How to minimise IHT on a family business

One very important point to check is that your interest in the business will qualify for business property relief (BPR) from inheritance tax. Your business may have begun life very clearly as a trading company, and so you may have been led to believe that BPR will be fully available, enabling you to pass on your shares to your beneficiaries free of IHT. However, it is common for the nature or structure of a business to alter over time.

Suppose, for example, that when you had surplus cash in the business some years ago you bought a series of properties that have been let and have generated a very attractive rate of return over the years. It may even be that you have focused more on the property side of things recently as trading conditions for your business have become much tougher.

For your shares to qualify for BPR your company must be wholly or mainly a trading entity. So, if the pendulum has swung too far towards investment properties HMRC may, on your death, want to tax the entire value of your shares at 40 per cent, including that attributable to the trading elements.

If you are married then you may have a straightforward will leaving everything to your spouse if you die first. There is nothing wrong with that – or is there? It does have the advantage of simplicity, but you run the risk of wasting the IHT relief. Everything you leave to your spouse is exempt from IHT anyway assuming that you are both domiciled in the UK. So, by leaving your relieved shares to your spouse you waste the relief.

Suppose your spouse then sells the shares, the cash sale proceeds will be fully chargeable to IHT and so your children will bear IHT at 40 per cent on your spouse’s subsequent death on value which you could have passed on at no cost.

Including a specific gift in your will to pass your shares to a discretionary trust for your spouse, and your children can have the best of both worlds – your estate can claim the BPR and your spouse can still benefit from the shares themselves or from the proceeds of their sale. If the shares have been sold then their cash value should be ring-fenced from any charge to IHT on your spouse’s death.

Another way in which the availability of BPR may be restricted is if there is more cash in the business than is reasonably required for the genuine purposes of the business. This could be the subject of a negotiation with HMRC, and the more evidence you can provide to support a business need for larger cash amounts, the better.

For example, Richard and Belinda each own 50 per cent of the shares in an electrical manufacturing company, RB Electric Components. The business is currently worth around £5m. The company also holds some investment properties, and last year the income generated was roughly 50/50 from both sides of the business.

The investment properties represent 55 per cent of the company’s fixed assets. Neither Richard nor Belinda are married. Richard has a director’s loan of £1m, so the total share value is reduced to £4m after this liability has been taken into account. Each of Richard’s and Belinda’s shareholdings are therefore worth £2m.

Leaving your business interests to the next generation under a trust structure introduces a number of additional factors to consider.

Absolutely key to making this structure work is your choice of trustees. While trustees do not necessarily need to have any legal or accounting knowledge, as they can pay professionals for this, they do need to have a healthy quota of common sense, and it is imperative they are able to work well with each other.

Using a trust structure also means you can keep your shares together as a single holding and still benefit a large group of people – usually your spouse, children and grandchildren.

The role of trustee is not one to be accepted lightly. It can bring with it some onerous duties and responsibilities. In particular, the trustees’ duty is to maximise the benefit their beneficiaries receive.

Frances Davies is partner and head of private client at law firm Gordons LLP

CASE STUDY

With no planning:

If Richard were to die the IHT position would be as follows:

With no planning the director’s loan would be fully taxable – IHT of £400,000.

HMRC may deny IHT relief on the shares, so Richard’s shares would be taxable at 40 per cent – giving rise to a further IHT charge of £800,000.

Total IHT £1.2m.

With planning:

Assume Richard’s loan account has been converted into additional shares and that the two elements of the company have been separated.

Each company is now worth £1.5m.

Provided HMRC is satisfied that all the cash in the trading business has a genuine reason to be there, they will allow the BPR claim on the shares in the electrical company.

The total IHT charge will therefore be reduced to £600,000.

KEY POINTS

It is very easy to ignore putting in place suitable provisions to ensure that maximum value from a family business can be passed on to one’s heirs.

If you are married then you may have a straightforward will leaving everything to your spouse if you die first.

The role of trustee is not one to be accepted lightly.