Last week I looked at the detrimental effect holding excess cash in a business can have on business relief for inheritance tax purposes.
Such cash held without an identifiable business purpose attached to it is likely to represent an excepted asset, which will result in a proportionate denial of business relief.
Simply put, if 20 per cent of the company’s assets was represented by cash with no identifiable business purpose, then only 80 per cent of the share value would qualify for business relief.
So how about the “small faces” test I referred to last week? The all or nothing test for business relief?
Not by halves
First, let me remind you that, in relation to corporate structures, 100 per cent business relief potentially applies to all unquoted shareholdings in qualifying trading companies.
Business relief is available to both working and passive shareholders. It is a misconception that you need to be a director or work full-time in the company. And there is no minimum shareholding requirement, which means holdings of all sizes can qualify. Lastly, it is possible for non-voting and preference shares to attract relief, so it is not just ordinary voting shares that qualify.
Business relief works to reduce the value of the asset (shares) transferred to nil. However, it can also be restricted, which I would like to look at now, with a special focus on cash.
Before addressing the potential impact cash can have on business relief, though, it is worth restating the relevant shareholding must be held for at least two years prior to the transfer/death to qualify.
This two-year holding rule would seem to be there to prevent relief being obtained on pre-deathbed acquisitions of shares. However, where the shares are acquired on the death of a spouse/civil partner (but not on a lifetime transfer) the deceased’s period of ownership also counts towards the two-year minimum ownership period (section 108(b) Inheritance Tax Act 1984).
Another non-cash-related issue to consider is that there will be no business relief if a binding contract for the sale of the shares has been entered into at the time of the transfer or death, unless this is part of a company reconstruction or amalgamation. This can be especially relevant in relation to share succession arrangements. It is quite easy for the “buy/sell” agreement to be in binding format (that is, “will sell/will buy”).
This will be enough to deny business relief, which would be very relevant if the shares are left to anything other than a surviving spouse or civil partner: for example, into a “by-pass” trust.
The advantage of advice
The benefit of informed advice in this area of financial planning is very clear. You need to get the right cross option agreement and the right trust, together with the right life cover, to ensure you achieve your tax objective effectively.
As mentioned above, business relief-eligible companies are referred to as qualifying trading companies. The starting position reflected by legislation is that all shareholdings are eligible for business relief unless the company’s business consists wholly or mainly of:
- Dealing in securities, stocks or shares, land or buildings; or
- Making or holding investments (subject to an important exception for qualifying holding companies).
Business relief has thus been recently denied for property letting activities, even where the landlord provided some services. It has also been refused on a furnished holiday letting business on the basis the few services provided by the taxpayer were “unlikely to be material” and “insufficient to prevent the business being mainly one of property investment”.
As I have indicated above, the trading or not test is determined on an all or nothing basis: the shareholding either qualifies in full (subject to the excepted assets exclusion – very relevant in relation to cash) or it does not.
It is therefore possible for a company’s shares to fully qualify for 100 per cent business relief provided it is not mainly carrying out an investment business (that is, it is mainly trading). Thus, a small or incidental investment activity run alongside a predominantly trading one would effectively attract business relief through the value of the shareholding.
I will consider this important issue in a little more detail next week to close off this interesting subject.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn