Many major shareholders and business owners are oblivious to the traps surrounding Business Relief, some of which can leave their estate at risk of a very large and unexpected Inheritance Tax (IHT) bill.
Business Relief, formerly – and still, by many – known as Business Property Relief, is much like Entrepreneurs’ Relief: a valuable tax relief afforded to business owners. Unlike Entrepreneurs’ Relief, however, its origins aren’t about rewarding entrepreneurial spirit but ensuring that on the death of a business owner, the business itself does not need to be sold or wound up to meet the IHT bill.
Business Relief reduces the value of a business or its assets when working out how much IHT has to be paid. In practice, most business property will qualify for a reduction in value for IHT purposes of 100% – in other words, total exemption.
What’s not readily appreciated is that Business Relief only applies to relevant business property, with the value of any ‘excepted assets’ being excluded. Given the potential value of this relief, it is essential that business owners understand where the boundaries lie.
Excepted assets are left out of account when valuing property which will qualify for relief. An asset will be an excepted asset if it was neither:
- used wholly or mainly for the purpose of the business for two years immediately before the transfer (most commonly death or gift into a discretionary trust*), nor
- required at the time of the transfer for the future use of the business.
This is perhaps best illustrated through an example. Philip is a 50% shareholder of XYZ Trading Limited. He has owned the shares from inception, in 2011, and estimates the total value of the business to be £3m. His own shareholding therefore has an estimated value of £1.5m.
As a trading business, Philip believes the entire value of his £1.5 million shareholding will be exempt from IHT. However, XYZ Limited has accumulated £700,000 of cash, which is retained by the business. It is a sum which has been steadily increasing and there are no plans for the business to use these monies either now or in the future. As a result, the £700,000 of cash is likely to be an excepted asset and, as Philip has a 50% shareholding, £350,000 of his shares in XYZ Limited will be exposed to IHT.
Like Philip, many business owners let profits build up in the company bank account because they want to avoid paying higher rates of Income Tax on any money they take from the business. Unfortunately, HMRC rules state that, if a business holds cash that is not used in the company’s trade, then a proportion of the company’s assets are subject to IHT.
In some cases, it is possible to claim Business Relief where it can be shown that the cash is being retained for future investment in the business. However, it is not always possible, so it is best to obtain professional advice, especially while you are still able to put things right.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
*Trusts are not regulated by the Financial Conduct Authority.