Reducing Inheritance Tax with Business Relief (BR)

Most families with a net worth above the Inheritance Tax allowance – currently £325,000 for each individual – will be looking for ways to reduce their Inheritance Tax liability.

One way to do this is to give money away during your lifetime but amounts over the annual gifting allowance (£3,000) are only exempt from Inheritance Tax if the donor lives for seven years after the money has been gifted.

Business Relief, on the other hand, is available only two years after an asset has been transferred, making it a potentially attractive option for those who are able to take advantage of it.

In this article, our expert team at PIL Southampton explains what Business Relief is, how it can reduce Inheritance Tax liability and what the benefits and risks of this option are.

What is Business Relief? 

Business Relief (BR) used to be called ‘Business Property Relief’. Shares of a company that qualifies for Business Relief are exempt from Inheritance Tax liability. Exemption relies on qualifying shares being owned for at least two years before the owner dies, and being owned when they die.

Why Business Relief exists 

It was first introduced in the 1976 Finance Act, to ensure that a family-owned business could continue to trade when its owner died – it meant that a business could be passed on to the next generation without it having to be sold or broken up to pay an Inheritance Tax liability.

Since it was first introduced, Business Relief has been extended to cover a wider range of businesses than those directly involved in family-run businesses, as governments encouraged people to invest in trading businesses.

The types of business that typically qualify for BR

BR is likely to be available for shares in a qualifying company listed on the Alternative Investment Market (AIM), or shares in an unquoted qualifying company, even if it’s a minority holding.

An unincorporated qualifying trading company business, or having an interest in one – like a partnership – could also be available for BR.

Since 2013, the government has made it possible for AIM-listed shares to be held in ISAs, which means that investors can hold their BR-qualifying shares within a tax-efficient ISA wrapper.

What are the benefits?

Owning BR-qualifying shares means that your assets stay in your own name, and you directly receive any paid dividends.

Investing in BR-qualifying shares only takes two years of being invested in at the time of death to be exempt from Inheritance Tax, unlike other forms of gifting or setting up trusts, which need to have been in place for seven years at the time of death in order to be Inheritance Tax free.

BR investments are not included in the value of your estate, which is helpful for estates that would fall within the Nil Rate Band allowance without it.

What are the risks?

Your capital is not guaranteed. The value of the shares could fall and you may get back less than you invest, particularly as AIM-listed shares can be more volatile than certain other funds.

The value of tax reliefs will depend on your personal circumstances, which could change. 

Tax rules may change at any point, which could reduce or withdraw the Inheritance Tax exemption, and the BR-qualifying company/ies that you invest in may not stay BR-qualifying, for example if they become publicly listed. 

Ownership rules 

To reiterate, the BR-qualifying shares need to have been owned for at least two years on the event of the owner’s death to qualify for business relief.

When ownership transfers to the surviving spouse or civil partner, their ownership counts from the start of the deceased person’s ownership. So, as long as the deceased owned the assets for two years at death, then the assets are also free from IHT for the beneficiary, assuming they are held at the beneficiary’s death. 

If the asset was transferred to the spouse or civil partner while their partner was alive, the two-year ownership rule starts again, regarding their own estate. As long as the donor survives seven years, the gift will be free from Inheritance Tax on their estate. 

Replacement property 

BR can be transferred from one qualifying property to another, and the two-year ownership period will not be reset as long as the sale proceeds from selling the first BR-qualifying property are used to buy the replacement property within three years of selling the original property.

BR continues to be available if the combined time that the original and replacement properties covers at least two out of the five years immediately before the transfer or death. The exception to this rule is if the property owner dies before the replacement property is purchased.

The amount of BR on a new property or properties cannot be more than the original qualifying property. 

HMRC’s position is that, if the replacement property is worth more than the original property, the extra amount will not be automatically eligible for BR and a new two-year period will kick in on that amount. This rule is to avoid someone who has qualified for BR purchasing a more expensive business asset just before they die or make a transfer.

Gifting business assets 

The main reason for gifting business assets is to ensure that a business continues to run smoothly in the event of the owner’s retirement or death. This is especially important for family businesses, where keeping shares and voting rights in the hands of key decision makers can be crucial. 

Because of this, succession planning may be a higher priority than tax planning.

Gifts to individuals on death

If the assets were owned by the deceased for at least two years at the time of their death, no Inheritance Tax will be payable. The beneficiary inheriting those assets will benefit from BR on those assets straightaway, as long as the asset still qualifies for BR and the two-year ownership period has been met.

In a situation where the asset hadn’t been owned for two years before the death of the owner, there will be no BR available at that time and the two-year ownership period for the new owner will start on the date the previous owner died.

Where the assets are inherited by a surviving spouse or civil partner, it’s possible to use the combined ownership period to determine eligibility for BR.

Gifting to discretionary trusts 

As assets qualifying for BR are not subject to Inheritance Tax, reducing Inheritance Tax by transferring them into a discretionary trust isn’t an incentive. 

However, you may wish to consider doing so if it keeps the value of the net estate below the £2 million taper threshold and retains the Residence Nil Rate Band.

It may also be worth doing to protect or control assets, if they are shares in a family business.

Another reason people gift BR assets to a discretionary trust is to claim holdover relief and defer CGT on disposal of the assets. This would mean, though, the loss of CGT Business Asset Disposal Relief (previously referred to as Entrepreneurs Relief).

How PIL Southampton can help you 

Our qualified and experienced team of independent financial advisers is here to talk you through all your options regarding reducing your Inheritance Tax liability. 

How you can contact PIL Southampton

You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.