Craig Simpson, Tax Partner at Bates Weston highlights the impact of the changes to Inheritance tax on business and agricultural assets in the private sector as well as the farming community.
Craig looks at the scale of the issue, gives a worked example and looks at possible solutions. He is clear. The issue affects some 728,000 businesses and poses significant risks to business succession and sustainability. To reduce the risk of the tax burden, planning is essential.
If you would like to speak with him regarding your own situation, please do get in touch.
Since 1992, business and agricultural assets have been passed down to future generations largely exempt from Inheritance Tax. Encouraging, growing and protecting food sources and business interests was widely accepted to be good for our economy. Now we face a new era of the assets being exposed to Inheritance Tax (IHT).
The shift in Government policy on the taxation of business and agricultural property on death, has attracted a lot of media attention, particularly the impact on farmers.
The Labour Government insists that the majority of farmers will not be impacted. This is hotly disputed as there will be a multitude of ownership arrangements and valuation issues which mean some will pay Inheritance Tax (IHT) and others will not.
What has been largely overlooked is the significant impact on privately owned businesses. There are 5.5 million private sector businesses in the UK employing 27.7 million people. The tax and practical implications for these businesses is significant and the need to formulate a plan to deal with the potential of a considerable tax burden is urgent.
What are the changes to Inheritance Tax Business Property Relief (BPR) that will affect business owners?
The 2024 Autumn Budget made changes to IHT Business Property Relief (BPR) and Agricultural Property Relief (APR).
Based on the Budget publication the rate of relief from 6 April 2026 will be:
a) 100% on the first £1m (shared between BPR and APR assets); and
b) 50% thereafter
Applying the IHT rate of 40% to the unrelieved value gives an effective rate of 20% IHT above £1m.
The amount of £1m limit available on death will be adjusted for any failed potentially exempt transfers or transfers into trust in the previous 7 years.
Up to and including 5 April 2026 the rate of BPR and APR remain at 100%, with anti-forestalling rules for gifts after 30 October 2024 that become chargeable as a result of the donor not surviving 7 years from the gift, the donee still owns the shares and the date of death is on or after 6 April 2026. The anti-forestalling rules operate to recalculate the BPR on death applying the new rates, with the usual tapering rules applying from year 3 onwards.
It is still therefore possible to make substantial gifts to trust before 6 April 2026 and survive 7 years. More later on planning.
How many businesses are likely to be affected?
Based on the BPR claim statistics published in the Budget document there were 4,170 BPR claims in 2021/22. Of these claims 552 (13.23%) related to business property with a value above £1m. Extrapolating the percentage across the private business sector of 5.5m means that potentially 728,000 businesses could be impacted. I acknowledge that this is a broad calculation, and not all shareholders will pay IHT as they will plan, but you take my point; this is a big challenge for private business.
A worked example of Inheritance Tax Business Property Relief
Mr A and Mrs B are unrelated and have owned shares in a trading company for over two years, worth £10m 60:40. They do not have a shareholders’ agreement and the Articles of Association do not deal with how shares are to be treated on death. Mr A and Mrs B have not discussed what will happen to the shares on death as their focus is on running the business. Mr A dies unexpectedly on 6 April 2026 and his Will leaves the shares to his adult children. As he has a controlling interest the value of the shares for IHT purposes is £6m.
The IHT on Mr A’s death is:
– 0% on the first £1m
– 40% on £2.5m (applying 50% BPR) = £1m
The residue of assets in the estate is left to Mr A’s spouse and they equate to a house worth £750,000 and cash savings of £300,000.
The sons approach Mrs B to buy the shares from the estate to fund the tax liability but she refuses as she doesn’t have the money and also the company is capital intensive and doesn’t have the spare cash to fund a company purchase of own shares. So the sons have no choice but to hold onto the shares.
Note here that the IHT liability is not a liability of the company, it is a liability of the estate. The IHT itself is payable six months from the end of the month of death or can be paid by instalments over a 10-year period. Interest will be charged on the total IHT balance at a whopping 7.25% (from 26 November 2024).
So how is the Inheritance Tax liability paid?
As the IHT is a liability of the estate, depending on how the Will is drafted it is possible that the residue of the estate will have to pick up the liability. This would mean Mrs A, the spouse having to sell the family home and use £250,000 of the savings, leaving her with £50,000 and the sons owning the shares.
You might conclude that the children need to fund the tax somehow from the illiquid value of the shares, but if there is no prospect of selling the shares and Mr A no longer being a director, then it is entirely possible that dividends will not be paid either to fund the IHT liability.
If the IHT is paid by ten instalments then current legislation means interest is not levied on shares qualifying for BPR, this could of course change. If the tax is funded through the payment of dividends then the tax cost becomes even greater.
A well advised client may well consider a deed of variation to leave the first £1m of shares to a discretionary trust and the balance to an immediate post death interest trust for the spouse. But this would require the agreement of all the beneficiaries of the Will. It would however delay the tax problem and give the family time to plan.
Whilst this example might seem extreme it does reflect the reality that many shareholders may have to face. It is not uncommon, certainly for younger shareholders, to have a majority of their capital tied up in their trading business. The new tax policy also penalises capital intensive businesses, manufacturing and construction being two, where the balance sheet and hence value of the business may be higher than say the service industry.
Thoughts on solutions
Shareholders Agreement
Shareholders in private companies will be well advised to think about a company plan to ensure the safe passage of the company to the next generation.
A shareholders’ agreement might capture these points and include:
• How is the value of the shares to be realised and funded in the event of death?
• Are the shares to be passed on to the next generation?
• How will the shares be valued? Will this be by independent valuation or a mechanism built into the Articles of Association?
• Will there be a put and call option granted over the shares to enable a sale and purchase.?
• How will any IHT liability be funded?
This document must not create a binding contract for sale or BPR will be lost. The put and call option is the usual route to avoid this outcome.
Life insurance
The potential IHT could be insured in order to provide the executors with sufficient funds to pay the tax bill or least make a big dent in it.
This could be relevant life cover, whereby the premium is funded by the trading company, with corporation tax relief, no benefit in kind and the proceeds paid to into a trust to avoid it forming part of the estate for IHT purposes. This may be a suitable solution for younger shareholders, for example insuring for a period of say 20 years to cover an unexpected liability whilst other succession planning is considered and implemented.
Or alternatively shareholder protection might be appropriate. These policies typically help the remaining shareholders acquire the shares from the estate by paying out proceeds to a trust which are then used to acquire the shares from the executors. In this case the shareholder group are insuring each other’s lives. So, in the example above, Mrs B would be insuring Mr A’s life and vice versa. The premiums in this case are met by the shareholders.
In any event advice should be taken from a suitable financial advisor. The challenge with any insurance product is that values move and so over time the cover may not be sufficient. Life insurance may not be suitable for the older client though due to the expense of premiums. Nevertheless, it is expected that life insurance will play a significant role in the solution for most clients.
Make a substantial gift of shares
It remains possible to make a gift of shares to trust or to family members before 6 April 2026. In the case of a gift to trust, provided the shares qualify then a claim for 100% BPR is available, and the capital gain could be held over under s.260 TCGA 1992.
This would start the seven year clock ticking and, provided the donor survived seven years, then the gift would fall outside of their estate, with the tax tapering away by 20% each year from three years after the date of gift. In the event of death within seven years, where the donee still owns the shares and the death is on or after 6 April 2026, the anti-forestalling measures require the original 100% BPR claim be recalculated under the BPR rates applying from 6 April 2026. i.e. 100% for the first £1m and 50% thereafter.
The trust will be within the relevant property regime and so the prospect of a 10 year anniversary charge, broadly 3% of the value of the shares in excess of the nil rate band at the time should be factored into the considerations.
A gift could also be made directly to family members, subject to the shares not being employment related under “normal family relations” exemption, and it being possible to holdover the gain under s.165 TCGA 1992. Such a gift will be a potentially exempt transfer (PET) for IHT. The same anti-forestalling rules apply to the BPR in relation to a failed PET where the individual dies within seven years of death.
There are also significant challenges for shareholders who are elderly and might not be able to survive seven years from making a gift. It may be possible to insure the Inheritance Tax liability on a reducing value basis to mirror the tapered Inheritance Tax liability.
For the younger generations, the passing of the family shares to trust or to the next generation should be considered much earlier than may be the case currently. Giving shares away whilst the donor has a better prospect of surviving seven years will be a valuable strategy.
Overarching this issue though is whether it is desirable to give away the capital value of the business, particularly if it is to be sold and there is a need to live off the proceeds of an eventual sale. Every situation will differ and the objectives of the shareholders will need to be determined in order to formulate a longer term wealth transfer plan.
Growth shares
An alternative to an outright gift of shares to trust are growth shares. The basic proposition is that all or some of future growth is given away by creating a class of share that has the entitlement to capital above a predetermined hurdle level. For example, a company may currently be worth £1m and owned 100% by Mr A. He could enter into a share reorganisation limiting the capital rights on his shares to say £1.5m and carving out a new class of shares which carry the growth above say £1.5m of capital. The growth shares could then be gifted to trust or directly to the next generation. If it was possible to limit the value in a married couple’s estate to £2m then with two £1m 100% BPR allowances available then it may be possible to reduce or eliminate the IHT burden.
The alteration of share rights by a close company will be a disposition under s.98 IHTA 1984 and be a chargeable lifetime transfer. However a claim to BPR may be possible if the shares qualify or are within the Inheritance Tax nil-rate band of £325,000.
Care should be taken on the arriving at a hurdle value which is above the current value of the shares. In addition it may be appropriate for the growth shares to have income and voting rights. Whilst the capital rights may well be frozen into the shares, it is not the only reference point in arriving at a valuation. The dividend yield and retention of control through voting rights will also have a bearing on valuation. However, some form of growth shares seems to be a sensible way of approaching the problem.
Review and amend the Wills
Existing Wills should be reviewed and amended to ensure that the 100% £1m BPR limit is utilised on death. For example, if the Wills currently say all BPR qualifying assets will be transferred to a discretionary trust on death then the terms of the Will could trigger an IHT liability where the shares are worth more than £1m. It may therefore be advisable to transfer £1m of shares to a discretionary trust and the balance to a life interest trust for the surviving spouse. This would then defer the remaining IHT until second death and also give access to a further £1m of 100% BPR relief for the surviving spouse after two years of ownership.
In Conclusion
The Budget release on Inheritance Tax states “it is not fair or sustainable for a very small number of claimants each year to claim such a significant amount of relief”. Fairness of course depends on the perspective of each individual.
The point here is that the number of businesses impacted is not very small. By my earlier calculation some 728,000. Yes, the number of claims might be small each year but this change now represents a significant business risk to succession and sustainability.
The need for planning and structure is therefore key to reduce the risk of the tax burden. If the 100% BPR limits are kept at £1m for a sustained period then fiscal drag will bring more and more businesses into the regime. Coupled with the pension changes in April 2027 the mood in the business community is not positive.
Ending on a positive note, it is possible to plan and deal with this change if you are young enough and in good health. Business succession planning is now more important than ever.
If you would like to speak with Craig Simpson regarding your own business, please do get in touch.
As always, you are reminded that this article is generic in nature and you should take no action based upon it without consulting your professional advisor.
Sources: • According to the House of Commons Library Business Statistics report published on 11 November 2024, as of 1 January 2024
Notes: At time of writing draft legislation has not been published and so this article should be read in the knowledge the actual rules as enacted may differ.
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