BPR: The basics
Undoubtedly, the relief from IHT for business property is the most powerful relief in the whole of the UK’s IHT code. An interest in a business or shares in a company qualify for relief at 100%, that is their whole value is completely left out of account in charging the tax on death or lifetime gifts. Any kind of business will qualify for the relief, so long as it isn’t trading in shares or land etc., or a business of making or holding investments.
Fifty per cent relief is available for certain assets, like properties, that aren’t actually held within the business but are used for the purposes of a business, which you are carrying on either personally or through a company you control.
Furnished holiday lets
The question of whether a business is investment or trading in nature is a very topical one at the moment, in the context of furnished holiday lets. The case of Pawson recently heard at the Tribunal represented a runaway victory, or so it seemed, for the taxpayer. Reading between the lines of the case, it looks as though the old lady whose IHT was in question actually did very little but receive the rents from holidaymakers who visited her cottage in East Anglia. This therefore put her squarely within the Revenue’s new practice (it changed its approach a few years back without telling anyone), and even though furnished holiday accommodation is treated as a trade for other taxes, it isn’t automatically treated as a trade for IHT. The Tribunal thought otherwise, but unfortunately this case has been overturned more recently on appeal.
So, at the moment, owners of furnished holiday accommodation have no idea whether their asset will qualify or not. In a way, the judgment of the appeal judges is just as attackable in the opposite direction as the original judgment in favour of the taxpayer was. They both almost said the equivalent of ‘it stands to reason that furnished holiday letting is a trading/investment (delete whichever is applicable) business’. Our own view is that some businesses will qualify and others won’t, depending on how active the owner’s involvement actually is. The more active, the better.
But so much for the basics. What were those interesting tax-planning ideas we were talking about?
1. Turn 50% (or 0%) relief into 100% relief
It’s surprising how often people get this one wrong. We’ve just mentioned the rule that says that if you hold a property outside the business you get 50% relief if the business itself qualifies. But this relief is only 50%. Indeed, it’s worse than that if the business is carried on by a company and you, as an individual, don’t actually control that company (for example if you own the shares 50/50 with a business partner). In this instance, holding the property outside the company is a tax disaster, because you get no BPR at all, even if the property is fully utilised in a trading business.
Even worse is the situation where the business property is held in a separate company, which you own in parallel with your trading company. If you do it like that, you haven’t just fouled up your IHT planning position: you’ve also made a pig’s ear of your capital gains tax as well!
People often set up things like this to ring-fence what may be the most valuable business asset (the property) from any financial disaster that might strike the trade itself, for example a disastrous legal claim or losses made for other reasons.
But there is a way you can get the tax benefits without endangering the property asset in this way. One version of this is to put the property in a holding company which then owns the shares in the trading subsidiary company. Because, overall, you are looking at a 100% trading position, your shares in that holding company will qualify for 100% relief. There is an equivalent, which is arguably even better from the point of view of other taxes, in the context of LLP-based structures.
2. The ’50% rule’
Clever use of the ’50% rule’ will enable you to get relief for assets that are not actually trading in nature at all, but merely investments.
How can this be, when we’ve just said that BPR isn’t available for investment businesses, under the heading of ‘The basics’ above?
Simple: BPR is only denied if the ‘business’ in question comprises ‘wholly or mainly’ the making or holding of investments. The Revenue, no doubt correctly, interprets wholly or mainly as meaning more than 50%. Ergo, if your business is no more than 50% investment in nature it will still qualify for the relief in full.
So if, for example, you are in partnership and that partnership has assets (perhaps property or goodwill) worth £1 million, there’s no reason why you shouldn’t smuggle in a buy-to-let property, which would normally be treated as a fully IHTable investment, into the business. Its value will then form part of the overall value of a business which comprises at least 50% trading assets, and therefore is eligible for relief.
3. Property development or property investment?
Regular readers of these words will be familiar with this principle. Where you have a property portfolio, the question of whether its value is taxable on your death or on lifetime gift is one of what is going on in your mind. Do you hold the properties for the purpose of developing and selling at a profit or do you hold them for the purpose of long-term rent? If the former, you are a property developer with a business that is 100% outside IHT. If the latter, the whole value of the investment property portfolio is chargeable, in principle, at 40%.
So why is this mentioned in a list of planning points?
The answer is, because the distinction depends entirely, in the final analysis, on your intention. And intentions can change. Let’s take the example of the elderly person, perhaps in ill health, who has held a portfolio of properties for some years without change, and is living off the rents.
This is a prime candidate for planning of this sort, because if nothing is done to change that old person’s intention (which the Revenue will assume to be an investment intention) the whole amount will fall into his estate, and that could be rather soon.
He could, if circumstances were right from the commercial point of view, enter into partnership, perhaps with younger members of his family, with a view to developing the portfolio actively for sale. In principle, there is no reason why the whole portfolio should not thereby be transformed, literally overnight, into a completely non-taxable asset. But you need to make sure that the evidence is there, and one way to do this is to change the whole structure within which the portfolio is held into a corporate structure, more associated with trading businesses.
Note that this overnight transformation even gets round the normal rule that applies for BPR to the effect that you must hold the business property for at least two years before it qualifies. (This rule was clearly brought in to prevent ‘deathbed planning’.) The rule doesn’t say that the properties concerned need to have been business property for two years: merely that they need to have been owned for at least two years.
This is one of our favourites, and works like this. Mr A has just died, leaving the shares in the family trading company, worth £1 million, together with £1 million cash, to his widow. As a bequest between spouses, this is completely exempt from IHT.
Mrs A, when she has recovered from her grief, consults a tax advisor, who suggests that she vary her late husband’s will to leave the shares in the family trading company to the children. This she duly does, leaving behind the £1 million cash that she has received. The variation of the will doesn’t give rise to any IHT, because of BPR. Fine.
The next stage, perhaps after an interval, is that Mrs A offers to buy the shares in the company back from the children. She pays them £1 million cash, and therefore they have the cash and she has the shares. (They make no capital gain because they are treated as having acquired the shares in the company at probate value on the death of the old man, that is £1 million.)
On Mrs A’s subsequent death, she leaves the shares back down a generation again, and the same shares therefore qualify for BPR again.
The result? The £1 million cash, which would have borne tax on Mrs A’s death, has been passed down a generation without IHT, by way of ‘double dipping’.
Jim Storm’s articles appear regularly in The Schmidt Tax Report, a monthly newsletter aimed at showing UK taxpayers ways they can pay less tax.