The Prudential’s Technical team takes an in-depth look at Business Property Relief and when and how it can be used in clients’ tax planning, in particular in respect of inheritance tax.
Business property relief is a valuable inheritance tax relief for business owners whether making a lifetime transfer or on death. Chief reasons are that business owners may receive relief at either 100% or 50%, dependent on circumstances and Business property relief is available after an ownership period of two years.
Types of property that qualifies
Inheritance tax (IHT) legislation (IHTA 1984) provides relief for certain types of business or business property included in either a lifetime transfer or the deceased’s death estate. Relief is available for business property anywhere in the world.
For deaths and transfers, on or after 6 April 1996, the categories of property which are capable of qualifying as relevant business property are broadly as follows with rate of relief:
- Property consisting of a business or interest in a business: 100% relief
- Control holdings of unquoted securities in a company: 100% relief
- Unquoted shares in a company: 100% relief
• Control holdings of quoted shares in a company: 50% relief - Land, buildings, machinery or plant used by a company controlled by the transferor or by a partnership of which the transferor was a member: 50% relief
- Settled land, buildings, machinery or plant in which the transferor had an interest in possession and used in his business (This applies to lifetime transfers only): 50% relief
All statutory references are to IHTA 1984.
The ownership test
The general rule is that property does not qualify for business property relief unless it was owned by the transferor throughout the two years immediately preceding the transfer (S106). The nature of the business carried on needn’t be the same throughout the two-year period, but there must have been a business throughout that period.
The general rule is relaxed in three situations:
- Where the transferor became entitled to the property on the death of another person
- Where the transferred property replaced other business property
- Where the transferred property had been acquired on an earlier transfer within the two year period
Where the deceased / transferor became entitled to property on the death of another person, he / she is treated as having owned it from the date of the other person’s death (S108(a)). Where the deceased / transferor became entitled to property on the death of their spouse or civil partner, he / she ‘inherits’ the ownership period of the spouse or civil partner irrespective of how long they had been married (S108(b)).
‘Ownership’ means:
- Legal ownership by trustees where there is no interest in possession,
- In all other cases, beneficial entitlement including entitlement to trust property in which the deceased/transferor had a beneficial interest in possession
Lifetime transfers – additional conditions Consider:
- A failed potentially exempt transfer (PET) that would have qualified for business property relief at the time it was made; or
- An immediately chargeable lifetime transfer (CLT) which did then qualify for business property relief
In these circumstances, there are additional conditions (S113A & 113B) for deciding whether business property relief is due where the transferor dies within seven years. These conditions are designed to deny business property relief in connection with charges arising on the transferor’s death if, broadly, the recipient has disposed of the property without replacement or, if it no longer qualifies.
The conditions therefore affect the value transferred by a PET, and the additional tax payable on a CLT if the transferor dies within seven years.
The rate of relief (100% or 50%) and the value on which it is given are determined by reference to the original gift and the position at that time. If the rate of relief has changed, then the rate at date of death applies.
The conditions to be satisfied are that the original property must:
- Have been owned by the recipient from date of the transfer to death of the transferor (or earlier death of the recipient)
- Still be relevant business property immediately before the death of the transferor (or earlier death of the recipient)
If the recipient has replaced the gifted property with other business property then that is allowable.
If the conditions are only satisfied in relation to a part of the gifted property, then there needs to be a proportionate reduction.
James made a PET of £200,000 comprising shares in a private trading company to Karen. Before he dies, Karen sells one-half of the holding for £40,000. Business property relief is available on £100,000.
Where the conditions are not satisfied at all, the consequences depend on whether the transfer is a failed PET or a CLT. With a failed PET, the value transferred by the PET is ascertained on the basis of no business property relief. With a CLT, the additional tax chargeable on death is calculated on the basis of no business property relief.
What is a business?
The meaning of ‘business’ is not defined for IHT purposes, so it has its ordinary meaning, which is a trade or profession carried on for gain.
Business “includes a business carried on in the exercise of a profession or vocation, but does not include a business carried on otherwise than for gain” (S103(3)). This therefore excludes ‘hobby businesses’.
The definition therefore includes property such as a sole trader’s business and a partner’s share in a partnership carrying on a business. The property must consist of a business as a whole or a share or interest in such a business. Transfers of individual assets are not included, whether they are comprised in the business or just used in the business.
The meaning of ‘unquoted’
The current definition in S105 is that unquoted means not quoted on a recognised stock exchange with shares dealt on the Alternative Investment Market being unquoted for these purposes.
Land, buildings, machinery or plant qualifying for 50% relief
Business property relief applies to any land, buildings, machinery or plant, which immediately before the transfer was used wholly or mainly for the purposes of a business carried on by either a company the transferor then controlled, or a partnership of which the transferor was then a partner.
It is not uncommon for a sole trader to incorporate but, for example, to personally retain the business premises. This scenario could therefore give rise to 50% business property relief on the premises.
Investment businesses
Business property relief is not due where the business, or the business carried on by the company, consists wholly or mainly of:
- Dealing in securities, stocks and shares
- Dealing in land or buildings, or
- Making or holding of investments.
These types of businesses are not relevant business property and so do not attract business property relief. It should be noted however that this exclusion does not generally apply to shares in a holding company. In other words, shares in a holding company which owns share in a trading subsidiary would, in principle, benefit from business property relief.
Moreover, relief is not denied for shares in a genuine building and construction company holding a number of properties as stock. It is important to consider the nature of the business at the time of the transfer (a business which started as a house builder but at the time of the transfer had not recently built any houses and was selling off its landbank wouldn’t qualify for business property relief).
Businesses concerned with caravan sites, furnished lettings, furnished holiday lettings, and commercial letting can be particularly problematic. The two tests that need to be applied are:
- Whether the activities carried on constitute a business (S105(1)(a)), and
- If they do, is business property relief precluded because that business was one of ‘wholly or mainly holding investments’?(S105(3)).
The phrase ‘wholly or mainly’ doesn’t simply refer to the income, or the capital or the activities of the business. All aspects of the business must be considered. In deciding whether a business falls within S105(3), consideration will be given to preponderant activities, assets and sources of income or gains at the time of the transfer and over a reasonable period leading up to it. Each company has to be looked at in the round. HMRC does however state:
“It may however be readily accepted that, where the majority of both the tangible asset value and profit of the company is attributable to trading activities, relief is available.”
Shares & Assets valuations Manual SVM111150
Excepted assets (including ‘surplus cash’)
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