Reforms of Inheritance Tax, agriculture, property, farms, estates

There has never been a more important time to consider the succession plan for the family business. Increasing uncertainty and volatility with BREXIT and now Covid-19 means it is crucial that the business is in the hands of those that are empowered and driven to protect its future. Further, with many considering Will planning due to the Covid-19 risk, it is also important to consider the current ownership of assets in view of the risk that the current inheritance tax (IHT) regime may not be with us forever.

Inheritance tax (IHT) is a tax on the value of an estate (property, money and possessions, less liabilities) of someone who has died. The IHT rate on death is 40%. However, reliefs are available to reduce the value chargeable. The current reliefs include the nil rate band (£325,000 per person), agricultural property relief (APR) and business property relief (BPR).

BPR can reduce the value of an interest in, or unquoted shares in, a trading business and assets used in a trading business by 50% or 100%. The rate of relief depends on the ownership of assets and how the business is structured.

APR is a relief on the agricultural value of property occupied for the purposes of agriculture. Again APR may reduce the value by 50% or 100%. In some cases BPR can reduce any value over agricultural value.

Proposed reform

Last summer the Office of Tax Simplification (OTS) issued their recommendations for changes to IHT with the aim of making it simpler. The main recommendations include:

  1. Restrictions to BPR

To qualify for BPR the business must not consist of wholly or mainly holding investments. Through case law this has been argued to be a greater than 50% test. Therefore, a diversified business which includes a rental business or active investments, will qualify for BPR on the combined business (including rentals/investments) if the rental/investment business is not greater than 50% of the overall combined business, looking at the value of the capital invested, turnover and profits as well as the time spent in each area. For CGT purposes, to claim holdover relief or entrepreneurs’ relief, the test is a ‘substantial’ test – greater than 80%.

The OTS recommended the BPR test should be aligned to the CGT test which, subject to businesses planning for this change, would result in many businesses ceasing to qualify for BPR.

  1. Removal of CGT uplift on death

On death no CGT is payable but the assets are uplifted to market value. Therefore assets can be sold shortly afterwards without CGT. Further, where an asset is exempted or relieved from IHT through APR/BPR the CGT uplift means the asset can be sold without either IHT or CGT payable. The ability to receive a CGT uplift on death can put people off passing assets on to the next generation during their lifetime. To remove this distortion the OTS recommend the CGT uplift is removed where a relief or exemption from IHT applies.

Since then, the all-parliamentary group (APPG) released their report, Reform of Inheritance Tax. The APPG recommendations go much further and include recommendations to:

  • Decrease the IHT rate from 40% to 10% for estates worth less than £2M
  • Decrease the IHT rate from 40% to 20% for estates worth more than £2M.
  • Annual gift allowance of £30K
  • An IHT rate of 10% on gifts in lifetime over the annual gift allowance
  • No further charge on lifetime gifts at death
  • Removal of the gift with reservation of benefit rules
  • To remove all reliefs including APR and BPR
  • To charge un-used pension funds
  • No CGT uplift on death
  • An annual charge for trusts

An example Phil, a widower, dies leaving his son a working farm worth £3M (currently qualifying for 100% BPR and APR). He also leaves his daughter his shares in his family’s fabrications business worth £1M (qualifying for 100% BPR) together with some cash and his house, which is not a farmhouse, to both of them jointly, together worth £650K.

Current regime: No tax on Phil’s death. The chargeable assets worth £650K (house and cash) fall within the two nil rate bands of him and his widow. The rest of the estate qualifies for APR and BPR. The children inherit the assets free of tax and at a rebased capital gains tax (CGT) value. CGT is the tax paid on the sale of assets so no CGT would be payable if Phil’s children decide to immediately sell the inherited assets.

New regime: £600K IHT liability. The total estate is £4.65M. After deducting the death allowance, 10% is payable on £2M (£200K) and the balance of £2M is taxed at 20% (£400K). The total IHT liability is £600K funded over ten years in interest free instalments of £60Kpa. There is no rebased CGT value so on a later sale of the business CGT is payable on the total gain since Phil’s acquisition.

Assume Phil makes a lifetime gift of his shares worth £1M to his daughter and survives three years.

Current regime: No tax in lifetime or death. Although Phil died within seven years, full BPR is available, provided daughter retained the shares in the unquoted trading company. No further IHT due on death.

New regime: £500K IHT liability. £100K tax is payable at 10% in ten yearly instalments on the lifetime gift. On death, after deduction of two nil rate bands, £3M is chargeable to tax on death, of which £2M is charged at 10% (£200K) and £1M is charged at 20% (£200K). By handing the shares on early, the rate of tax is less than keeping it until death (10% rather than 20%).

Whilst this radical reform would make IHT simpler, the removal of APR and BPR would have far reaching implications for business owners and those with estates worth more than £2M, resulting in IHT at 20%. Whilst the IHT would be payable over ten years, potentially interest-free, it would require businesses to generate sufficient profits to cover this or to take out borrowing, reducing capacity to invest in the business going forward.

Whilst there were no changes in the spring budget it is unlikely the recommendations will be ignored forever. The government is likely to consult on any major change to tax policy. However, given the increased need to raise funds, interim changes are expected. Therefore business owners should take advice and, where appropriate, consider banking the current APR and BPR by gifting property during lifetime, before the existing measures change.

If you require further support, or would like to discuss anything mentioned in the above article, please get in touch with your usual Albert Goodman contact.

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