairs – your financial plans, private legal matters, and investments. In this final article, we’ll be considering the implications for business owners, because an awareness of the impact of IHT is vital not just in your personal legal and financial affairs, but in your commercial interests too.
Benefits of Business Relief
In preparing to sell or pass on a business, owners can often focus solely on mitigating the effects of Capital Gains Tax. However, without the right planning, Inheritance Tax can also significantly decrease the wealth that a business owner is able to pass on to his or her family.
Many businesses will qualify for Business Relief from Inheritance Tax on the business owner’s death. This can be up to 100% relief from IHT. However, eligibility depends on what type of business it is and how it is structured. Put simply, to qualify it needs to be seen as primarily a trading business.
In some cases, as a company grows, the structure of it will change according to the commercial decisions that the management make. For example, if a business is successful and generates a large amount of cash, owners will sometimes invest that cash in non-trading assets like land or property, and this part of the business may continue to grow over time. However, if, on the owner’s death, HMRC decides that the non-trading part of the business has grown to make up more than 50% of the company then the business owner would lose all eligibility for Business Relief and would be liable for Inheritance Tax at 40% on everything.
In this sense, Business Relief on Inheritance Tax is very much ‘all-or-nothing’ in how it’s applied. This means it’s important for business owners to regularly monitor where they sit on this scale of the trading versus non-trading balance of their company. However, this can be a tricky task in itself, and it’s also difficult to predict how HMRC might interpret each individual situation.
Various cases have passed through the courts, giving some indication on how HMRC apply this 50% rule. Generally, they will take a view of the business as a whole and consider whether it feels like a trading company overall, or whether it feels and operates more like a business for making or holding investments. They’ll also look at the figures. They will compare the turnover on trading with the turnover on investments, and the profits they are generating. They will weigh up the employee hours used on the trading side versus those on the non-trading side too.
Bringing the Right Balance
For business owners who are concerned that they may be approaching the 50% balance, one way this can be addressed is by keeping regular Board meeting minutes where they recognise there is a large non-trading asset on the balance sheet. First and foremost, from a commercial perspective this helps to demonstrate to any potential customers and suppliers that they have a healthy balance sheet. However, it can also be used by the business to show HMRC that they have been monitoring their situation and that the board of directors have made the decision to retain those non-trading assets on the balance sheet for commercial, trading purposes.
Similarly, many businesses choose to undertake a demerger for various commercial reasons (I wrote a piece about this last year), but this can also have the effect of rebalancing its trading versus non-trading proportions and therefore its eligibility for Business Relief. The owners might want to ring-fence a particular asset, for example, and choose to do this by demerging this part of the business. It’s important to remember here that in terms of Business Relief, there has to be a clear commercial rationale for carrying out the demerger, which the business would need to demonstrate to HMRC. They would need to show that they hadn’t just done it to secure Business Relief alone.
Transferring to a Trust
If you’re planning on selling a business, there are ways to ensure that you pass a larger proportion of the proceeds on to the next generations of your family, limiting the impact of Inheritance Tax when you die. Setting up a trust before the sale allows an owner to transfer shares in the business into the trust for their children and grandchildren. After the sale, the proceeds are held in trust and outside the owner’s estate for IHT purposes. Had the sale proceeds been put into the trust after the sale, they would have been subject to cash limits on how much could be deposited. However, as long as they qualify for Business Relief there is no limit to the amount of shares that can be put into trust before the sale takes place.
Similarly, business owners can leave shares in a separate trust in their will and when they die these will go into the trust tax-free, again as they qualify for Business Relief. If there is a surviving spouse, for example, they can then buy these shares from the trustees leaving cash in the trust and the spouse with the shares. Then, when the surviving spouse dies, they can again leave the shares in a separate trust in their will, where they would be eligible for Business Relief again. This means they are effectively getting two lots of relief on the same shares because the sale proceeds exist in a trust outside the estate.
Over this four-part guide to Inheritance Tax planning, we have considered the topic from every relevant angle in an attempt to give you the best and most comprehensive understanding possible of how it can affect your affairs. Our aim has been to equip you with the knowledge and insight required to plan effectively to mitigate the impact of IHT on your personal and family life, your succession planning, your investment strategy and your commercial and business interests.
If you would like some help or advice with your Inheritance Tax planning, as a business owner or in any other personal, legal or commercial capacity, please get in touch. The unique structure of Progeny allows us to provide expert legal and financial advice that delivers joined-up solutions to your estate planning challenges. We’d love to help you plan how to most effectively pass your wealth on to the next generations of your family.
To read the other three parts in our four-part series on Inheritance Tax planning, click below: