There are many grey areas to be aware of when looking to business property relief: a form of inheritance tax relief
Two recent First-tier Tax Tribunal decisions, with somewhat contradictory outcomes, have addressed the question of whether a business is classified as an investment or trading one.
The difference is important, as the former does not qualify for business property relief, while the latter can, subject to proportionate reduction to the extent there are excepted assets in the business.
The first case – Executors of the Estate of M Ross (deceased) v HM Revenue & Customs  UKFTT 507 (Ross v HMRC) – concerned a furnished holiday let business.
Eight holiday cottages in Cornwall were let as self-catering units. They were adjacent to a hotel which the deceased had previously owned. The guests from these units were allowed to take advantage of some of the hotel’s amenities – for instance, they could order bar snacks and take breakfast there. Various other additional services were offered, such as a mid-week clean and change of bed linen.
The executors of the estate argued that the provision of all these extras changed the character of the business from being one which was mainly an investment in land to one providing a holiday experience, and that the investment in land was a subordinate part, therefore the business qualified for business relief.
However, the Tribunal did not agree. While they accepted the level of services was more extensive than those provided in other furnished holiday let businesses where business relief was denied, they concluded the essence of the activity remained the exploitation of land in return for rent.
The second decision – The Personal Representatives of the Estate of Maureen W Vigne v HMRC  UKFTT 632 (Vigne v HMRC) – concerned a livery stable business on a large piece of land.
The personal representatives of Mrs Vigne argued that her business was significantly more than merely letting or licensing the land for use by the horse owners as she provided valuable additional services, such as health checks of the horses, providing them with hay and worming products, and removing manure from the fields.
In this case the Tribunal accepted the argument and concluded that “no properly informed observer could have said that the deceased was in the business of just holding investments”. It should be added the personal representatives alternatively claimed agricultural property relief but this claim was rejected.
As always, each case was decided on its particular facts. However, there was one interesting point made by the Tribunal in the Vigne case.
Rather than starting with the assumption that a business based on a holding of property is one of making or holding investments, and working out whether any factors have changed that view, the correct approach is to establish the facts before determining whether the business is as such.
Even if it was decided that a business passed this fundamental first test, there could still be partial denial to the extent the business has assets not used in it.
Another way in which business relief can be denied on death is through the use of the wrong type of share purchase agreement.
Although the objective of agreements for the sale and purchase of a share in a business between owners following the death of one of them is that the surviving owners will buy and the personal representatives will sell the deceased’s share, the terms of the agreement should not be obligatory.
This is because the Capital Taxes Office (now HMRC) regarded such an agreement as forming a binding contract for sale and thus made the transfer of shares on death ineligible for business relief for IHT purposes.
Of course, it may not matter if the share of the business were to pass to the deceased’s spouse, but for other IHT planning reasons the transfer of the share under a will may well not be to the spouse; possibly into a trust.
Fortunately, however, HMRC accepts a double option agreement is not a binding contract for sale and does not prejudice business property relief (Statement of Practice SP12/80).
This is even though the result of the double option agreement is that as long as one party to the agreement exercises their right to sell or purchase, the other will be bound to comply. Unless both parties decide not to exercise their options, the practical effect of the agreement is the same as a buy and sell agreement but eligibility for business relief is retained.
HMRC was asked for comments on several possible wordings for agreements in an exchange of correspondence between the Inland Revenue and the Accountancy Bodies in 1984, in which guidelines were formulated as to the circumstances in which business relief was accepted as being available.
There is a specific reference to a “double option agreement entered into under which the surviving partners have an option to buy (a call option) and the personal representatives an option to sell (a put option), such options to be exercised within a stated period after the partner’s death”.
Sometimes it is felt there may be a stronger argument in favour of the option agreement not being binding if the option periods for purchase and sale are not identical – for example, an option to sell for six months and an option to buy for three months from the date of death. That said, there is nothing in the correspondence with the Inland Revenue to indicate it would attach any particular importance to the length of the option period.
There was concern that the decision in Spiro v Glencrown (1991) provided authority for an option to be a contract for sale, thereby resulting in no business relief being available. Early in 1996, the Capital Taxes Office confirmed there had been no change in its opinion regarding SP12/80 and that the case would not be cited as an authority for an option constituting a binding contract for sale.
The more recent case of Griffin v Citibank Investments Ltd (2000) provides an even stronger argument that a put and call option in identical terms together do not constitute a single bilateral contract. The case had nothing to do with arrangements for share purchase between partners but it did concern two identical options and is of particular relevance for this reason.
Citibank Investments Ltd in December 1994 sought an investment that would generate funds in the form of capital gains rather than as income liable to corporation tax. It purchased two FTSE linked options, on terms that all transactions entered into on reliance of the purchase agreement formed a single transaction. Corporation tax was then assessed for 1994, 1995 and 1996 on the gains arising from the two option contracts.
On appeal to the Special Commissioners, Citibank Investments Ltd contended successfully that the gains arising from the options fell to be treated as capital gains rather than as profits or gains chargeable to tax under Schedule D. The Inland Revenue then appealed the Commissioners´ decision.
The Inland Revenue conceded that each of the two options, if taken separately, would be a “qualifying option” within the meaning of section 128 ICTA 1988 and accordingly any gains would have been exempted from a charge to tax.
However, if the two options fell to be treated as one composite transaction by the operation of the Ramsay principle (which basically means the court should not confine itself to the method of assessing the tax consequences of each individual transaction in a composite transaction, but instead should look at the composite result and consequences), as was the Revenue´s contention, that would fail to satisfy the statutory definition of a qualifying option within the meaning of section 128.
The court dismissed the appeal and found the Commissioners had not misdirected themselves in finding the two option contracts did not constitute a composite transaction.
The position is clear that cross option agreements do not constitute binding contracts and do not, of themselves, deny the availability of business relief.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn