Using business property relief to reduce inheritance tax

Business property relief is an effective way to reduce or eliminate inheritance tax on business assets.

Many UK businesses will qualify for up to 100% relief, but it is a complex area of estate planning that you may need expert help to get right.

You might also find that other strategies, such as lifetime gifting, could be more effective.

Business relief was formerly referred to as business property relief (BPR).

What is business property relief?

Business relief (BR) is a way to reduce the amount of IHT payable on certain business assets.

It was introduced as part of the 1976 Finance Act to help family-owned businesses continue trading after a death without needing shares or the whole business to be sold to pay the IHT owed.

Business relief has evolved since then, with governments recognising the value of encouraging people to invest in business.

In 2013, rules were changed to allow investors to hold BR-qualifying, AIM-listed shares in an individual savings account (ISA), making them even more tax-efficient.

What types of businesses qualify for business property relief?

To qualify for BR, the business must not be listed on a main stock exchange, meaning it may not be an option for public limited companies.

However, many private limited companies, limited liability partnerships and even sole trader businesses, or business interests, will qualify for BR.

Some examples include:

• Shares in unquoted companies, even if you have a minority holding
• Shares in companies listed on the Alternative Investment Market (AIM)
• An entire family business that is being passed down the generations

Since 6 April 1996, sole traders have qualified for 100% BR if they are transferring their business as a whole entity over to another.

However, sole traders will not qualify for any BR if they are transferring land, buildings or machinery used primarily for business purposes.

How can I qualify for business property relief?

Most businesses and partnerships can qualify for BR if they pass HMRC’s 50% trading test.

This means less than 50% of a business’s activity needs to be made up of investment activities, including:

• Buying stocks and shares
• Buying land and/or buildings
• Holding investments

As a result, a business in the property investment industry (where land/property is bought and sold without making changes), for example, would not qualify for BR.

It can get a bit complex here, as a property development company (where land is bought, built on and sold on) would qualify. Even if just 51% of the business’s activity is active trade, it will still qualify for BR.

You also need to ensure the business is not in the process of being wound up or amalgamated at the time, and within a year, of your death. 

If you’re not sure if your business qualifies, you should seek professional advice

How can business property relief be used to reduce inheritance tax (IHT)?

If you’re claiming after someone’s death, BR can be claimed by the executor of the Will or administrator of the estate.

Here are the steps you’ll need to follow:

1. Work out the value of the business and/or its assets.
2. Decide whether the business qualifies for 50% or 100% BR. If you’re not sure, your solicitor or a financial adviser should be able to assist.
3. If the estate qualifies for 100% BR, you don’t need to do anything else.
4. If the business and/or assets qualify for 50% BR, you’ll need to get your inheritance tax reference number from HMRC, either by applying online or by post. You’ll need this three weeks before making a payment.
5. Fill in both a form IHT400 and schedule IHT413 and submit them to HMRC.
6. Pay any inheritance tax owed within six months of the death

What assets can business property relief be used for?

Provided the business passes the 50% trading test, the following would qualify for BR at 100%:

• A business or interest in a business
• Unquoted shares (even those listed on the AIM)
• Unquoted securities that give control (either alone or in combination with other unquoted shares and securities) of an unquoted company

Many other assets qualify for 50% BR:

• Quoted shares that grant control over a company
• Land, buildings or machinery used primarily or exclusively for the purposes of the business
• Land, buildings or machinery used in a business carried on by a beneficiary

Some business assets are excluded from qualifying for BR.

One common example is the buy-to-let property, as this is considered purely investment. Other common assets to be excluded from BR are:

• Any assets or even the business as a whole for not-for-profit organisations
• Loans made to companies or partnerships
• Property owned by shareholders and used by a company (as opposed to a property owned by the business itself)
• Any assets that qualify for Agricultural Property Relief

Examples of business property relief for IHT

Inheritance tax is a challenging area, so here are two examples to help you understand how BR works.

Jim set up a successful car repair garage as a private limited company. Just before his death, he signs the company and all its assets to his daughter, Helen, making her the sole owner.

As the company is worth more than Jim’s nil-rate band (£325,000) Helen claims BR and avoids a hefty IHT bill.

However, had Jim been running the garage in partnership with a friend who still wanted to be involved in the business, he could have chosen to leave Helen land, buildings or machinery that is used in the business.

As Helen would not be inheriting the business as a whole, she could only claim 50% BR on these valuable assets.

Again, this would only apply if their value exceeded Jim’s tax-free allowance for IHT (the nil-rate band).

What are the pitfalls of using business property relief?

Business relief is best suited to situations where you want your family, friends or business partners to carry on running the business.

But if your loved ones have no interest in keeping the business going or would benefit more from the cash within your assets, it could cause tax headaches.

What about lifetime gifting and capital gains tax?

If you know your business will not qualify for business relief, lifetime gifting could be a tax-efficient option.

By gifting a ‘relevant business property’ (RBP) to your chosen successor at least seven years before your death, you can avoid at least some inheritance tax, as it will be classed as a ‘potentially exempt transfer’ or PET.

However, if you decide to make your business a lifetime gift, you must give it away outright.

If you continue to benefit from it, it would be considered a ‘gift with reservation of benefit’, and the recipient could be asked to pay inheritance tax on some or all of the business properties – potentially even more than if you hadn’t made a PET.

Here’s another example.

Amir owns several buy-to-let properties, which he knows will not qualify for BR. Amir could sign the properties to his children or place them into a trust if he no longer receives income or is a beneficiary.

As long as Amir survives for seven more years, nobody will have to pay inheritance tax.

There are a few more things to consider here. If you have a business or asset that has increased in value since you purchased it, you may have to pay capital gains tax.

You can also only put up to £325,000, or £650,000 if you’re a couple (the current nil-rate band limit), into a trust before you incur inheritance tax, but it’s worth discussing this with a financial adviser. 

Do I need a financial adviser to do this?

Inheritance tax is complicated, so it is best to get professional help from a financial adviser.  

Attempting to make your legacy tax efficient without professional help could not only be ineffective but could trigger many unintended consequences.

A financial adviser who specialises in estate planning can clearly explain your options and put in place a plan to reduce an IHT bill.

Even if you don’t qualify for BR, they will work with you to find another solution to help your beneficiaries enjoy as much of your assets as possible.

FAQs

Should I use a discretionary trust for business property relief?

It’s a good idea to set up a discretionary trust if there’s a possibility the deceased’s spouse or business partner may not want to run the business.

If it is sold, the cash tied up in the business will be released, meaning it no longer qualifies for BR.

By setting up a discretionary trust, which will legally own the assets and their proceeds, it doesn’t matter if the business or business assets or sold, as they will still qualify for BR.

Is there a spouse exemption?

If you’re the only person your spouse has listed as a beneficiary in their Will, you will usually be able to inherit their assets tax free.

What’s more, you can also apply any of your partner’s unused nil-rate band (their tax-free allowance for inheritance gifts) to your estate. Currently, that means you could have up to £650,000 in tax-free allowance to leave to your chosen beneficiaries.

How long does the business need to own the property before it can qualify?

A business can take advantage of business property relief after owning a property for two years.

You also don’t need to have used the land or property for the same business; all you need to demonstrate is that the space was used for any kind of business purpose.

There are three exemptions, however, that may allow you to claim regardless of the length of ownership:

• If the person transferring the property inherited it following another person’s death
• If the transferred property replaced another business property
• If the transferred property was acquired as part of an earlier transfer within the two-year period

If you’ve got any other questions about inheritance tax planning, we’ve answered more of the most common queries in our other articles on this topic.

Need help with your finances?

It can be tricky to navigate your finances, especially regarding your tax liability.

Unbiased can quickly match you with a financial adviser who can help you reach your money goals based on your unique circumstances and ensure you use any allowances and reliefs.