The value of your business is protected from inheritance tax by business property relief (BPR). This tax relief can be reduced if at any time you borrowed to fund the business. How can you prevent the loss of BPR?
IHT and business interest
Whether you’re in business as a self-employed individual, in partnership or own shares in a company, business property relief (BPR) can protect your estate from inheritance tax (IHT) if the worst were to happen to you. However, several years ago BPR took an unexpected hit from new rules targeted at tax avoidance.
Debts and assets
Broadly, the rules were introduced to block schemes that reduced IHT using debts, such as loans. At the time debts which were secured on an asset specifically reduced the value of that asset for IHT purposes.
Example. In July 2010 Sarah owned two homes; one was worth £500,000, against which she had a mortgage of £250,000, while the other was worth £200,000 and was free of debt. In 2010 the value of the properties which would have been taken into account for IHT purposes was £450,000 in total – £500,000 less £250,000 for the first property plus £200,000 for the second. The debt only affected the value of the mortgaged property.
IHT planning with debts
Before the anti-avoidance rule the IHT-efficient way to borrow money was to secure a loan against assets not connected with your business, for example, your home. This meant that its IHT value was reduced by the amount of loan owing while the full value of your business could qualify for BPR. In other words, the loan didn’t affect the amount of BPR you were entitled to.
Trap. Following the introduction of the anti-avoidance rule, a loan secured on a non-business asset, say your home, which is used to fund your business will reduce the value of the business first instead of the asset it’s secured on.
Example. Tim owns 25% of the shares in Acom Ltd. They are worth £800,000. He funds the purchase of his shares in Acom using a loan of £200,000 secured by a mortgage on his home. If Tim were to die or give away his shares, say to his children, the amount of loan outstanding will reduce the value of his shares rather than his home. The shares will still qualify for BPR so that no IHT would arise, but the full value of his home will be chargeable to IHT. This means his estate will pay IHT on an extra £200,000 compared with what would have been chargeable before the anti-avoidance rule.
Trap. While the anti-avoidance rule was introduced in 2013, it applies to loans/debts created at any time, i.e. before or after 2013. There’s no way to dodge the effect of the rule but you can take steps to mitigate it.
Tip. If your business needs funds, use your savings if you can afford to. Later – the later the better – take out a loan to replenish your savings. In the event of your death or if you give away your shares, it can be argued that the loan was not used to fund your business but to buy investments. This would protect the value of your business for IHT purposes as it would be unaffected by the loan and BPR will be maximised.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.