Business owners should look to the future and make plans to maximise tax relief after their death.
Faced with the daily hubbub of running a business, there’s often little time to give thought to anything beyond medium-term goals – let alone questions about one’s death and inheritance. What will happen to a carefully built business after death? What is the best way to maximise the value of a business that will be left behind to others? But the questions are important and are worth taking time over; the right action can make a significant difference to how much is retained by future generations.
And there are valuable reliefs from Inheritance Tax (IHT) available for business assets owned for a minimum of two years. Broadly, an interest in a business, unquoted shares, or quoted shares which give their owner control of the business, will qualify for 100% relief from IHT. Land, buildings, plant and machinery used wholly or mainly for the purpose of the owner’s business will qualify for 50% relief.
Elizabeth Smithers, a partner with law firm Clarke Willmott, explains that there are valuable tax reliefs available – and it is essential to ensure that one’s business is structured in such a way as to maximise them. “Care should always be taken when setting up a company,” says Smithers, “so that its documents of incorporation are drafted to maximise reliefs and to facilitate future IHT planning. For example, it would be advantageous to ensure that the transfer of company shares to trusts is permitted both during lifetime and on death,” she adds.
In addition, there are a number of provisions that could be fatal to Business Property Relief, says Smithers. “This includes providing for business interests to pass to personal representatives who are obliged to sell them to the surviving partners, who are also obliged to buy them,” she comments. “Such an arrangement is viewed by HMRC as a binding contract for sale and will mean complete denial of relief.”
Care needs to be taken that the company does not fall into some of the traps for the unwary that lurk within the relevant legislation. These include diversifying business activities from trading to those regarded by HMRC as ‘investment activities’, such as the letting of commercial property. “If the business becomes an investment company, then Business Property Relief is denied on a transfer of value,” she explains. Another snare is to maintain a cash balance which is not required for normal operations. “This is often done out of a wish to minimise personal taxation, but such cash balances will not qualify for relief,” she adds. Likewise, the ownership of premises outside of the business will mean the rate of relief is reduced by half to 50%.
Once a company is set up in the best way to benefit from tax reliefs, then thought should be given to what happens in the longer term. In fact, the most important tool in achieving this objective is a well-drafted, tax-efficient Will; a document that should be regarded as essential for anyone with business assets. The first point to bear in mind when structuring a Will is that business assets should qualify for 100% relief from IHT; as such, a gift of these to a surviving spouse or registered civil partner is a waste of that relief as these gifts are exempt in any case.
“The preferable course of action is to leave the business assets to a discretionary trust in the owner’s Will,” she adds. “No IHT will be payable on the business owner’s death before his or her spouse, because of the availability of spouse relief and Business Property Relief. However, the shares are outside of the surviving spouse’s estate. This could be very advantageous should the law change to make the relief less generous by the time of the second death, or if relief is no longer available because, by that point, the business has been sold.”
She gives the example of Derek, who has died leaving his company shares worth £300,000 to a discretionary will trust, while his wife Carol has been left the rest of his estate. “Carol can still receive dividend income from the shares at the trustees’ discretion,” she explains. “The business is sold three years after Derek’s death and Carol dies five years later. The cash proceeds of the shares are outside of Carol’s estate in the trust and do not suffer IHT in Carol’s estate, saving IHT of up to £120,000 on current rates.”
If it is intended that a business should remain trading indefinitely – perhaps for another generation – then it is possible to achieve a double dose of Business Property Relief to minimise IHT and, perhaps, add to the business’s future viability. “The surviving partner can achieve this by buying the shares left to the discretionary trust,” she explains. So, in the example of Derek’s death, Carol continues the business with their son Andrew. Carol buys the company shares from the trustees of Derek’s discretionary will trust for £300,000. Carol, on her death, owns the shares, which have 100% IHT relief; the money she paid for them sits outside of her estate in the discretionary trust. “Effectively £600,000 worth of assets are outside of the IHT net, with relief claimed on both Derek’s and Carol’s death,” she adds. This delivers an IHT saving of up to £240,000 – a significant sum of money.
“The essential points for all business owners are to take advice. Make sure incorporation documents are structured in the right way; and remain vigilant against the dangers of prejudicing the availability of relief,” she counsels. “Also, individuals really need to make a Will and ensure that it makes maximum use of reliefs and mitigates IHT as much as possible.”
The levels and bases of taxation and reliefs from taxation can change at any time.
The writing of a Will and aspects of succession planning involve the referral to a service that is separate and distinct to those offered by St. James’s Place. Wills and trusts are not regulated by the Financial Conduct Authority or the Prudential Conduct Authority.