One of the things about managing a business that owners often forget to deal with until it’s too late is the potential impact of inheritance tax and the options for business property relief. In the tax year for 2020/21, HMRC collected just over £5 billion in inheritance tax.
As with all tax rules, there are legal options that you can take advantage of to reduce your liability. Planning these in advance can make a huge difference and give you peace of mind.
It’s important when considering your estate to take all your assets into account, including those relating to your business such as shares and assets in the alternative investment market.
Getting it wrong could mean that your business loses out to the HMRC rather than your assets going to those you intended.
Business property relief for inheritance tax allows you to get relief and protect the assets of your company, whether you own the company outright or have an interest in it. Business property relief was introduced in the 1970s as a way to protect companies that were being handed down through generations.
Effective estate planning is essential if your assets taken together are likely to exceed the current threshold of £325,000. Business property relief gives you greater control and the ability to plan for the future and exempts some assets from the IHT calculation entirely.
While a probate solicitor may well be able to help your executors maximise income through business property relief at the point when it is calculated, it pays to start the process much earlier to ensure there is no chance of an error.
Here we look at what inheritance tax is, how it’s calculated and when business property relief applies.
What is inheritance tax?
When you die, your property, money and possessions, including business assets, may be subject to inheritance tax. The threshold is £325,000 above which you need to pay tax.
If your assets do not meet this threshold, then those who inherit your estate do not have to pay anything to HMRC.
The value of assets can be difficult to determine, however, especially if you have elements such as a business, property and other assets in your portfolio.
That’s why it’s important to start estate planning as early as possible if you think you are reaching or likely to exceed the threshold.
The threshold itself can be increased if for example, you are leaving all assets to your spouse or civil partner. Certain reliefs can also be applied, for example, if you leave a certain percentage of your estate to charity you pay a lower tax rate.
How is inheritance tax calculated?
In general, the rules state that tax should be paid on any estate that is worth over £325,000. Below this mark, also known as the nil-band rate, you pay nothing.
Above the threshold, the rate is generally 40%.
For example, if your estate is worth £400,000, you would pay nothing on the first £325,000 but 40% on the remaining £75,000.
The IHT threshold rises to £500,000 if you are passing on your estate to your spouse or civil partner. This can be critical if you have a business asset, for example, that takes you over the normal threshold.
There are other ways to reduce IHT including through business property relief, which enables you to take certain assets, such as shareholdings, off the table either entirely or partially.
What does business relief apply to?
You can qualify for business relief if you:
- Own or have an interest in a qualifying business.
- Own shares in an unlisted qualifying business (whether majority or minority shareholder).
- Own shares in a qualifying business that has investments in the Alternative Investment Market.
To get business relief, you will need to have owned the business (in part or fully) or the business assets at least two years prior to your death.
This means that if you recently acquired a business and suddenly passed away, you may not be eligible for business property relief.
The exception to this is if you inherited the business or its assets from your spouse.
For businesses in the farming sector, agricultural property relief is normally available. If not, business relief may be a viable alternative.
How do you calculate business relief?
Business property relief calculations depend on the type of asset.
For example, if you own or have an interest in a business you can claim 100% relief. You can also claim the same relief for any unquoted shares through business relief.
If you have quoted shares and they give you control over the company in question, you can get 50% relief on their value. You can also get 50% business property relief on any land, property, machinery or plant that was used by the company immediately prior to the transfer following your death.
Business property relief can only be claimed after your death and must be handled by the named executor or executors.
They will need to fill out 2 forms:
- Form IHT400.
- Schedule IHT413.
Once the HMRC receives these forms, they can agree any adjustment to the IHT that needs to be paid from the individual’s estate.
Can a business be inherited?
If you own any business assets, whether they be property, shares or an interest in a company, you can pass these on through your last will and testament. If the recipients then decide to sell the business or its assets, they may be liable for capital gains tax.
Are Ltd companies exempt from Inheritance Tax?
Whether you own a small family business or have a shareholding in a limited company, the assets that belong to you are potentially subject to IHT and the status of the business has little or nothing to do with this.
What is the limit for inheritance tax?
The limit for IHT is £325,000, rising to £500,000 if you are passing on your assets to a spouse or civil partner. You can qualify for business property relief if your assets fall above this threshold.
Business relief is an important area to consider if you believe that your assets are likely to be calculated above the threshold when you die and they are passed on.
Understanding which assets qualify for business property relief can make a significant difference to the amount of IHT that you end up paying.