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Relief roads

Many businesses and farms have borrowings and it is important to be aware of how business property relief and agricultural property relief operate in these circumstances.

For business property relief, the key determinant as to whether one applies the relief to the value of the property before or after deducting the outstanding loan is the purpose of the loan. If the loan is for a business purpose, it is deducted before relief, regardless of whether the debt is secured on the business property.

For agricultural property relief, the key to deductibility is whether or not the loan is secured on the agricultural property. If it is, the loan is deducted before relief.

For example, in the case of a freehold agricultural property worth £500,000, with all the relevant conditions for 100 per cent relief being satisfied, if there is a £100,000 mortgage secured on that property, the relief will be calculated on £400,000.

If a mortgage protection policy is in force that will repay the loan on the death of the taxpayer, this will not affect the calculation, which will be:

Asset value £500,000

Less loan -£100,000

Less APR -£400,000

Plus proceeds

of life policy +£100,000

Net value for IHT =£100,000

It will be seen that if the loan had not been secured on the property, regardless of the purpose of the loan, relief would have applied to the full value. The net value for IHT would then have been reduced to nil.

Case law, however, continues to develop the detail of business property relief.

For any business, whatever its structure, it is essential to remember that it is only relevant business property that qualifies for relief. If this were not the case and the full value of any business qualified for relief, an obvious opportunity would exist for individuals to put all their valuable assets into the business and claim relief on the whole business value by virtue of the outer shell.

To prevent this taking place, it is only trading businesses, that is, those that exist wholly or mainly to trade (so excluding investment companies), that qualify for the relief.

The business only qualifies to the extent of that part of its value represented by relevant business property. Thus, even if the business is a trading business for the purposes of the first test, the application of the second test could deny relief. Property that is not relevant business property is called excepted property. In most cases, long-term investments would be excepted property.

The extent to which a business holds investments has been highlighted in the context of business taper relief for CGT. This issue has caused some to reconsider investment strategies for businesses involving financial services products. However, this is likely to have a negative IHT impact because, even if the business is a trading company to the extent that it has an interest in an investment bond (usually non-UK on corporation tax grounds), the value of that property will not qualify for IHT business property relief.

Some assets that may appear to be business assets are not and, as a result, operate to deny relief. This often comes as a shock to those involved, for whom it may be too late to do anything more to reduce or plan for the IHT liability. This is another example where being aware of the position enables one to plan accordingly. Knowledge really can be valuable.

In a case I have in mind, a lady (H) and her daughter (B) were in a business partnership until H&#39s retirement in April 1993, when B continued in business and H&#39s capital account remained intact. H&#39s capital account was derived from the capital she had introduced to the partnership and from accumulated profits which she was entitled to but had not withdrawn.

H died in June 1997. Section 43 of the Partnership Act 1890 states that the amount due from a continuing partner to an outgoing partner in respect of the outgoing partner&#39s share is a debt that accrues at the date of the dissolution. The Inland Revenue determined that, on her death, H did not have an interest in the business that was relevant business property. Thus, the amount in the H&#39s capital account at the date of her death did not qualify for business property relief for IHT purposes.

B appealed, contending that H had an interest in the business due to her capital account which remained at her death. The appeal was dismissed.

The Special Commissioner found that, prior to her retirement, H was a partner in the business. On her retirement H&#39s rights were simply that of a creditor of B who was, in effect, now a sole trader.

For commercial purposes H&#39s capital account was a liability of the business and represented her financial interest in the business. However, for IHT purposes, the capital account was not an interest in the business for the purposes of the definition of relevant business property. The key issue appears to have been the nature of the deceased&#39s interest immediately before death. At this point, as H had retired, her interest was merely a debt.

Persons planning for, say, partnership share purchase following a partner&#39s death need not be concerned provided the partner was involved actively, that is, had not retired immediately before death. In such circumstances, the only IHT fear should be that relief is denied or limited in some other way. Relief is only available in respect of business assets, so investments or cash would cause problems.

Advisers should be aware that a binding buy/sell agreement would also operate to deny relief, regardless of the status of the deceased in connection with the business.

Relief may not be too relevant if the spouse exemption applies. However, planners are becoming increasingly aware of the benefits of spousal bypass planning to ensure shares or partnership interests pass into an appropriate trust to minimise overall IHT while ensuring access to the sum or assets via the trustees for the surviving spouse. A lack of relief on the transfer would be disastrous for such planning.


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