Owner managers of Limited companies - Inheritance Tax, 'Business Property Relief', 'Excepted Assets' and assets not used for the purposes of 'trade'
Business Property Relief (BPR) can be an extremely valuable tax relief on a transfer of shares in a private limited company. It works by reducing the value of your shares by up to 100% for the purposes of calculating any Inheritance Tax due, and it applies whether the transfer takes place during your lifetime or on death.
If your shares qualify for BPR, the whole of the value of your company could therefore escape any liability to Inheritance Tax, but there are some detailed criteria that must be met to secure it, and various factors which can either erase or erode the value of the tax saving.
‘Excepted assets’ reduce the amount of BPR that will be available. Essentially, an 'excepted asset' is one that is owned by a business but is not used for a ‘business purpose’ throughout the two years preceding transfer/death, or is not required for future use in the business immediately preceding a transfer/death.
An excepted asset might therefore include a yacht or a helicopter at one extreme, but it can also include large cash deposits which are not employed directly for the purpose of the company’s business.
If your company does own ‘excepted assets’, the value of BPR is reduced, and the formula for calculating the reduced proportion of share value that qualifies for BPR relief is ‘Value of Gift x (Total Assets – Excepted Assets/Total Assets)’.
Mr X owns a 60% shareholding in a trading company. The shareholding is worth £1m for IHT purposes. The company has total assets of £2m, including a cash balance of £500,000 which is an ‘excepted asset’.
Mr X dies, and the shares pass to his son by his Will.
The executors of the estate will only get BPR on £1m x (£2m- 500k)/2m = £750k.
So, £750k of Mr X’s legacy is IHT free (by virtue of BPR), but £250k is taxed at 40%, and that increases the estate’s IHT liability by £100k.
To maximise BPR you therefore need to try and make sure none of the company’s assets are ‘excepted’ at the time of transfer. However, if there is no ‘trading’ use for the cash, and you don’t want to draw the money from the company (thereby incurring higher and additional rate tax charges, and increasing the value of your taxable estate for IHT purposes) what can you do?
The following are a couple of ideas you could consider:
Company investments in ‘non-trading’ business assets
It is possible for a company to invest its surplus cash in ‘business assets’ (ie, assets used for a general ‘business purpose’ that is nevertheless not a ‘trading purpose’), and thereby avoid the ‘excepted asset’ problem.
For example, a manufacturing company might invest surplus cash in a residential property that is let out, and the let property will qualify as being used for a ‘business purpose’ (but not a ‘trading purpose’). The important point to note is that the surplus cash has been invested for a ‘business purpose’, in a way that produces income for the company, so it is no longer an ‘excepted asset’.
However, investing in ‘non-trading’ assets can also lead to potential complications, because BPR is only available to companies that are ‘mainly trading companies’, and a ‘property business’ is not a trade (whereas a manufacturing business is). BPR can therefore be an ‘all or nothing’ relief.
If a company is ‘mainly trading’ the whole value of the shares is eligible for BPR (subject to the excepted asset rule), but if a company is not ‘mainly trading’ it will not qualify for BPR at all, so there could be a problem if the company invests in residential rental property (and/or other ‘investments’) to such an extent that the rental business becomes the ‘main’ business. In fact, the whole £1m of Mr X’s share value could become taxable at 40% as a result.
This is where careful monitoring of non- trading activities becomes important. There is quite a bit of case law on the subject what ‘mainly trading’ actually means, but (in simple terms), since the case of Weston’s Executors v CIR, HMRC’s approach seems to be that they will only deny BPR if more than 50% of the income generated derives from non-trading income.
Mr Y owns 100% of the shares in Company A, a company which generates £500k turnover p.a from professional services and £50k from rental income. The value of the business as a whole is £1.1m, and £500k of that value is attributable to the rental properties; however, the company is clearly engaged in ‘mainly ‘trading’ activities, so the whole value of the shares qualifies for BPR, and escapes any IHT liability.
Mr Z owns 100% of the shares in Company B, a company which generates £49k turnover p.a from professional services (he has wound down this activity over the past few years) and £50k from rental income. The value of the business as a whole is £560k, and £500k of that value is attributable to the rental properties, but the company is not ‘mainly trading’ so none of the value of the shares qualifies for BPR.
Mr X and Mr Z both owned companies which hold property worth £500k, but X’s estate pays nothing in tax on the value of those properties when he dies, whereas Y’s executors pay £200k.
In summary, one or two residential properties with modest rental income (or other business investments) might not be a problem for most companies, but you do need to be careful, and it is essential to monitor the situation if the balance of ‘non-trade’ and ‘trade’ activity changes and begins to threaten a company’s ‘mainly trading’ status.
Alternatively, it may be possible for your company to make contributions into a pension scheme on your behalf, thus removing the ‘surplus cash/excepted asset’ from the company environment without incurring any personal tax liability. The value in a pension fund in a pension schemes can also escape all IHT liabilities, and can therefore be an extremely effective means of passing wealth tax free down through the generations.
Other advantages of this option would be:
a) The contributions made are fully tax relievable in the company as a business expense – ie, they reduce your Corporation Tax bill by the value of the pension contribution x 20% – so, when compared to investments outside the ‘pension wrapper’, you make a significant tax saving profit immediately
b) The funds in a pension scheme are tax exempt, so they can grow free of income or Capital Gains Tax – ie, the cumulative growth of the fund is enhanced because it is in a ‘pension wrapper’
c) Funds in a pension are ‘ring fenced’ from the risk that may be associated with a trading business
NB. If you are over 55 and you need to draw on your pension fund for any reason you can now access all or some of it at any time (25% tax free, with the remainder being subject to income tax at you marginal rates). Prior to the rule changes this would not have been possible, except at a very high tax cost.
Sutton McGrath Hartley is a multi-disciplinary firm of chartered accountants, financial advisers and lawyers offering comprehensive financial expertise for all business, personal and family interests. Our specialist departments can help with inheritance tax, wills, trusts and estate planning. To discuss your requirements please contact David Sutton on 0114 266 4432 or firstname.lastname@example.org.
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