If you have clients who own their own business, it’s highly likely you’ve had conversations with them about tax in the past few months.
For instance, those considering paying a dividend may be facing a higher charge following the change to dividend tax earlier this year. Meanwhile, recent legislation changes have restricted the amount of money they can invest in a personal pension while still keeping all of the associated tax benefits.
Fortunately, there are some solutions. Business owners and owner-managed businesses are increasingly turning towards government-approved tax-efficient investments. Investors can feel confident the tax benefits they claim are in return for helping UK smaller companies – an important part of our economy – to prosper.
And there is another area where financial advisers can add value for business-owning clients: when it comes time for them to sell their business. While the family business would usually be expected to be passed on free of inheritance tax (IHT), the client may leave behind an IHT liability in respect of the proceeds if they sells the business during their lifetime.
IHT planning
IHT is unlikely to have been much of a concern for clients who have been running their own business for many years. Their shares would most likely have qualified for Business Property Relief (BPR) upon their death, meaning the shares could have been passed on free from IHT.
When it was introduced in 1976, the main aim of BPR was to ensure a family-owned business could survive as a trading entity after the death of its owner without having to be sold or broken up to pay an IHT liability. Over time, successive governments have expanded BPR, and for the past two decades it has also been an investment incentive for private investors. Investments that qualify for BPR can be passed on free from IHT upon the death of the shareholder, provided the shares have been owned for at least two years. There is no maximum amount of investment that can qualify. As BPR has been expanded down the years, some of its finer points have changed. But the broad principle has always been that ‘relevant business property’ will receive relief from IHT.
However, with the sale of their business, a business owner could trigger a potential IHT liability on their estate practically overnight. Many business owners might be unaware that IHT exemption on their business is lost at the time the sale of the business is agreed, not when the deal has been signed and business ownership has been transferred.
Window of opportunity
If the client was in poor health, an adviser would likely urge caution against traditional forms of estate planning, such as gifts and trusts, which take seven years or more before becoming free from IHT. However, there is a three-year window during which time the proceeds of a business sale can be invested back into BPR-qualifying assets. Known as ‘replacement relief’, if the client invests some of the sale proceeds in a BPR-qualifying investment, they won’t have to wait two years – their investment will immediately be exempt from IHT.
BPR incentives
There are other benefits to consider. Whereas settling assets into trust or gifting permanently remove assets from the client’s ownership, shares in BPR-qualifying investments continue to be held in the client’s name. Subject to liquidity, investors can ask to sell shares and have the proceeds returned to them, or they can set up regular withdrawals to meet changing needs, such as care home fees. Also, BPR-qualifying investments do not use the nil-rate band. Investors can plan for their estate to use their £325,000 allowance to reduce the IHT charge on less liquid assets, such as their home, which are otherwise difficult to remove from the estate when planning for IHT.
This same approach could be applied for business-owning clients with other concerns. Take the example of a younger serial entrepreneur, who has sold a business and would like to take time out before reinvesting the proceeds into another business venture – the client could invest some or all of the sale proceeds in BPR-qualifying investments before deciding on their next course of action. This would make sure the estate was not exposed to an IHT bill in the intervening period, as well as providing the opportunity for the client’s next business to instantly qualify for BPR without resetting the two-year clock.
Settling assets into trust
If a client expects to realise a large lump sum on the disposal of their business, one of their first thoughts might be to make early provision for future generations. A discretionary trust can present an attractive opportunity to retain some control while starting to plan for IHT. As the client’s investment should qualify for replacement relief, they could decide to settle the new BPR-qualifying investment into trust (without needing to wait for two years first) and should not be required to pay the chargeable lifetime transfer charge of 20 per cent that would otherwise be due.
The client does not need to invest the total proceeds of the business sale in order for the investment to qualify for replacement relief. However, the estate will only be entitled to claim BPR on the qualifying shares held at the time of death. In order to be exempt from IHT, BPR-qualifying investments must have been held for at least two of the five years preceding death.
Understanding the risks
Of course, investments that qualify for BPR will not be suitable for everyone. Clients need to be made aware that their capital is at risk. It’s also important to bear in mind that BPR is a tax relief that works as an incentive to make higher risk investments.
The type of companies that qualify for BPR can rise or fall in value more significantly than those listed on the main market of the London Stock Exchange. Whether a client will benefit from the available tax reliefs will depend on their personal circumstances and could change in the future. It’s also worth bearing in mind that HM Revenue & Customs will only declare a BPR-qualifying investment free from IHT after the investor has died, or if the assets have been transferred into trust. Until this happens, it cannot be stated for certain that a particular company, or even a portfolio of companies, will qualify for BPR. Which is why it always makes sense to use the services of an investment manager with considerable experience of managing BPR-qualifying portfolios.
Working towards a stress-free retirement
Business owners may find themselves having to sell up for a number of different reasons, not just through ill health. Whatever the reason, it seems entirely fair that people who have worked hard to accumulate wealth through their business should be able to pass on as much of it as possible. BPR investments can allow them to invest in areas that appeal to them while protecting the IHT exempt status that their business used to enjoy. Your clients will then be able to enjoy their retirement, and the hard-earned fruits of their labours, while also feeling more assured that their families’ future is also being looked after.
Paul Latham is managing director at Octopus Investments
