Tax Tuesday encapsulates some of the elements and benefits of inheritance tax this week, whilst acknowledging each situation will have its’ own considerations.
For inheritance tax purposes there is a generous relief called business property relief (BPR), which can cover up to 100% of the value of an unquoted trading company in the hands of its owners if certain conditions are met.
A fairly straightforward inheritance tax planning exercise in the right circumstances is for an individual to gift assets on which inheritance tax reliefs such as BPR do not apply (taking into account other tax implications such as the possibility of capital gains tax on certain gifts) and retain BPR -qualifying assets, such as shares in an unquoted trading company, until death.
Therefore, on death, assuming they have survived seven years from the time of the gifts of non-qualifying assets, these will fall outside of the ‘death estate’ while assets qualifying for 100% BPR will remain within their estate.
However, where the ‘business assets’ held by the owners are partially in the form of loans to their unquoted trading company rather than shares, BPR will not apply to the value of the loans.
Such loans may exist for any numbers of reasons; for instance, the owners may have sold their unincorporated business to the company with the amounts left owing by the company to them, to be paid off as profits arise. Or, they may have needed to lend money to help the company finance an investment such as the purchase of a new trading premises.
Therefore, in situations where the loans are significant in size at the time of a business owner’s death, an unexpected and unwelcome inheritance tax liability can sometimes arise.
The normal rate of inheritance tax on the value of assets not covered by a specific relief or the ‘nil rate band’ is 40%.
In some cases, preference shares, which can be structured to act very similarly to a loan in terms of the amounts and timings of ultimate repayment of the capital and the payment of interest, can have some commercial advantages over an ordinary loan. For instance, the terms can be formalised and officially included within the company’s capital structure along with the ordinary shares.
Preference shares held by a controlling shareholder can also have inheritance tax advantages over loans; if various conditions are met (including the usual two year minimum holding period), the value attaching to these preference shares will be fully covered by BPR.
From an administrative perspective it is relatively easy to issue, maintain and ultimately redeem preference shares and so it is not a complex exercise to convert loans to preference shares and hold ownership in this manner going forward.
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