Wills and Tax Planning
Wills and business assets
If you own shares in a private company, are a partner in a partnership or are a sole trader, you can make a gift of your business assets in your Will completely free of Inheritance Tax (IHT) provided those assets attract full Business Property Relief (BPR). BPR is a relief from IHT available for certain business assets. This relief allows you to make gifts under your Will or during your lifetime free from IHT or at reduced IHT rates. You can plan for further tax savings by employing particular BPR tax strategies in your Will. These have the potential to produce very significant reductions in the tax payable when you die.
Many of our clients want to leave their business assets to their spouse, or at least want that spouse to benefit from the value of those assets. They could achieve this by gifting those assets direct to the spouse in their Will. There would be no IHT on that gift – even without BPR – because the gift is ‘spouse exempt’. But once the business assets have been sold, the surviving spouse is likely to be left with a large chunk of cash which does not attract BPR and so is no longer exempt from IHT.
Although the present IHT rules offer a surviving spouse or civil partner the possibility of a double IHT allowance (currently worth up to £650,000), many business owners are likely to leave assets well in excess of this value. Consequently that spouse or civil partner’s estate may still face a significant IHT liability on their death.
This can be reduced or entirely removed by using an appropriate tax strategy in a client’s Will.
How can this be done?
If your intention is to leave the business assets to your spouse, you have a legitimate opportunity to do some tax planning. As explained above, if you just leave assets benefiting from BPR direct to your spouse (who is exempt from IHT on that gift anyway), you are in effect wasting a valuable tax relief. To maximise the benefit of that relief you have a number of options. These include:
Leaving the assets to a discretionary trust in the will
Leaving the assets to a Discretionary Trust in the Will. There will be no IHT charge on the transfer into the trust, because the availability of BPR means the assets have a zero value for IHT purposes. The trustees of the Discretionary Trust can then agree to sell the business assets to the surviving spouse in return for an IOU. So long as these assets remain business assets and the spouse retains them for at least two years, they will once again get the benefit of BPR. The spouse can then gift them to the children, for example. Provided the spouse lives for seven years from the date of the gift, the gift would be free of IHT. If the debt remained outstanding, it should be deductible from the spouse’s estate on death. (Note that the debt would not be deductible from the estate if the shares were still owned by the spouse when he or she died.)
The main advantage of this method is that it can double the IHT relief on those business assets. It also gives the trustees a great deal of flexibility in how they manage the assets; the arrangement above is just one of the options available to them. The Trust simply provides a framework for tax planning and enables the trustees to take into account of any changes in tax rules between the date of the Will and the date of death before deciding on the most efficient way of dealing with the assets.
The main disadvantages are that (1) it introduces a level of complexity into the family’s arrangements and (2) there could be a 10-yearly charge to IHT (at a maximum of 6%) which would apply to the extent that the value of the IOU taken out by the surviving spouse exceeds the applicable IHT allowance (the ‘nil rate band’). If the spouse survives for a number of 10-year anniversaries, then the IHT benefits decrease over time.
Gifting your business assets to one or more your adult children
Gifting your business assets to one or more your adult children. A direct gift will of course benefit from BPR. A further option would be for the child/ren to sell those business assets back to the surviving spouse in return for an IOU in a very similar way to the arrangement above. (If you doubt they would do that, you can always grant your spouse an option to buy the shares from the child/ren.)
This provides the same potential IHT relief as before (provided the spouse had disposed of the shares by the time they died) but without the risk of the 10-yearly charge to tax. The child/ren are simply fulfilling the same role as the trust did in the first example.
The main disadvantage is lack of control. Family circumstances can change very quickly and you would need to be comfortable with the risks associated with this option. Where the client feels such a specific gift of business assets may be appropriate, a child’s divorce or bankruptcy at the wrong time (not that there is ever a right time for such an event!) may place the business at risk.
So what are the tax savings?
The tax savings produced by using the IOU scheme would be up to 40% of the value of the debt. So if the IOU was worth £1,000,000, the savings could be up to £400,000. As mentioned, the value of this benefit would diminish if the spouse survived for a number of 10-year anniversaries. The total IHT saving will vary depending on the value of the business assets, but as shown, could be very significant indeed, particularly as the strategies still allow couples to take advantage of the double IHT allowance (the ‘transferable nil rate band’) on the second death.
Does my business qualify for BPR?
A company shareholding, a partnership share or a sole trader’s business will qualify for BPR if:
it has been owned for two years before the date of the owner’s death or a lifetime gift, and
it is not subject to a binding contract for sale a the date of death/gift, and
it is not a business that mainly owns properties or investments which provide rental or investment income.
There are two rates of BPR: 50% and 100%.
Transfers of businesses, shares in unquoted (i.e. unlisted) trading companies and partnership shares will qualify for 100% BPR. The shareholder can still benefit from the tax relief even if he or she is not directly connected with the running of the business e.g. as a director or employee.
Transfers of shares from a controlling holding in a quoted trading company will qualify for 50% relief. In practice this occurs only rarely. This rate will also apply to gifts of land, buildings, plant and machinery where the assets are used by the partnership in which the owner is a partner or by a company where the owner of those assets retains control of it. This situation occurs more frequently.
To maximise the benefit of any BPR it is essential to take advice when preparing your Will. You should also consider the effect of any proposed changes to your business on this tax relief so that you don’t inadvertently lose the benefit of BPR.
Disclaimer: This note is written as a general guide only. Any course of action will depend on individual circumstances, so you are advised to take professional advice before you proceed. We do not accept any responsibility for action which may be taken as a result of having read this note.