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November 26th 2020

Recycling 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 an unquoted trading company has been owned for a minimum of two years.

In some circumstances it can be “recycled” and be used as an effective method of passing your estate to your children, please see the example below:

Example

John ran a very successful trading company, John Trading Ltd, prior to his death. John owned 100% of the shareholding in the company. John was married to Ann and they have a son, Patrick.

John made no lifetime gifts prior to his death which will therefore result in his nil rate band of £325,000 being transferred to Ann.

On John’s death his estate comprised of the following assets:

Shareholding in John Trading Ltd

£650,000

Freehold house

£525,000

Investment portfolio

£420,000

Cash

£300,000

Total estate

£1,895,000

Spouse exemption

(£1,895,000)

John’s will left his estate to Ann which will result in no IHT liability, because transfers between spouses are exempt from IHT.

Ann sadly died four years after John’s death. In her will she left her estate to her son Patrick. The shares she inherited from John’s company will qualify for BR.

Ann never made any lifetime gifts and her executors will have an available nil rate band of £650,000 available (Ann’s £325,000 nil rate band plus John’s £325,000 transferable nil rate band).

Her executors will also be able to claim an additional residence nil rate band of £350,000 because Ann and John’s main residence is being left to a direct descendent, her son Patrick. Please note that if John and Ann’s estates exceeded £2 million (including the shares qualifying for BR) then the residence nil rate band would have been reduced by £1 for every £2 of the excess.

Ann’s IHT liability will be as follows:

Shareholding in John Trading Ltd – BPR 100%

£-

Freehold house

£525,000

Investment portfolio

£420,000

Cash

£300,000

Total estate

£1,245,000

Residence nil rate band

(£350,000)

Nil Rate band

(£650,000)

Estate exposed to IHT

£245,000

The IHT payable on Ann’s estate will be £98,000 (£245,000 @ 40%).

Solution?

Step 1 – alter John’s will

John’s will leaves the shares in his trading company to Patrick and the remainder of his estate to Ann.

The shares left for Patrick will qualify for BR and be exempt from IHT. The remaining estate will be exempt from IHT because it his left to Ann.

Step 2 – Ann buys the shares from Patrick

Patrick sells the shares to Ann for £650,000. Under current tax legislation, there will be no or minimal CGT payable on the disposal of the shares, because Patrick will benefit from the free uplift in the value of the shares on John’s death.

Ann finances the purchase of the shares by utilising the cash and disposing of some of the investments she inherited (CGT consequence the same as the above paragraph).

Ann owned the shares in the company for more than two years prior to her death, so her executors will be entitled to claim BR.

On Ann’s death the IHT liability will be as follows:

Shareholding in John Trading Ltd – BPR 100%

£-

Freehold house

£525,000

Investment portfolio

£70,000

Cash

£-

Total estate

£595,000

Residence nil rate band

(£350,000)

Nil Rate band

(£245,000)

By implementing the steps, there will be no IHT payable on Ann’s death. A saving of £98,000!

Patrick will inherit the following assets:

Shareholding in John Trading Ltd – BPR 100%

£650,000

Freehold house

£525,000

Investment portfolio

£70,000

Total assets

£1,245,000

In the above solution the BR was used twice, first on John’s death and then on Ann’s death. John and Ann effectively “recycled” the BR in order to pass assets onto Patrick.

Tax warning #1

If Ann were to die within two years of buying the trading company shares from John, BR would not be available and in that scenario the IHT liability would be £98,000 (i.e. the same as in the previous scenario).

As with all tax planning, the facts and circumstances need to be considered carefully and all risks quantified and understood before any action is taken.

Tax warning #2

The government are currently considering changing the rules so that in future there is no free uplift in the value of assets on death, where these assets will also benefit from BR or Agricultural Relef.

Contact us today to discuss any of the matters covered in this article.

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