Death Duties - What a Relief

Zac Lucas explores the potential pitfalls surrounding Inheritance Tax and highlights the limits of its application.

As readers may be aware, Inheritance Tax is chargeable both on gifts made during a person's lifetime, and following their death. Broadly, the tax is assessed on the value of the gift and depending on the circumstances, is charged at progressive rates, from 0% to 20% up to a top rate of 40%. However, sections 103 to 114 of the Inheritance Taxes Act 1984 provides relief where gifted assets, or assets comprised in a deceased's estate are considered 'relevant business property'.

With this in mind, business owners could reasonably consider that their best option is to hang on to the business until death, safe in the knowledge that no Inheritance Tax will be due. However, the relief is not as pervasive as it would first appear, and there are number of pitfalls by which it is either wholly withdrawn or made partially available. Set out below are some of the common circumstances by which this can occur.

Trade/investment business
It is important to recognise that relief only applies to a 'trade', either conducted solely, in partnership or via a trading company. It is not applicable to an investment business, where a typical example would be a property letting business that is conducted either by an individual or through an investment company.

Excepted Assets
Relief is restricted where assets, comprised in the business, are not used wholly or mainly for the purposes of the trade. A typical example is where a company property is occupied by a shareholder/director as a principal residence, or substantial cash reserves are held on deposit.

Binding contracts to sell the business
Relief is denied where 'relevant business property' is subject to a 'buy and sell' agreement; for example where partners or shareholders agree to sell and purchase their interests in the event of either parties death. In this case the deceased's Personal Representative will be obliged to sell their interests and the surviving partners/shareholders will likewise be obliged to purchase those interests. The Inland Revenue considers this a binding contract of sale, and as such the relevant business property is comprised in the sale proceeds and relief is denied.

Lifetime Gift Trap
Business property relief is available not only on the death of a business owner, but also on the occasion of any gift during the owner's lifetime. A typical example of this would be the giving of shares in an unquoted family company to the owner's children. Provided all conditions for the relief are satisfied, the gift would attract 100% business property relief, and as such no immediate Inheritance Tax implications would arise. However, if the donor of the shares were to die within a period of seven years of making the gift, and at that time the donee (children) did not then continue to hold the shares, business property relief would be withdrawn. This is a potentially catastrophic event for the donee of the gift since, depending on the value of the gifted shares (broadly, the loss to the donor's estate on making the gift), an Inheritance Tax charge would arise and would be payable by the donee.

Inheritance tax can have far reaching implications on business taxation. The above illustrates just some of the common circumstances by which the relief is either restricted or wholly denied and company owners are well advised to periodically review applicability of the relief, particularly prior to any major change to the business.

Zac Lucas is a solicitor in Russell-Cooke's Private Client department, where he specialises in inheritance, capital gains and income tax, and general tax planning.

This article first appeared in the January 2003 Edition of South East Business Magazine.