When it comes to selling up or transferring on a business to the next generation, entrepreneurs and family business owners are usually encouraged to take measures to reduce the level of Capital Gains Tax payable on the disposal of the business. Far fewer entrepreneurs are advised to consider their Inheritance Tax (IHT) planning, though, and yet failure to consider the IHT aspects of a sale can cost families dearly in the long term, when 40% IHT is levied on the proceeds of the business sale in due course. Many think of IHT as a tax which only afflicts family wealth if the business owner is still holding the proceeds of the business sale on their death. However, IHT is a complex tax, affecting lifetime gifts as well as assets held on death. Successful IHT planning is not just about being caught with the proceeds ‘when the music stops’ (i.e. on death!). It is not the tax equivalent of a game of musical chairs!
Successful IHT planning for business owners starts pre-sale, with a proper evaluation of whether any part of the value attributable to what is being sold qualifies for IHT Business Property Relief (BPR). BPR is not available if the nature of the business consists wholly or mainly of dealing in land or buildings, or making or holding investments. Extensive caselaw has arisen, mostly in connection with caravan parks and furnished holiday lettings, to try to determine when a commercial business involving residential property qualifies for BPR. Due to the level of services provided, businesses which operate hotels, as well as those which develop or construct them, should be capable of qualifying for BPR but if the building or land itself is owned by an individual and yet the operating business is run through a partnership or company, either the rate of BPR may be reduced or it may not be available at all on the hotel or land. Hence it is worth getting a ‘BPR audit’ done on hotel businesses pre-sale, to check if the structuring is optimal for attracting any BPR that may be available.
Where available, this generous IHT relief can be used to allow an interest in a qualifying trading business/partnership or unquoted shares in a trading company to be transferred to the next generation completely free of IHT. As the 2009 Nelson Dance case demonstrated, BPR doesn’t just apply to the sale of a qualifying business either – it can apply to the sale of assets used in a qualifying business as well. The effect of the relief is to reduce the value for IHT purposes of what might otherwise be a chargeable transfer for IHT. At its most generous extent, any IHT that would otherwise be payable on a transfer of a qualifying interest or qualifying assets is entirely relieved. With careful planning, it does not matter if the business owner fails to survive the transfer by the usual seven year period that is needed for the purposes of IHT.
If there would be concerns about transferring a business to the next generation outright, transferring the business into a structure for the next generation’s benefit is possible too, if the business owner wishes to retain control of the business and yet still be treated as having made a gift for IHT purposes. However, if a trust is to be used, it is imperative that pre-sale planning is carried out because, unless BPR qualifying assets are placed into the trust, the amount of value that can be put into the trust is limited to the available IHT ‘Nil Rate Band’ – currently £325,000. The following example highlights this important but often overlooked planning point:
Richard operates a successful hotel in Manchester through a company, of which he is the sole shareholder. The hotel itself is an asset of the company. He is now ready to retire from the hotel trade and intends to sell the company to new owners. Part of the deal involves Richard selling his shares for £10 million. He has two teenage children and pays for their private education. In due course he wants to fund them through university and pay for their first homes. He thinks he will need a fund of £3 million to do that. The shares qualify for 100% BPR.
If he puts £3 million of shares into a trust for his children (with a carefully drafted trust, he can still retain control of them during the sale process), on an eventual sale, the trustees will then hold £3 million of the sale proceeds in the trust. Richard will have got £3 million of value into the trust without having to pay any IHT upfront.
However, if Richard allows the sale to go through and only then thinks about putting £3 million of the sale proceeds into trust, he will have an immediate IHT charge of at least £535,000, as lifetime transfers to virtually every kind of trust give rise to an immediate charge to IHT at a rate of 20%. Richard can put, at most, £325,000 of the sale proceeds into trust for his children.
There are other taxes to consider but the above example illustrates the IHT point. An unlimited amount of assets qualifying for IHT BPR can be put into a trust. However, leave it until after the sale and business owners can only put £325,000 of cash sale proceeds into trust (or £650,000 at most for married couples), as cash does not qualify for BPR. It may be possible for Richard to carry out some remedial IHT planning post-sale but it is not ideal. Business owners miss pre-sale IHT planning opportunities at their cost.