Christiaan explores some of the challenges for small business owners looking to claim Inheritance Tax Business Relief.
Business Relief (BR) provides a 100% exemption from Inheritance Tax (IHT) on the value of an unquoted trading company. This is one of the most valuable IHT reliefs available and it is important that the relief is maximised where possible.
BR can be claimed where specific conditions are met; one of the conditions is that shares an unquoted trading company must normaly have been owned for a minimum of two years.
I have provided an example of a common BR scenario which face owners of unquoted trading companies below:
Trevor’s unquoted trading company, Trevor Trading Limited, has been successfully trading for a numerous number of years. The company is currently valued at £4 million.
The company also has a bank overdraft of £250,000, bank loans of £425,000 and a director’s loan balance of £500,000 (company owes Trevor) which is included in the above valuation.
As well as owning all the shares in the company, Trevor personally owns the business premises from which the company operates, and the property is valued at £1 million.
Trevor personally has built up significant wealth over the years and has approximately £800,000 in savings.
Trevor’s wife passed away a few years ago. He has two adult children who are not involved in the business and have no intention in doing so.
His personal home and other assets will fully utilise his IHT Nil Rate Band, including any Nil Rate Band transferred from his deceased wife.
1. Problem – holding the property outside the business
BR will only cover 50% of assets owned personally and used in trading business controlled by an individual. As things stand, £500,000 of the business premises will not be covered by BPR and form part of Trevor’s estate.
Trevor transfers the business premises into the company. Trevor can claim Capital Gains Tax (CGT) hold-over relief on the transfer of the property and avoid any CGT.
If the property is located in England, there will be Stamp Duty Land Tax payable of £39,500 on the transfer (£35,250 LBTT if the property was located in Scotland).
The introduction of the property will now increase the value of the company by £1 million and also remove £500,000 from Trevor’s estate immediately.
Although Trevor paid £39,500 Stamp Duty, he potentially saves £200,000 in IHT (£500,000 @ 40%)!
2. Problem – significant personal savings
Trevor’s savings of £800,000 will form part of his estate and will be exposed to an IHT liability of £320,000 (£800,000 @ 40%).
Trevor uses £675,000 of his savings and subscribes for new shares in his trading company. The company can now pay off the existing debts.
After two years the value of the new shares will qualify 100% for BR.
By removing £675,000 cash from his estate and converting it into IHT exempt shares, Trevor has reduced his IHT exposure by £270,000 after two years!
Trevor can subscribe for more shares and the company could utilise the cash injection for trading purposes for example purchasing new equipment. After two years the new shares will qualify for BR.
The above IHT planning works efficiently because the cash injection for the new shares is used to pay off the company’s existing debts or for other trading purposes.
However, if the company simply left the cash in the company’s bank account and did not use it, then the cash could be regarded as an “excepted asset” and be included in Trevor’s estate.
3. Problem – director’s loan balance due
A debt due to an individual is a completely separate asset from a company’s shares.
The director’s loan balance due to Trevor from the company of £500,000 would form part of his estate.
The director’s loan balance owed to Trevor can be repaid free of income tax, however there could be potential IHT problems. For example, if Trevor simply puts the cash into savings and investments he still has not decreased the value of his estate.
If he gifts the repayments to family or friends, then the value of these gifts may only be out of his estate as “potentially exempt transfers” if he survives for seven years from the date of those gifts.
The loan repayments will also be subject to the actual cashflow position of the company for example if the company can only afford to make £50,000 loan repayments per year and Trevor passes away within three years, the outstanding director’s loan would be £350,000. The IHT exposure on the remaining director’s loan balance is £140,000!
There are some potential solutions available to Trevor including:
- Trevor’s company issues new shares by way of a rights issue which replaces his director’s loan balance. The new shares are treated as being part of the original shareholding for BR purposes and should qualify for 100% relief immediately!
- Trevor could take the loan repayments and invest the cash in certain AIM shares or EIS companies which may attract BR after two years; however these investments still carry an element of risk in that there is no guarantee that they will make any return on investment and the capital is at risk.
The above example and potential solutions will be dependent on an individual’s tax and personal circumstances and professional advice should be obtained before implementing any IHT planning. Contact us to discuss your specific situation.