Despite recent proposals to reform inheritance tax ('IHT') and capital gains tax ('CGT') legislation, the tax regime relating to business succession is still favourable for business owners looking to minimise the tax that could arise on passing their business to the next generation. We set out below the key aspects of the legislation as it stands and some planning opportunities business owners might consider.
BPR: the current regime
BPR is a relief from IHT that is available on the value of certain business interests. In order to qualify for BPR, a business owner must have held the 'relevant business property' for a period of two years. If available, BPR can provide relief on up to 100% on the value of the relevant business property.
Advisers often highlight that BPR is available so long as the business is trading. HMRC guidance and case law indicates that a business will be considered to be trading so long as less than 50% of the business's activities are made up of investment activities. The test is applied on an all or nothing basis. If the trading activities outweigh the investment activities, the whole of the business will qualify for BPR and vice versa.
Business owners looking to benefit from BPR should periodically review the level of investment activities in their business. This is particularly important if the business has diversified resulting in the development of operations that might be considered investment activities. Such activities may take a variety of forms depending on the context of the business; for example, if a business has acquired land to generate rental income, intellectual property for licensing purposes or artwork as an investment.
In determining whether a business is likely to tip the trading-investment balance and jeopardise the availability of BPR, business owners should consider the importance of the trading activities to the business as a whole, which elements of the business require the most input from the staff and managers as well as the level of income that is produced by the trading activities compared to the investment activities.
There has been increasing commentary on the "50% trading test" and the Office of Tax Simplification in their recent report (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/816520/Final_Inheritance_Tax_2_report_-_web_copy.pdf) recommends that government increases the threshold of the trading test from 50% to 80% to match the current position with respect to CGT (see below), which would narrow the scope of BPR. Therefore, businesses that are currently closer to the 50% mark ought to reflect on whether it would be a sensible step to 'bank the BPR' now while the test is still favourable – for example, by way of a gift into trust, although any gifts should also consider possible CGT consequences (see below). Alternatively, restructuring the business so that its investment activities are hived off into a separate entity could also be considered.
Where an individual makes a gift of assets during their lifetime, he or she makes a chargeable disposal of those assets. If the assets have increased in value during the period of ownership, the gain will be subject to CGT at the individual's marginal rate. By contrast, if assets are retained until death their value will be rebased for CGT purposes, so that recipients of the deceased's assets receive those assets at the current market value, tax free.
There are circumstances where CGT can be deferred by claiming hold-over relief. Broadly, hold-over relief is available on gifts which would create an immediate IHT charge (such as gifts to some trusts or companies) or gifts of business interests (such as shares in a 'trading' company) to individuals or otherwise. For CGT purposes, a business will be trading so long as 80% of the activities carried on are trading activities.
The Office of Tax Simplification Report also considers whether the tax free uplift in value of assets on death for CGT purposes should continue and, in particular, it recommends that it should be withdrawn for assets that qualify for BPR. If CGT rebasing is removed, lifetime gifts would seem an increasingly appealing option as there would be no difference in the CGT treatment of such gifts, provided hold-over relief is available, compared to retaining them until death.
In deciding whether to make lifetime gifts, business owners will have a multitude of issues to consider such as whether their income needs can be met without continued ownership of the business, if corporate controls need to be implemented to ensure the business is managed in line with their expectations following a gift or how to structure a gift to preserve other valuable tax reliefs such as entrepreneurs' relief.
In light of the current favourable BPR regime we would encourage business owners who are looking to reduce their IHT exposure to review the activities of their business together with their estate plans and explore the possibility of lifetime gifting of business assets.
It is also important to consider the availability of Entrepreneurs Relief from CGT when making disposals of assets – see here for more details.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.