12th January 2024
Wills and Business Property Relief – Inheritance Tax danger for owner managers of SMEs
Many owner managers of small to medium sized businesses are aware that on death, their shareholding or partnership interest or sole trader business’ value will qualify for the specialist Inheritance Tax treatment in the form of 100% Business Property relief, which reduced to zero the Inheritance Tax burden that would otherwise arise on any non-exempt beneficiaries. Exempt beneficiaries are current spouses and civil partners not being divorced etc, by the date of the business owner’s death, and charities.
So, Business Property Relief is a valuable relief if someone is trying to pass at least the value of the business, if not the business itself, onto the next generation.
Frequently, such well-informed business owner managers will seek to take advantage of this by having a Will drafted for them which ensures that this benefit is properly used. The well-informed business owner manager may add in certain insurance arrangements; if they own a business with others, and in the instance of their death, that what they want their family to inherit, is the cash equivalent to the value of shares (rather than the shares themselves), thus ‘de-risking’ their inheritance of them. Similarly, as far as the other business owners are concerned, they’ll want the flexibility of being able to run the business without perhaps their deceased co-owner’s family having a say in decisions they may not be able to positively contribute to.
But all of that does tend to lead to further actions or omissions, which can prejudice the Inheritance Tax beneficial position likely to have been achieved.
That is that either innocently or otherwise, over time, assets become held by the business that are not trading assets.
An example could be premises that the business started operating out of, but that the business outgrew moving to new premises, and the original premises are retained and let out to a third party for a good amount of rent. That is not a trading activity, and the value of the original premises may not acquire Business Property Relief in death.
Another instance is that the business does well and has large sums of retained profit cash held within the corporate shell – undistributed.
The issue here is whether the business is sitting on ‘excessive cash to its usual funding requirements’, i.e. the company is artificially rich because profits are being hoarded within the business.
So, if the company itself holds cash reserves which are well in excess of usual funding requirements (i.e. cash is being left to accrue in the company so that on the death of a shareholder, Business Property Relief (BPR) potentially covers the value of the excess cash within the company) HMRC may deny BPR on the excess cash value within the company as a result of what HMRC perceive to be high levels of cash being held.
Say a 100% shareholder of a company which is worth £3,000,000 with the cash included, but say £2,000,000 excluding the high levels of cash. BPR is likely to be given on the lower £2,000,000 level, not the £3,000,000. Meaning the estate on death is £1,000,000 more than expected, so if the figure is more than his available IHT allowances on death, his estate will have a tax charge at 40% of the £1,000,000.
A question sometimes asked by way of contrast relates to a director’s loan account, where the company owes the director/ shareholder who has simply not withdrawn cash (rather than the other way round where the director in danger has an overdrawn director’s loan account).
This will be a debt from the company to the now deceased shareholder, and that debt is an asset in the hands of the deceased shareholder. It does not attract BPR, although the equity shares that the deceased owned, if all the other conditions for BPR are met, will attract BPR.
I contrast that with say a debt instrument/ other securities – i.e. a shareholder/ director who is introducing funds to the company, and those funds may well attract BPR relief (at the 100% discount value rate). However, there is an additional hurdle – the relief is only given where the other securities give the holder control of the company (which include any debt charged on company property or as evidenced by a document under a seal), so debentures and loan notes may well qualify.
However, the other securities either by themselves or with any unquoted shares must have given the testator ‘control of’ the company before death and establishing that this is likely to be the case, requires this question to have been looked at well before any death has happened. This is an all or nothing type of outcome – either 100% BPR relief will be given on death or none.
Control may in some circumstances be obvious – so a shareholder with 75% of the equity shares in XYZ Ltd with some debt instrument/ other securities will get BPR on both the real-world value of the shares at 100% and the real-worlds value of the ‘other securities’. Contrast that with someone holding 30% of the equity shares and some loan notes – whilst the equity shares will qualify for BPR, it is more likely than not that the value of the loan notes will not.
If a small to medium business manager owns assets outside of the business itself, which were used ‘wholly or mainly’ (typically being ‘land/ premises’ on the one hand, and ‘plant and machinery’ on the other) for the purposes of the business, which the testator then had control of at the date of death, then that value of those assets used in the business will attract a 50% BPR relief. So, say the business of which the deceased was the 100% owner of the shares held the property from which the business operated in his sole name, i.e. outside of the company itself, then that property will attract a 50% BPR relief.
In this example, say the premises were worth £1,000,000 in real world terms, and they were left by the business owner’s Will to his three children (and had no other assets or persons who received assets on his death etc.), £650,000 of value would pass free of IHT to the children, and thereafter, every £1 in value over that figure would attract the usual IHT charge on death (40%).
If that is an unattractive position, then thoughts should be had as to the costs associated with rectifying that – premises could potentially go into a SIPP (a self-invested personal pension scheme) or SASS pension arrangement (small, self-administered scheme), if there is sufficient liquidity/ value in the pension arrangement, and/ or either land or plant could be acquired by the business.
So, pre death company commercial advice is required here as well as the right type of Will, is essential in this area for any prudent small to medium sized enterprise owner managers making preparations for the future.
For further information in this field, for drafting appropriate forms of Wills, Trusts and BPR , contact Edward Walter at email@example.com, or for company commercial advice, contact Alex Lee at firstname.lastname@example.org