Inheritance Tax (IHT) is chargeable on the value of an estate when someone dies, although it could also be chargeable on certain lifetime transfers, as well on property held within a relevant property trust. The rate of tax is 40% above a certain exempt amount, and there are various reliefs and exemptions. It is widely understood that shares in an unlisted company qualify for full IHT relief (Business Property Relief – “BPR”), but what are the rules regarding investment and non-trading interests?
Know the rules
There is an important condition in the sense that shares of an unlisted company will not qualify for BPR where the business carried on by the company consists wholly or mainly of one of the following; dealing in securities, stocks or shares, land or buildings, or making or holding investments. Where a company has more than one activity, it is essential to evaluate whether there is a qualifying business activity which represents the “core” value of the company and group. If the core value is attributable to say a commercial property letting business, it is unlikely that there would be any relief from IHT on the basis that the company’s business consists wholly or mainly in the “making or holding of investments”. On the other hand, it is worth noting that companies whose business is wholly or mainly for instance property development, construction, property management services (along with many other sectors) could qualify for relief.
Assuming that there is a qualifying business activity in the first instance (and which represents the whole or main, i.e. greater than 50%, part of the company’s or group’s total operations and interests), there is a further condition which states that Inheritance Tax relief cannot be given to the value of any “excepted assets”. These assets must not have been used wholly or mainly for the purposes of the business in question throughout the previous 2 years (or less depending on when the company acquired the asset). In addition, these assets must not have been required at the time of the transfer of value for future use, for the purposes of the business.
Surplus cash on deposit could therefore be a risk, if it is not required for present or future purposes (which could be challenged if it is not earmarked for a specific project or purpose). This could ultimately result in IHT being chargeable on the value of shares in a company, attributable to such excepted assets! This may be relevant for companies and groups which have accumulated large cash deposits.
Hybrid business activity
The concept of a “hybrid business activity” is often overlooked and could be very valuable to maximise IHT relief. Where a company has investment interests, it is necessary to ascertain whether these are held as part of a hybrid business activity.
If the hybrid business activity has a qualifying activity (generally a trade) which forms the “main” part of the overall business value, it is held that the “excepted assets rule” cannot apply.
Let’s use the example concerning surplus cash. If this cash is being actively managed to generate investment returns (interest or dividends from stocks and shares), it could be argued that there is a “hybrid” business activity, which may result in full relief.
Another example of where these rules may also apply is in the event a property development or trading company decides to rent out units, or alternatively where a trading company lets out surplus space. This is based on the assumption that the letting activity constitutes a “business” – which means that there must be a certain degree of activity, so bear that in mind.
In the above examples, there is of course a connection between the activities. For instance, the surplus cash being actively managed initially arose from a trading or qualifying activity.
In the rental example, the company letting out surplus space or accommodation would be likely using the remaining space or accommodation for trading or qualifying activity purposes.
But what would be the position if a company with surplus cash purchases an investment property for use as part of a property business activity? Could there still be a “hybrid” business activity if there is no connection between the activities?
The following comment from the case of Privy Council in American Leaf Co vs Director General (1979) may provide some authority on this: “In the case of a company incorporated for the purpose of making profits for its shareholders, any gainful use to which it puts any of its assets prima facie amounts to the carrying on of a business.”
Get your affairs in order
It is a useful reminder that Inheritance Tax is complex legislation, and the conditions for relief must be observed very carefully. There may be useful planning opportunities to increase the level of IHT relief which may otherwise be permitted. Equally, there may be planning opportunities to protect existing interests which currently qualify for relief, from being tainted. With the nil rate band (IHT exemption threshold) of £325k having been frozen since 2009 (despite inflation), together with a complex area of IHT law, and a 40% tax rate, it is essential that individuals get their affairs in order.