Business Property Relief: A window of opportunity for business owners considering a business sale
Most successful business owners are, understandably, focused on running and growing their business, but this often comes at the expense of putting effective estate planning measures in place. This can prove costly in tax terms, particularly so in the case of a sale. Whilst a business owner is likely to take appropriate professional advice from a corporate perspective when negotiating a sale of the business, it's also important to take personal advice in advance on how best to structure that sale for the benefit of themselves and their family. The inevitable result is that many business owners find themselves with significant cash proceeds on which inheritance tax (IHT) would be charged, at 40%, on death, whereas if the right planning had been undertaken in advance, some or all of the sale proceeds could have been sheltered from IHT and protected for future generations.
A Valuable Relief
The key to this is a very valuable relief from IHT, known as Business Property Relief (BPR). Subject to certain conditions (broadly, the business must be trading rather than investment in nature and the business, or shares in the business, must have been owned for at least two years), BPR relieves 100% of the value of the shares from IHT. This means that a business owner can undertake estate planning in advance of a sale, largely free of any IHT constraints, which is simply not possible with the cash proceeds, which would not benefit from any IHT relief at all.
A Window of Opportunity
Prior to a sale, therefore, there is a window of opportunity for a business owner to remove significant value from their estate at no IHT cost. This may be by way of outright gifting or by the transfer of a proportion of the business/shares to a family trust.
There are two key advantages to planning with trusts, when compared with outright gifting. The first is the ability for the business owner to retain control over the shares, and ultimately the sale proceeds, as a trustee (albeit without benefitting personally from them). The second is the asset protection benefits which such a trust structure may offer in the event of, for example, a divorce or bankruptcy of a family member, or perhaps family members simply developing extravagant spending habits.
Whilst, post-sale, cash of only £325,000 (the current IHT nil rate band) could be transferred to a family trust without incurring an immediate 20% IHT charge, there is no such limit where the assets being transferred qualify for 100% BPR. So it is important that the transfer to the trust happens before the sale of the business is completed. Provided the business owner survives the transfer into trust by seven years, the value transferred will fall entirely out of their estate for IHT purposes.
Capital Gains Tax Considerations
There is another tax at play in pre-sale planning, and this is capital gains tax (CGT). Most business owners will be aware that a sale of a business/shares in the business will give rise to a CGT liability on the difference between the sale price and the original cost of the shares, at a current rate of 20%. A transfer of shares into trust is also a disposal for CGT, but often the tax can be deferred until the sale is completed.
Whether it will be appropriate to defer the CGT may be influenced, in part, by the availability of Business Asset Disposal Relief (BADR, formerly known as Entrepreneurs Relief). Provided certain conditions are met, BADR serves to reduce the rate of CGT to 10%, subject to a lifetime cap of £1 million of gains per individual. Whilst trustees can in principle benefit from BADR, the trust will have to be structured in such a way that a beneficiary who is entitled to the income from the trust satisfies the qualifying conditions for BADR, which is not always possible, so the business owner may choose to pay, rather than defer, the CGT on making the transfer into trust. Either way, it is important that both IHT and CGT planning are considered together.
There has been much speculation in recent years about whether fundamental changes will be made to the IHT rules and, if so, whether BPR could be withdrawn, or at least changed given it's very generous nature. The Treasury responded on 30 November 2021 to reviews led by the Office of Tax Simplification into the technical design of IHT, including suggestions to simplify lifetime gift exemptions and change the scope of reliefs including BPR and agricultural property relief. Clients and advisors will be relieved to note that the response has confirmed that the Government has decided not to proceed with any related changes for the time being.
It would nevertheless be prudent for business owners who intend to share the spoils of their hard work with their families, to address this sooner rather than later, and certainly in advance of a sale, so that their affairs can be structured as tax efficiently as possible and maximum advantage can be taken of all available reliefs.
The law is complex and the advice you require will depend on your personal circumstances. This article is for general guidance only. We cannot, therefore, accept any responsibility for actions taken on the basis of this article alone.