Taking advantage of business relief in estate planning
How can business relief be used as an estate planning solution?
In our CPD-accredited webinar on estate planning and managing inheritance tax liabilities, which took place in December 2022, we looked at the fundamentals of business relief and inheritance tax.
The virtual event was hosted by Lorraine Wilson, an associate at national law firm Weightmans, alongside Anne O'Loughlin, a sales manager at Beringea.
Lorraine acts for private clients in relation to their estate planning and has extensive experience in applying for probate and dealing with the administration of estates.?
Anne has over 25 years’ experience in financial services encompassing tax planning, asset management and pensions. Since 2016 she has served as sales manager at Beringea, the transatlantic venture capital investor that manages the ProVen products including our VCTs and estate planning service.
Below is a transcript of the key points that were discussed.
A brief guide to inheritance tax
Inheritance tax is charged on death and is taxed at 40%. It applies to the value of a UK individual's worldwide assets. The first ￡325,000 of an individual’s assets is free of inheritance tax (the Nil Rate Band or NRB). Spouses and civil partners can transfer the allowance after the death of one, meaning the relief is effectively doubled on the death of the second individual.?
Some individuals will qualify for an additional tax-free allowance of ￡175,000 if there is a family home that is left to a direct descendant. This is known as the Residence Nil Rate Band (RNRB). Again, the allowance can be doubled between spouses and civil partners, so a potential allowance of ￡1m is available before inheritance tax is charged.
If an estate is worth more than ￡2m, the RNRB tapers down and is lost altogether on estates worth more than around ￡2.4m.
How can people mitigate or reduce an inheritance tax liability on death???
The main way is to give away assets during their lifetime. If they live for seven years after the gift has been made, it's outside of their estate for inheritance tax purposes and the gift won't be charged inheritance tax on their death.?
So if you are considering giving money away, the sooner the better.
Another important thing to remember is that when somebody gives away an asset, they must not retain a benefit in it. The classic example is somebody who gives away their home and they transfer the title of their house to their children, but they continue to live in the property. This will not work for reducing inheritance tax, even if the transfer was done more than seven years before an individual’s death.
Trusts and family investment companies are ways of effectively making lifetime gifts but retaining a good degree of control and protection.
There are also annual exemptions to inheritance tax. People can give away smaller amounts of up to ￡3,000 every year (in total, not per beneficiary) without the seven year rule applying.
Other things that can be done outside gifting are to save into a pension and to nominate a beneficiary or beneficiaries. Pensions pass outside of the estate. Other options are to put death in service benefits and life insurance into trusts so it passes outside of the estate.
People might want to check out insurance for a potential inheritance tax liability, particularly if all the wealth is tied up in assets like property or a family business that would have to be sold in order to pay the tax.
How can business relief reduce inheritance tax?
Business relief is really useful for those who qualify for it. The idea behind it is that businesses and family companies do not have to be sold in order to pay any inheritance tax due by the family.?
An individual must have held their business interests for a minimum of two years in order to qualify for the relief.
But there are some exemptions to that rule.?The first is replacement property relief. Somebody may sell their family company (which qualifies for business relief) and are holding that money in cash. They then reinvest those funds into another business relief qualifying asset. They can claim a continued ownership period even though it was broken in the middle. HMRC is very generous and allows a three year window to reinvest.
100% business relief applies to the value of a business or somebody's interest in a business, and the value of unquoted shares in a limited company. For assets that are owned personally but are used in that person's business - such as machinery - 50% relief applies.
Firms must be classed as a trading business, and not an investment business, to qualify for business relief. Property rental businesses will not qualify for the relief.
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Example of inheritance tax bill
Fred is married to Wilma. After both their deaths they have a total estate worth ￡15.7m.
Total amount liable for inheritance tax (IHT): ￡3.85m?
Total IHT bill: ￡1.54m
NOTE: It can be useful for business owners to transfer company shares to a discretionary trust on their death, rather than a spouse inheriting the shares. This is so business relief is banked at that point and they are protected in a trust structure. It reduces the risk of the shares no longer qualifying for business relief further down the line because circumstances have changed.
What about business relief for investors?
Business relief-qualifying investments will be exempt from inheritance tax after just two years instead of seven years if you use gifting or trust solutions. Some estate planning services also offer an option to receive dividends, so you can still get some income.
Shares on the alternative investment market (AIM) generally tend to qualify for business relief.?
An estate planning service - such as the ProVen Estate Planning Service - typically invests in unquoted businesses. They offer diverse investment strategies that qualify for business relief and will be exempt from inheritance tax after just two years.
Historically, estate planning services have been used for older clients or those people with ill health. But we are noticing the age profile is coming down as investors realise the flexibility these solutions offer.
Business relief offers flexibility and if a client’s situation changes and they need the money, the investment can be sold (subject to liquidity).?
Example of how business relief can reduce an IHT bill
James and Sophie both establish rival businesses. After two years, both gain IHT exemption through business relief.
Each sell their respective businesses for a profit of ￡500,000. James buys a second home and Sophie invests in an estate planning service.
James has a total estate worth ￡1.22m on his death and leaves his loved ones ￡862,000.?
Sophie also has a total estate worth ￡1.22m but leaves her loved ones ￡1,070,000. This is because she invested the money in investments that qualify for business relief. (We have assumed there is no RNRB because we are not sure who they left their family home to).
With IHT thresholds frozen until 2028, have you seen an increase in people inquiring about business relief?
Inheritance tax receipts are at record highs and are expected to increase over the coming years. This is partly because of the freeze in thresholds and also because of rising house prices. IHT is no longer a tax just for very wealthy people.
So we are seeing a lot more people interested in business relief as an inheritance tax solution. Inheritance tax receipts are rising and business relief is very much increasing in popularity.
IHT can be referred to as a voluntary tax. That doesn't mean to say it doesn't need to be paid if it’s due, because obviously it does. But there are ways to significantly reduce it or mitigate it by planning ahead.
As with all investments, your capital is at risk and past performance is not a reliable indicator of future results.
UK tax rules and regulations are subject to change, and such changes may be retrospective. Your ability to obtain tax reliefs will depend on your personal circumstances.
The contents of this article should not be construed as investment, tax, financial or legal advice.