IHT Business Relief – how it works

IHT Business Relief – how it works

Business Relief (BR) is a valuable relief from Inheritance Tax (IHT) for business owners. Its purpose is to reduce IHT charges arising on the transfer of qualifying business interests during a person’s lifetime or on their death to allow the business to continue. In many circumstances it can mean that a business can be passed on free of IHT.

It is vital to consider the availability of BR proactively in the context of a business owners’ succession or wider estate planning, for example, when the owner wishes to pass the business to the next generation or a family trust. 

  • The basic rules
  • Excepted assets
  • Clawback of relief
  • Relaxation of two-year holding requirement

The basic rules of Business Relief

BR reduces the value of gifts of Relevant Business Property (RBP), made during lifetime or on death, for the purposes of calculating any IHT due on those gifts. The reduction in value will be either 100% or 50%, depending on the type of asset and ownership. 

In broad overview, the conditions for an asset to qualify as RBP are:

  1. The assets include a business (carried on by a sole trader or interest in a partnership), shares in an unquoted company or assets held personally used in a qualifying business. 
  2. Ownership throughout the two-year period leading up to the transfer.
  3. The business must be carried on with the intention of making a profit.
  4. There is not a binding contract for sale of the asset.
  5. Companies must not be in liquidation or winding up.
  6. The business must not consist “wholly or mainly” of dealing in shares, land or buildings or making or holding of investments.

All these tests need to be passed at the time of the gift (i.e. when a lifetime gift is made or on death) for the asset to qualify for relief.

It is common to refer to a qualifying business as ‘trading’ although the provisions are slightly nuanced in that any shareholding in an unlisted company can qualify for BR unless it undertakes a disqualifying activity (see 6 above). It is a different test compared to capital gains tax (CGT) Business Asset Disposal Relief or the corporation tax Substantial Shareholdings Exemption, but some principles are similar. 

Relief is available for a controlling interest in a quoted company, but such circumstances are rare. Shares listed on AIM are treated as unquoted for these purposes. 

Excepted assets

Once you have confirmed that an asset is RBP, it is necessary to consider if there are any excepted assets within the business / company. 

The value of any excepted assets is left out of account for the purposes of BR (i.e. they remain chargeable to IHT). Excepted assets are any assets not used wholly or mainly for the purposes of the business and not required for future use in the business.

This would include assets held within a business / company for personal use (e.g. property investments) and could also include large cash balances where the cash is not required for current or future business purposes. 

If there are excepted assets within the business, BR can still be available but it will be reduced proportionally so that no relief is given for the excepted assets. 

In some cases, a ‘hybrid’ trading and investment business may qualify in full for BR. 

There is clawback of BR in certain circumstances, for example on lifetime gifts if the person dies within seven years and the recipient no longer owns the property or if the asset no longer qualifies as RBP.

Relaxation of two-year holding requirement

If RBP is transferred from one spouse or civil partner to the other on death, the survivor is automatically credited with the ownership period of the deceased spouse or civil partner. 

There is also a relaxation of the two-year holding requirement when RBP is replaced by new property, that is also RBP, within five years.

Recommended action for business owners

Business owners should regularly review their business operations to check the BR position and plan accordingly. Actions can potentially be taken to ensure or enhance the BR qualifying status. 

It is possible in some circumstance to apply to HMRC for advance clearance on the availability of BR. This can only be done however, where a chargeable transfer is being contemplated, e.g. a transfer to trust. A holdover relief claim for CGT can also be made at the same time so there is no CGT on the transfer of an asset to a trust.

Entrepreneurs should be mindful of the replacement property rules, which relax the two-year holding requirement, as long as the new property is acquired within five years.

Read our article on protecting your family's assets.

How BDO can help

For help and advice on any Business Relief or IHT issue please contact Ben Handley or Tim Lynch.

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