Business property relief is an effective way to reduce or eliminate inheritance tax on business assets. Many UK businesses will qualify for up to 100% relief, but it is a complex area of estate planning that you may need expert help to get right. You may also find that other strategies, such as lifetime gifting, are better suited to your unique circumstances.
What is business property relief?
Business property relief (BPR) is a way to reduce the amount of inheritance tax (IHT) payable on certain business assets. It was first introduced as part of the 1976 Finance Act and aimed to help family-owned businesses carry on trading after a death, without the need for shares or the whole business to be sold to pay inheritance tax.
BPR has evolved since its inception and is now a popular way to minimise tax deduction following a death or on lifetime gifts. For example, a 2013 decision allowed investors to hold BPR-qualifying, AIM-listed shares in an ISA, making them even more tax efficient. It’s likely it will continue to change in the future – hopefully, for the benefit of inheritors.
What types of businesses qualify for business property relief?
In order to qualify for BPR, your business must not be listed on a main stock exchange, meaning it may not be an option for public limited companies. However, many private limited companies, limited liability partnerships and even sole trader businesses, or business interests, will qualify for BPR. Some examples include:
Since 6 April 1996, sole traders have qualified for 100% BPR if they are transferring their business as a whole entity over to another. However, sole traders will not qualify for any BPR if they are transferring land, buildings or machinery used primarily for business purposes.
How can I qualify for business property relief?
Most businesses and partnerships can qualify for BPR if they pass the 50% trading test. According to HMRC, this means less than 50% of a business’s activity needs to be made up of investment activities, which include:
- Purchasing stocks and shares
- Buying land and/or buildings
- Holding investments
As a result, a business in the property investment industry (where land/property is bought and sold without making changes), for example, would not qualify for BPR. It can get a bit complex here, as a property development company (where land is bought, built on and then sold on) would qualify. And even if just 51% of the business’s activity is active trade, it will still qualify for BPR.
You also need to make sure the business is not in the process of being wound up or amalgamated at the time, and within a year, of your death. It’s best to seek professional advice if you’re not sure if your business qualifies.
How can business property relief be used to reduce inheritance tax (IHT)?
If you’re claiming after someone’s death, BPR can be claimed by the executor of the Will or administrator of the estate when working out its value. Here are the steps you’ll need to follow:
- Work out the value of the business and/or its assets
- Decide whether the business qualifies for 50% or 100% BPR. If you’re not sure, your solicitor or a financial adviser should be able to assist.
- If the estate qualifies for 100% BPR, you don’t need to do anything else
- If the business and/or assets qualify for 50% BPR, you’ll need to get your inheritance tax reference number from HMRC, either by applying online or by post. You’ll need this three weeks before making a payment.
- Fill in both a form IHT400 and schedule IHT413 and submit them to HMRC
- Pay any inheritance tax owed within six months of the death
What assets can business property relief be used for?
Provided the business passes the 50% trading test, the following would qualify for BPR at 100%:
- A business or interest in a business
- Unquoted shares (even those listed on the AIM)
- Unquoted securities that give control (either alone or in combination with other unquoted shares and securities) of an unquoted company
A number of other assets qualify for 50% BPR:
- Quoted shares that grant control over a company
- Land, buildings or machinery used primarily or exclusively for the purposes of the business
- Land, buildings or machinery used in a business carried on by a beneficiary
Some business assets are excluded from qualifying for BPR. One common example is the buy-to-let property, as this is considered purely investment. Other common assets to be excluded from BPR are:
- Any assets or even the business as a whole for not-for-profit organisations
- Loans made to companies or partnerships
- Property owned by shareholders and used by a company (as opposed to a property owned by the business itself)
- Any assets that qualify for Agricultural Property Relief
Examples of business property relief for IHT
Inheritance tax is a challenging area, so here are two examples to help you understand how BPR works.
Helen’s father set up a successful car repair garage as a private limited company. Just before his death, he signs the company and all its assets over to Helen, making her the sole owner. Now, if the company is worth more than her father’s nil-rate band, Helen could claim BPR and dodge a hefty inheritance tax bill.
However, if Helen’s father was running his garage in partnership with a friend who still wants to be involved in the business, he may instead choose to leave Helen land, buildings or machinery that is used in the business. As Helen would not be inheriting the business as a whole, she could only claim 50% BPR on these valuable assets. Again, this would only apply if their value exceeded her father’s tax-free allowance.
What are the pitfalls of using business property relief?
BPR is best suited to situations where you want your family/friends/business partners to continue to benefit from your business in its current form (i.e. they’d like to continue running, or step up and run, it). But if your loved ones have no interest in keeping the business going, or would benefit more from the cash contained within your assets, it can cause tax headaches.
What about capital gains tax and lifetime gifting?
If you know your business is not going to qualify for BPR, lifetime gifting could be a tax-efficient option. By gifting a ‘relevant business property’ (RBP) to your chosen successor at least seven years before your death you can avoid at least some inheritance tax, as it will be classed as a ‘potentially exempt transfer’ or PET.
If you choose to make your business a lifetime gift, it’s important you do not continue to benefit from it. Otherwise, it will be considered a ‘gift with reservation of benefit’ and the recipient could be asked to pay inheritance tax on some or all of the business properties – potentially even more than if you hadn’t made a PET.
Here’s another example. Mark owns a number of buy-to-let properties, which he knows will not qualify for BPR. Mark could sign the properties over to his children or place them into a trust, as long as he no longer receives income or is a beneficiary. As long as Mark survives for seven more years, nobody will have to pay inheritance tax.
There are a few more things to consider here. If you have a business or asset that has increased in value since you purchased it, you may have to pay capital gains tax. You can also only put up to £325,000, or £650,000 if you’re a couple (the current nil-rate band limit), into a trust before you incur 20% inheritance tax.
Do I need a financial adviser to do this?
Inheritance tax is best handled with the help of an expert – who will usually be an independent financial adviser (IFA). It’s easy to find yourself in HMRC’s bad books if you try to make your legacy tax efficient on your own. An IFA will clearly explain your options and help you reduce IHT as much as possible. And if you don’t qualify for BPR, they will work with you to find another solution to help your beneficiaries enjoy as much of your assets as possible.
Should I use a discretionary trust for business property relief?
It’s a good idea to set up a discretionary trust if there’s a possibility the deceased’s spouse or business partner may not want to run the business. If it is sold, the cash tied up in the business will be released, meaning it no longer qualifies for BPR. By setting up a discretionary trust, which will legally own the assets and their proceeds, it doesn’t matter if the business or business assets or sold, as they will still qualify for BPR.
Is there a spouse exemption?
If you’re the only person your spouse has listed as a beneficiary in their Will, you will usually be able to inherit their assets tax free. What’s more, you can also apply any of your partner’s unused nil-rate band (their tax-free allowance for inheritance gifts) to your estate. Currently, that means you could have up to £650,000 in tax-free allowance to leave to your chosen beneficiaries.
How long does the business need to own the property before it can qualify?
A business can take advantage of business property relief after owning a property for two years. You also don’t need to have used the land or property for the same business; all you need to demonstrate is that the space was used for any kind of business purpose. There are three exemptions, however, that may allow you to claim regardless of the length of ownership:
- If the person transferring the property inherited it following another person’s death
- If the transferred property replaced another business property
- If the transferred property was acquired as part of an earlier transfer within the two-year period
If you’ve got any other questions about inheritance tax planning, we’ve answered more of the most common queries in our other articles on this topic.