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TaxationWeb by Steve Sanders

Steve Sanders of LexisNexis Tolley Tax Training provides an overview of a valuable relief from Inheritance Tax.Inheritance Tax accounts for about 1½% of government revenue and raises about £3.5 billion a year. If we compare this with income tax or national insurance or VAT, the IHT contribution is a drop in the ocean. This is largely due to the generous array of reliefs which act to significantly reduce the value of a person’s estate for IHT. The most common (and the most valuable) of these reliefs is Business Property Relief (BPR).

This article will concentrate on the fundamental principles of BPR, starting with the general rules about availability then moving on to computational aspects.

Statutory references in this article are to the Inheritance Tax Act (IHTA) 1984.

Introduction

Business property relief reduces the transfer of value for IHT purposes. BPR is given before any annual exemptions.

                          Value transferred	     X

                          Less:  BPR @ 50%/100%	    (X)

                                                   _____	

                                                     X

                          Less:  annual exemptions  (X)

                                                   _____



                          Chargeable transfer	     X

                                                   _____

BPR is also available to reduce the value of business property in a death estate.

BPR is given automatically if the conditions for relief are satisfied. No formal claim is required.

“Relevant business property”

BPR is only given if a donor makes a transfer of “relevant business property”. The definition of relevant business property is given at S.105 IHTA 1984. There are 5 types of relevant business property. These are listed below, together with the current rates of relief;

	Relevant business property                                                 Rate (%)

		

1.	A business or an interest in a business (eg, a partnership share).          100 

        BPR is not available on the transfer of a single business asset.  

	

2.	Shares in unlisted trading companies.  Any number of shares                 100 

        will qualify – there is no minimum holding.  

	

3.	Shares in a quoted trading company if the donor has voting control           50

        of the company (usually meaning more than 50% of the ordinary shares).  

        It is rare for one individual to hold more than 50% of the shares of 

        a quoted company. Therefore in the majority of instances, shares in 

        quoted companies will not qualify for BPR.  

	

4.	Land or buildings or plant and machinery owned by an individual and          50 

        used either by his partnership or a company he controls.   

	

5.	Securities (loan stock) in a company controlled by the transferor 

        (ie, where the transferor also has more than 50% of the voting shares).	 100 or 50

In the case of securities (5 above), the BPR rate is 100% if the company is unlisted, and 50% if the company is quoted. “Quoted” means the company has a full listing on the Stock Exchange. Shares on the Alternative Investment Market (“AIM”) are treated as unlisted shares for BPR purposes.

Trading businesses

Section 105(3) IHTA 1984 tells us that assets

“…are not relevant business property if the business… consists wholly or mainly of one of the following… - dealing in securities, stocks or shares, land or buildings or making or holding investments”.

Therefore if shares are to qualify for BPR, they must be shares in a trading company. Shares in investment companies or property dealing companies will not be relevant business property.

Furnished holiday lettings (FHLs) are usually treated as business property provided that the property owner is “substantially involved with the holiday-makers” in the course of their activities. The appointment of a lettings agent to deal with potential customers could therefore lead to a denial of BPR.

Where a business holds investments in addition to trading, BPR is normally still available providing that trading activities account for more than 50% of the total activities of the business (see Weston v CIR). If businesses hold non-trading assets, BPR will be restricted under the “excepted assets” rules (see below).

Ownership requirements

General rule

The donor must have owned the property for at least 2 years before the transfer.

There are exceptions in Sections 107 through to 109.

(i) S.107 IHTA 1984

Section 107 allows BPR where “old” business property has been sold and replaced with “new” business property.

BPR is given on the replacement property if the aggregated ownership periods total at least two of the five years immediately preceding the transfer. However, the BPR on the replacement asset cannot exceed the BPR that would have been available had the original asset been retained.

(ii) S.108 IHTA 1984

Section 108 deals with gifts of business property. Generally speaking, if a donor gives business assets to a donee, the donee’s ownership period for BPR purposes will start at the date of the gift. However, a donor’s period of ownership can be aggregated with the donee’s period if the transfer was between spouses on death. The definition of a “spouse” now includes civil partners registered as such under the Civil Partnership Act.

(iii) Section 109 IHTA 1984

Section 109 deals with successive transfers in a two-year period. In the case of successive transfers:

(a) if the earlier transfer qualified for BPR, and

(b) either of the two transfers was made on death, then

BPR will be given on the later transfer regardless of the ownership period.

Contracts for sale

If there is a binding contract for the sale of the asset in existence at the date of the transfer, the Revenue will deny any BPR. For example, if a vendor has entered into a contract to sell the asset but he subsequently dies before the sale is completed, no BPR will be available in his death estate.

The Revenue has used this rule to deny BPR on partnership interests where the partnership agreement provides for the share of one partner to be sold to his fellow partners on death. The use of “cross-options” to pass on the partnership share will avoid falling foul of this provision.

Excepted assets

BPR will be restricted on a transfer of shares if the company holds “excepted assets” on its balance sheet. An “excepted asset” is an asset that is not used for business purposes throughout the two years immediately preceding a transfer, or is not required for future use in the business.

Excepted assets will typically include shares held for investment purposes, or properties which are let out and produce rental income. It could also cover large cash deposits held for investment purposes and not required for future use in the business. The amount of the transfer qualifying for BPR, is the value of the shares gifted multiplied by the fraction below:

Qualifying transfer = Gift x  Total assets - Excepted assets

                              ______________________________

                                    Total assets

Therefore if the company has no excepted assets, all of the value of the shares will qualify for BPR.

It is worth remembering that if non-trading assets make up more than 50% of total assets, the Revenue may seek to deny BPR completely on the grounds that the company is not trading.

Computational aspects of BPR

Chargeable lifetime transfers

When an individual makes a chargeable transfer for IHT (for example, a gift to a discretionary trust), BPR is taken into account when calculating the lifetime tax. BPR is given before annual exemptions.

If the donor dies within 7 years of making the transfer, additional tax will be payable by the trustees. We need to consider the availability of BPR when calculating the tax on death.

Even if BPR was given on the lifetime transfer, it does not necessarily follow that the same relief will be available to the trustees on death. In certain instances, the BPR given on a lifetime transfer will be withdrawn when calculating IHT on the death of the donor. This withdrawal of relief will most commonly occur if the trustees sell or give away the business property before the donor dies.

As a general principle, in order for a donee to receive BPR to reduce the death tax, the donee must retain the property until the death of the donor. Trustees should therefore be advised to think carefully before disposing of business property while the donor is still alive.

A withdrawal of relief will also occur if the property no longer qualifies for BPR at the time of the donor’s death. For example, if a donor gives shares in an unquoted trading company to a discretionary trust, BPR at 100% will be available to reduce the value of the lifetime transfer. However if the unlisted company subsequently becomes listed on the Stock Exchange, the trustees will hold quoted shares at the date of the donor’s death. In this instance BPR will be withdrawn as the trustees will no longer own “relevant business property”.

There is one occasion when a sale of the assets by the trustees will not lead to withdrawal of BPR. If the trustees sell the assets, then subsequently replace them within three years with other business property, BPR is retained on the donor’s death. In order to preserve the BPR, the trustees must reinvest the whole of the original proceeds of sale.

A withdrawal of BPR will increase the tax payable by the trustees on the donor’s death. It will not affect the original calculation of the lifetime tax, which remains undisturbed.

Death tax on potentially exempt transfers (PETs)

When an individual makes a gift of business property to another individual – i.e. he makes a PET – we ignore the BPR during the lifetime of the donor. This is because there is no lifetime tax on a PET, so the amount of any BPR does not need to be considered.

We only need to think about the effect of BPR if the PET becomes chargeable as a result of the donor’s death within seven years.

If the donee has retained the business property at the date of the donor’s death, when calculating the donee’s death tax we give an appropriate amount of BPR.

If the donee had sold the property before the death of the donor, no BPR will be available to reduce the death tax. BPR will be preserved if the donee sells the original property and uses the proceeds in purchasing a replacement.

Similarly if the assets no longer qualify as relevant business property at the donor’s death – for example if unquoted shares become listed on the Stock Exchange – BPR will be denied on death.

Conclusion

Given that the most common type of asset to be transferred between family members and trusts is shares in unlisted trading companies, it is hardly surprising that tax examiners place a high value on students’ need to understand BPR and communicate this simply and effectively to their clients.

A couple more tips to finish:

1. Don’t study BPR in a vacuum. Remember that a gift of shares in an unlisted trading company will be a disposal for capital gains tax (CGT), so a good understanding of CGT gift relief is also important here.

2. Don’t forget BPR’s "little brother", APR (agricultural property relief). The idea is the same and the rules have much common ground, but do note the differences between the two. The APR rules follow the BPR sections in the legislation.

3. Concentrate on the basic rules and make sure you can explain how the relief works, what is relevant business property and how and when BPR will be available on death.

Steve Sanders
July 2006

Steve Sanders is a member of the tax training team at LexisNexis Tolley where he lectures and writes material for ATT & CTA courses, and audio visual CD ROMs for the student training market. Steve can be contacted via the Tolley Tax Training website at www.tolleytraining.co.uk.



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