Inheritance Tax – Mitigation Using Business Relief

Introduction

One of the most comprehensive reliefs from Inheritance Tax (IHT) is Business Relief (BR). This has been part of the IHT landscape since the tax was first introduced in 1984 and, for many years, has provided 100% (originally 50%) relief for qualifying business assets. The Government’s rationale for BR is purely economic. Enterprises, particularly small and medium size enterprises (SMEs), are the backbone of the UK economy and provide hundreds of thousands of jobs, jobs that might be at risk if business owners had to pay IHT on death.

Of course, even entrepreneurs retire and often sell or pass on their business assets, so not many people die still owning qualifying business assets. However, there is a route through which Investors can benefit from this valuable IHT relief.

Business Property Relief rules

As you would expect, there are some strict rules applying to BR, key amongst which is that the enterprise must be involved in “trading” activities, as opposed to “investment” activities. So, for example, property development is a trading activity, whilst property ownership, collection of rents, etc., is an investment activity. So a business that solely builds and sells properties would be qualifying, whilst a business that owned and managed properties would not. A business that did a bit of both might qualify, but as soon as the investment activities exceeded the trading (development) activities, that qualification would be lost.

One of the attractions of BR is that the relief is established after just 2-years of ownership of a qualifying business asset. Many other mitigation arrangements involve a 7-year time-frame before they become fully effective. Also, all those other strategies involve giving away assets, either directly to the beneficiary or via Trust, whereas, with BR, the assets are retained in the estate and are available to be accessed and/or to generate an income.

With “roll-over” relief, one qualifying asset can be sold and the proceeds reinvested in another qualifying asset without the clock being reset to zero. So BR potentially lost on the sale of a business can be re-established and portfolios of BPR-qualifying assets can be effectively managed.

All unquoted SMEs, so long as they fulfil the trading conditions, qualify for BR. However, the Government also needed to consider how much further up the “food chain” BR should apply and decided that they wanted to stick to an SME definition and, therefore, exclude shares in companies quoted on a “Recognised Stock Exchange”. In domestic terms, this means that every UK company quoted on the London Stock Exchange and, consequently, being a constituent of the FTSE All-Share Index, is excluded. However, trading companies quoted on the AIM (Alternative Investment Market) qualify.

Property owned by an entrepreneur

Often, the premises occupied by a business are owned by the entrepreneur who started that business and, if they still have a “controlling interest” – owning a majority of the shares – then the value of the property also qualifies for BR, but only to the extent of a 50%, instead of 100%, relief.

Establishing BPR

Clearly, not everyone wishing to mitigate IHT wants to start to run a business, but there are some “off-the-shelf” opportunities for establishing BR. By definition, to meet the BPR qualification criteria, assets that qualify carry a higher degree of risk than many other investments, but the risk can be mitigated by effective management.

If this is an area of interest, I can advise on a number of “off-the-shelf” schemes.

What are the risks associated with this type of investment?

Not all the risks summarised below are associated with all IHT BR schemes, but they are the issues Investors and Advisers should consider as a part of their pre-investment due diligence:

General

• Possibly only suitable for more sophisticated, wealthier Investors
• Delays in investing would affect the qualifying period for BPR relief
• As with all investments, past performance is not a reliable indicator of future returns
• Smaller companies have a higher failure rate than larger companies
• Performance of start-up or early-stage enterprises is difficult to predict
• Other than AIM shares, for which there can still be a limited/illiquid market, investment is, by definition, in unquoted, not publicly traded or freely marketable forms.
• The use of gearing – borrowing to increase the amount invested – increases the risk profile.
• Companies issuing unquoted shares can be more exposed than larger, quoted companies to such things as commercial risk, counter-party credit risk, project risk and interest rate risk.

Spread of risk

• Diversification may be difficult to achieve, which increases the risk profile.
• The nature of the underlying investment varies greatly, so there can be a great variation in the risk profile of apparently similar strategies.

Taxation

• Taxation levels, bases and reliefs can change and depend upon individual circumstances.
• Changes in tax or other legislation may adversely affect the value of a BR product.
• The BPR qualifying status of a product is dependent upon the BR status of the underlying investments, which can change over time.
• The BR qualifying status is subject to a minimum holding period.
• The granting of IHT relief is dependent upon an individual assessment by HMRC upon the death of the Investor.
• The BR relief will be refused if all the rules have not be complied with.

Charges

• The level of charges, including fees and, sometimes, substantial differences in buying and selling prices of shares, may be much greater than for other investment or tax-mitigation vehicles.
• There is a range of initial, ongoing and, in some cases, performance fees, which will reduce the value of the investment.
• Any fixed costs will represent a larger percentage of smaller funds.

The bottom line here is to read very carefully any prospectus, brochure or other literature available to ensure you know precisely what you are investing in, how the tax benefits will be achieved/maintained and what it will cost. Perhaps most important of all, however, is how you or your Executors can realise the investment when the time comes to do so.

Always remember the old adage, “Never let the tax tail wag the investment dog”, in other words, never invest in something you don’t fully understand or is outside your comfort zone just because it offers a tax break.

What’s next?

If you believe you have an Inheritance Tax problem and want to know what legitimate steps you can take to mitigate this, contact me today, or complete the form below.

About Clive Barwell

Clive Barwell is one of the most experienced and qualified financial planners working in the later life market today, he specialises in advice and guidance for the over 55s. To ask Clive a question, please email him at info@clivebarwell.co.uk. Alternatively, you can follow Clive on Twitter, connect with Clive on LinkedIn or see Clive's profile on Google+.