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Julie Butler advocates a more proactive approach to Inheritance Tax (IHT) planning by 'IHT-vulnerable' landowners.

Introduction

It can be argued that all land and most buildings have a degree of potential development or “hope” value. There will always be some opportunity to “grow” more houses, improve buildings and convert barns. The problem to consider is how might this value be protected to ensure Inheritance Tax (IHT relief) is achieved on either the potential or the development proceeds?

Risks of the 'Do Nothing' Strategy

If the potential development asset is held within a business, e.g., farmland within a large working farm there is a temptation to 'do nothing' now.

However, the question is asked, when potential development land is owned by the 'IHT-vulnerable’ (IHTV) e.g., the elderly farmer, a landowner with health problems, the widowed, etc., what action can be taken? Where potential development land has not obtained planning permission there is often no guarantee that the development land or a substantial part of it will be sold during the lifetime of the landowner. The “IHTV” may not just be the elderly, it can be anyone who is about to realise the development in the near future.

If the estimated time for obtaining planning permission is, say, 3 to 4 years in relation to a substantial proportion of the development land, then there is a real 'risk' that the landowner will still be alive when the development is realised and the value of his estate for IHT purposes could increase very substantially. This is because the hope value will have been realised. There is always a substantial leap in value, which reflects the change from a probability of planning permission, to a certainty. Any cash (or even a binding contract for sale under IHTA 1984 s 113) would not qualify for Business Property Relief (BPR). This is because either the surplus cash would be regarded as an excepted asset and so the value of the business (we are assuming held by a trading farmer) attributable to the value of the cash would not qualify for BPR or, worse still, the retention of such cash or any investments purchased with the cash could convert the business into a non-qualifying business, thereby depriving the remainder of the farmland of BPR under IHTA 1984 s 105(3). There could be a nightmare situation where the farming business holds the cash and is therefore deemed to be an investment business. This is because either the cash or the investment in development land is greater than the trading activity.

Reinvesting the Development Proceeds

Of course, there would still be the prospect of reinvesting the cash proceeds in other farmland, or other businesses, which qualified for BPR. There is case law to support the proposition that the cash would not have had to be reinvested at the time of the landowner’s death in order to avoid being an “excepted asset” so long as there was a credible plan for reinvesting it in a manner which qualified for BPR. There would have to be clear documentation of this intention.

There are very considerable practical and commercial obstacles to reinvesting the amount of money from a large development within a relatively short timescale:

1. From a commercial perspective it would be sensible to stay with the businesses that the landowner (or people close to the landowner in whom he has sufficient confidence to delegate the management of a business) understands and could manage;
2. If the consideration in (1) limited the business which could be looked at to that of farming, it might well not be easy to acquire sufficient quantities of additional land, of the right quality in the right location and at a sensible price, for the replacement land to be incorporated effectively into the same business;
3. There would be a fundamental question of who would then manage this greatly-expanded farming enterprise and whether the landowner would have the energy to carry out its management.

Therefore, there is the substantial risk that if nothing is done with potential development land, there will be an IHT charge at 40% on the full amount of any realised development value, to the extent that that realised development value has not been reinvested in qualifying assets. Such an IHT charge will be more onerous than a Capital Gains Tax (CGT) charge which is likely to be leviable at a much lower effective rate of charge – 18% or 28%, or possibly an effective 10% rate if Entrepreneurs' Relief applies.

CGT and IHT Battling for Prominence

The question of ‘doing nothing’ against gifting during one's lifetime, highlights the downside risk of increasing the 'effective rate' of CGT and weighing this against the upside benefits in terms of reducing IHT as a result of removing the asset from the landowner’s estate at a much lower market value. It is assumed that the lifetime gift is at a lower value before the full value is realised.

The advantage of 'doing nothing' is that if a person makes no actual or deemed disposal of an asset during his lifetime, he will incur no CGT liability. His estate will then obtain the benefit of the CGT-free step-up in base cost - TCGA 1992 s 62(1)(a). Therefore, the landowner’s personal representatives, if they choose to sell part of the land, are more likely to realise a smaller gain and thereby suffer a reduced CGT liability. Alternatively, the landowner’s personal representatives will be able to pass on the higher base cost when they assent the land in favour of persons who take as legatees (whether absolutely or as trustees of the settlement) – TCGA 1992 s 62(4).

If it could be predicted that the landowner would die before the development land would be subject to a binding contract for sale, then the 'do nothing' approach might lead to a lower overall tax burden: the development land could qualify for APR and BPR, even in respect of the hope value and the landowner and legatees could obtain the benefit of a market value base cost at the time of the landowner's death. It is assumed that this will be considerable. However, this is a serious consideration – the risk of 'doing nothing” is significant, as the date of death cannot be accurately anticipated.

Conclusion

With regard to IHT planning, if a farming landowner, or general business landowner is holding potential development land within their business with a view to sheltering potential IHT there are significant risks to ‘doing nothing’ as the development project approaches. Serious thought must be given to gifting to the next generation. The complexity and technical concerns of lifetime giving must be given full consideration for all potential development projects. 'Doing nothing' is not an easy alternative that can be assumed without working through the considerations of lifetime giving.