We meet with many clients who agonise over what to do with their business on death. The transition of the family business from one generation to the next can be a complex process but having no plan at all or an ill-conceived plan can be disastrous for the business itself and could leave your estate with a hefty Inheritance Tax bill.
What is the ultimate intention for your business?
Do you want to leave your family the value that you have built up in the business or do you envisage the business continuing with family members running it?
Once the overall intention has been agreed upon, it will then be necessary to look at the legal framework of the business. Limited companies will be governed by their Articles of Association and/or shareholders agreement which will already determine what should happen to the shares on the death of a shareholder. Commonly these agreements will offer the shares of a deceased owner to the other members, known as a right of pre-emption. This needs to be carefully considered if you want your shares to pass to a family member who may not currently own shares in the business.
It is also time to consider shareholder protection policies and linking these to double option arrangements which take effect upon the death of a shareholder.
Business Property Relief (BPR)
Having established the end goal then you can start to consider the most tax-efficient way of passing on the business and much will be determined by the availability of Business Property Relief (BPR). If BPR is available then shares in a private company can be transferred on death free of Inheritance Tax. This is a valuable relief that should not be wasted.
Many assume that their interest in the company will automatically qualify for BPR. Although the relief is generous, HMRC will look closely at the nature of the business and its assets and there are many traps that you can easily fall foul of.
Common traps
1. We often see clients that have incorporated their business but kept assets outside of the ownership of the limited company. Of course, there may be many good reasons why you would do this but it is important to understand how BPR will work in this instance. As the rules stand, assets that are used in the business but which are not owned by the company itself will attract relief at a rate of 50% rather than 100%. Commonly, it is the main asset of the company i.e. its premises.
2. As a company grows or the landscape surrounding the business changes, owners may start to diversify. Clients may choose to set up different companies for each arm of the business e.g. one company for the part which continues to trade and another company for the part which holds investment property. In this instance, there is a real risk that the part of the business that consists of investment activity will jeopardise the whole company group from qualifying for BPR.
3. Another common trap which business owners may fall foul of is by holding large cash reserves in the business that have not been earmarked for trade or future investment in the business. This may happen where shareholders accumulate the profits to mitigate higher rates of Income Tax whilst unknowingly jeopardising BPR.
It is also important to note that the terms of the Will itself may mean that you fall foul of the BPR rules.
For example
Martin is the sole shareholder in his company. Over recent years, Martin’s son, Thomas, has started to show an interest in the business. Martin would like Thomas to continue in the family business after his death and to build on what he has started.
Martin, therefore, decides to make a specific gift of cash and the family home to his wife, Sarah, and leave the shares in his company into his residuary estate which is to pass to Thomas.
On Martin’s death, the cash gift and the family home pass to Sarah and are deemed to be exempt from Inheritance Tax because Sarah is his spouse. The business qualifies in its entirety for BPR. The family, therefore, assume that there should be no Inheritance Tax to pay.
Unfortunately, Martin has failed to take account of a little-known trap called the ‘spreading provisions’. These provisions operate to reallocate any BPR that is left to the residuary estate against the specific legacies. In this instance, the BPR is wasted against assets that are already exempt from Inheritance Tax due to the spouse exemption.
Seek professional advice
Helen Salisbury is a Partner in our expert Wills & Probate team, specialising in Wills, Inheritance Tax planning, administration of estates, grants of Probate, and Powers of Attorney.
It is therefore important that you seek professional advice when considering business succession planning to ensure that you do not waste any of the relief and more importantly do not inadvertently increase your Inheritance Tax liability. We can guide you through the process and will consider your company documents to ensure that your wishes can actually take effect.
For more information please call 0800 024 1976 or contact us via our online enquiry form and ask to speak to a member of our expert Wills and Probate team.
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