For well over 30 years, death has actually been an effective form of inheritance tax (IHT) planning with business assets (such as shares in a trading company or farmland and farm buildings) passing free of IHT on death. However Chancellor Rachel Reeves’ first budget has ushered in some significant changes to Agricultural Property Relief (APR) and Business Property Relief (BPR) that are going to cause alarm in the family business and farming communities.
What Was The Pre-Budget Position?
Prior to the budget, APR and BPR provided a 100% relief from any IHT liability for certain assets. For APR, this comprises agricultural property, including farmland and certain buildings if they are used for farming or agriculture, and for BPR, this includes qualifying business assets, such as shares in unlisted trading (not investment) companies, sole trader businesses, and interests in some partnerships.
The effect of APR and BPR was that the relevant assets did not attract any form of IHT and as such, on death, those assets could be passed on to spouses or to the next generation free of any IHT liability.
What Has Changed?
APR and BPR will remain, but the 100% relief now only applies to the first £1m of relevant assets per estate (i.e. per person). Beyond the first £1m, the 100% relief is reduced to 50% meaning any value above that attracts IHT at the 40% rate, albeit discounted by 50%. This gives an effective IHT charge of 20% on all relevant business assets above £1m.
By way of example, if someone dies holding shares that are worth £3m (which would have historical qualified for BPR), then there is no IHT on the first £1m but the IHT charge on the £2m balance would, at the effective rate of 20%, be £400,000. Prior to the budget, the IHT charge in the same scenario would have been £0.
What Does This Mean For Family Businesses?
This is a significant change for any family business or farming business, and one that goes against well-established tax planning advice that has stood for the past 30+ years, and long-standing principles that many family businesses will have adopted (e.g. wills between couples that simply leave everything to one another on the first death, and to children on the second death).
Additionally, any potential IHT will need to be funded. HMRC usually allow IHT to be paid over a period of up to 10 years, but HMRC do charge interest which currently stands at circa 7%. This means the IHT either needs to be paid from other assets in the estate of the deceased (reducing what is immediately available for distribution to beneficiaries), needs to be financed by the business (where a £400k liability on a business valued at £3m is significant), needs to be funded, along with interest, over time out of the cash flow of the business (a potentially significant long term overhead), or in the worst case scenario, may involve selling off assets (e.g. farmland in the context of farmers) to meet the liability, although this is more difficult for a traditional trading business where it may be virtually impossible to simply sell off part of the business.
So what should family businesses be doing now and what trends will we see going forward?
Whilst we are still waiting for the final form of the relevant legislation and digesting the finer detail of the proposed changes, family businesses will need to look at what arrangements they currently have in place and take advice on what may need to change.
Valuation
First and foremost, there is a need to understand the value of the business concerned. This may involve speaking to the business’ accountants to understand what the business is worth and what each individual shareholding may be valued at on death. Share valuations can be complex and depend on whether the interest held by each individual in the family business constitutes a majority or a minority interest. Minority interests are often valued on a “discounted” basis, which for IHT purposes helps reduce down the value of the shares held by the deceased below the figure that a straight-line pro-rata valuation would give. The lower the valuation, the lower the IHT exposure will be. Understanding the business valuation and the valuation of each individual’s shareholding helps understand if there is a potential issue as a result of the changes announced in the October 2024 budget, and if so, the potential size of the issue and IHT exposure.
For example, a £3m business where the shares are split equally 5 ways between say mum, dad and 3 children, does not pose an issue at this point in time as each individual shareholding will be less than £1m. However, if you have a company valued at £10m, where the shares are simply held between spouses, then that presents a potential IHT issue under the new rules.
Wills Will Need To Be Reviewed
Wills which simply leave everything between spouses on the first death may no longer be appropriate. By way of illustration, if a husband and wife each own 50% of a family business worth £2m (simplistically £1m worth of shares each) then if the husband were to die, there would be no IHT charge on his £1m interest in the family business, if this was left to his wife under his will. However, at that point the wife would hold shares worth £2m, so if she were to subsequently die, there would be a £200,000 IHT charge on her death.
Updated wills could provide that on the death of mum or dad, the shares are left direct to the children instead of being left to their surviving spouse. In that scenario if husband were to die first and leaves his £1m worth of shares to the children, then there would be no IHT charge on his death, and that would leave his wife with shares worth only £1m. As such, on her death there would be no IHT charge if she then left her shares under her will, to the children.
Many wills that are already in place, particularly for business owners, will probably include some form of trust (often referred to as a “will trust” or “business property trust”), which comes into existence on death. These are designed to take in assets (such as shares in a family business) that are exempt from IHT. Given the changes, these may no longer be suitable, particularly where the value of the shares is in excess of £1m and therefore still attract a IHT liability. Accordingly, reviewing wills is an absolute must for anyone holding shares in a family business.
Succession Will Need To Be Discussed
Discussions around succession (and in particular the transfer of ownership – which may be different to day-to-day control or management) may need to be advanced. As a general rule, if a person gifts assets and then survives 7 years, then the gift of the assets is what is known as a Potentially Exempt Transfer (PET) and, providing they survive 7 years, the value of the assets won’t form part of their estate for IHT purposes. As a result, there is probably going to be a trend of gifting assets down to the next generation much earlier on as a PET to try and make the most of this “7 year rule”.
Transfers of assets between spouses are also exempt. Therefore, if say one person holds most of the shares in a family business, then it is worth considering a transfer of some of those shares to their spouse, so each can make use of the first £1m free of IHT.
This means family businesses will now have to actively discuss and plan ahead for succession of ownership, rather than simply waiting until someone passes. If it is agreed, ownership is to transfer early to the next generation, but day-to-day control or management, is to remain with the current generation. Articles of Association for the company, and Shareholders’ Agreements will then need to be drawn up (or updated if they already exist) to reflect the newly agreed structures and provide each generation with the appropriate protections.
Insurance Could Potentially Help
Insurance is something else to be considered. A life insurance policy could potentially provide the necessary funds to cover any IHT liability on family business or agricultural assets, without this having to be funded from ether the family business or elsewhere in the estate. Whilst there will be premiums payable that will be a cost to the business, and potentially, a benefit in kind for the individuals concerned, the premiums could well be far less than having to find 20% of everything over £1m. On the flip side, as we all know, insurance premiums increase as we get older and are impacted by medical conditions (such that for some, the insurance premiums will simply be too high to justify paying), however for the younger generation with a clean bill of health, this may be cost effective solution to provide some comfort that IHT is not going to be an issue if something unexpected were to happen.
Trusts
Trusts are another complex area but have historically been widely used in IHT planning. The usefulness of Trusts for IHT planning going forward, will very much depend on the small print following on from the budget, as the budget did hint at some specific measures aimed at trusts, which would potentially limit their usefulness. An example here was a budget announcement that for trusts set up prior to 30/10/2024, each trust would have the benefit of the £1mallowance, whereas going forward, the £1m allowance would be split across all trusts set up by an individual post 30/10/2024. This area is very much “watch this space”.
Articles Of Association And Different Classes Of Shares
Family Investment Companies (known as FICs) have share structures where typically the older generation have voting control via their shares, whereas the next generation tend to have shares that carry the capital value of the FIC and its assets/investments. These are established structures suitable for investments and wealth management and form an integral part of IHT planning – if done correctly.
However, simply trying to mirror these types of provisions in an established trading company, where everyone simply holds “ordinary shares” is potentially fraught with danger, and if done incorrectly, may even lead to triggering tax charges in excess of the IHT effective rate of 20%. This is because, suddenly, reclassifying a full capital and full voting share into, say, a voting only share with no capital rights, could actually be deemed to be “value shifting” or a “deemed disposal” which would trigger other tax liabilities.
Take Advice
Above all else, this is a complex area, where rushing to do something, or doing something in isolation, may not work as envisaged or could result in unintended consequences.
It is therefore vital that any agricultural or family businesses seek advice from professionals such as accountants, lawyers and independent financial advisors, who can advise holistically and in a joined up approach on firstly identifying any issues arising out of the October 2024 budget, and then explore the best options (which could include a package of different measures such as updated wills, gifting of shares, life insurance and the set-up of a trust) to help address the issues arising from Chancellor Rachel Reeves’ first budget.
About The Author - Christian Mancier is a partner at Gorvins and head of the Family Business team. Find out more by visiting their website here
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