Business Property Relief Guide
How Not to Give Away 40% of Your Business
DO YOU want to give the Government 40% of your business? No? Well, in that case, you need to make sure you don’t make one of the common errors that could lead to the loss of your business property relief (BPR).
How to Save Inheritance Tax
Without BPR, your heirs could effectively lose 40% of your entire estate in excess of a nil rate band of just £325,000 on your death. Where your business does qualify for BPR, however, its entire value will often be exempt from Inheritance Tax.
Losing Out
The difference it can make to your heirs if your business qualifies for BPR is enormous. Let’s say you have other assets worth over £325,000 (highly likely, as your house is included) and a business worth £10m. Without BPR, your estate will have to pay an Inheritance Tax bill of over £4m: enough to cripple your business. With the relief, you can effectively pass the business on tax free.
So, it’s vital to keep the relief available whenever possible. Generally speaking, this means that you will need to have owned qualifying business assets for at least two years.
Under the ‘replacement property’ provisions, however, you would retain full BPR as long as you owned qualifying business assets for a total period of at least two years during the five year period prior to your death. In effect, this gives you up to three years to reinvest the sale proceeds of a qualifying business into a new qualifying business without any loss of BPR. Provided that you actually do own qualifying business assets at the time of your death, that is!
The problem, of course, is that it is generally pretty unpredictable when this will be. Furthermore, it may be some time after you cease to be interested in running a business. Most people will want to retire at some point and, unfortunately, this will often result in the loss of the relief.
Selling Up
As soon as you have a binding contract for sale, you are, for Inheritance Tax purposes, no longer regarded as owning the asset being sold. Instead, you are regarded as owning a right to the sale proceeds.
That right is generally not a qualifying asset for BPR purposes. Hence, at one stroke of a pen, you can lose your BPR and substantially increase your family’s Inheritance Tax bill in the event of your death.
Example
Eddie owns an unquoted trading company, Cochran Limited. The company is Eddie’s only asset so, as things stand, Eddie has no need to worry about Inheritance Tax.
Eddie gets an offer from a French company, Aznavour S.A., to buy Cochran Limited for £10,325,000. He decides to accept the offer, so he flies to Paris, takes the Metro to Aznavour S.A.’s offices and signs a binding contract to sell his company.
Leaving the office, Eddie looks the wrong way crossing the street and steps in front of a bus. Inheritance Tax bill: £4m!
This is based on a true story and readily demonstrates the ease with which BPR can be lost and the dire consequences that may result.
An entrepreneur like Eddie might well have been intending to reinvest his sale proceeds in a new business venture and hence might have regained the protection of BPR within a few weeks by virtue of the ‘replacement property’ provisions.
Perhaps Eddie should have considered taking out some insurance to cover the Inheritance Tax risk during this short interval!
Retirement
BPR is lost as soon as a partner retires from a qualifying partnership business. Any capital that the retired partner leaves in the business is simply regarded as a loan.
One way to avoid this problem is for the partner to continue in partnership, but with a very small profit share. (Remaining in partnership has commercial implications, which should also be considered.)
When a sole trader retires there is no business so there can be no BPR. The answer here may be to take on a partner and then, at a later date, to ‘semi-retire’ – i.e. reduce to a very small profit share in the manner described above.
An individual owning qualifying shares in an unquoted trading company can happily retire without any loss of BPR, as their position depends on their shareholding and not on whether they actually participate in the company’s business. Incorporating the business prior to retirement may therefore sometimes be another good way to preserve BPR.
Buy-Out Clauses: A BIG NO-NO!
It is common business practice for business partners to enter into an agreement whereby their executors will sell their partnership share to the surviving partners in the event of their death.
Similar agreements are also often used by shareholder/directors of unquoted companies whereby their executors sell their shares back to the company, or to their fellow directors, in the event of their death.
Whilst these agreements make a good deal of commercial sense, from a BPR perspective, they represent a disaster waiting to happen. This is because, at the moment of death, a binding sale contract will come into force and the estate will not hold qualifying business property but, as we saw for Eddie above, will instead hold a non-qualifying right to sale proceeds.
It is therefore essential to avoid any form of agreement that may form a binding contract on the death of a partner or director.
Cross Options
A far better alternative is to use non-coterminous cross options.
In other words, the business partners should enter into an agreement whereby, in the event of a partner’s death, their executors will have an option to sell the deceased’s partnership share and the surviving partners will have an option to buy it.
Similarly, private company directors would enter into an agreement whereby, in the event of a director’s death, their executors will have an option to sell the deceased’s shares in the company and either the company itself or the surviving directors will have an option to buy them.
To be on the safe side, it is wise to ensure that the options are ‘non-coterminous’. Broadly, this means that the option to purchase and the option to sell may only be exercised at different times. (E.g. the deceased’s executors must exercise the option to sell within six weeks of the deceased’s death and the surviving business partners, or directors, must exercise the option to purchase more than six, but less than twelve, weeks after the deceased’s death.)
HM Revenue and Customs has confirmed that this approach is acceptable in the case of a business partnership and there is no reason to suppose that the same principles would not be equally valid in the case of company shares.
Using cross options will therefore preserve full BPR entitlement whilst also satisfying the commercial objective of allowing the deceased’s share of a business to be ‘bought out’.
Gifts in Consideration of Marriage
MARRIAGE is very much on the UK’s collective consciousness this month. We are no exception and would like to congratulate Prince William and Kate Middleton on the occasion of their wedding.
Inheritance Tax is probably not an issue for the Royal Family but, for the Middletons, and the rest of us, a wedding provides an opportunity to do a little extra Inheritance Tax planning.
Gifts made in consideration of marriage are exempt from Inheritance Tax up to the following limits:
- Parents: £5,000
- Grandparents, Great-Grandparents, etc: £2,500
- Other Donors: £1,000
All of the above limits apply on an individual basis. Hence, for example, the groom could receive £5,000 from each of his parents, plus £2,500 from each of his grandparents and £1,000 from all of his aunts and uncles: the bride could receive the same from her family.
Alternatively, the bride’s family could make their gifts to the groom or the groom’s family could make their gifts to the bride.
As a further alternative, gifts could be made into a trust for the benefit of the happy couple and/or any existing or future children.
To fall within the exemption, gifts must be made on or shortly before the marriage and must be fully effective when the marriage takes place. For example, “I give you my painting of Highgrove on condition that you marry my son.”
The same exemptions are also available when a same-sex couple enter a registered civil partnership; although it may be some time before we see a Royal Civil Partnership.
