The best time to start planning your business exit is the day you start your company. If that is not possible then a planning horizon of at least 1-5 years but the longer the better.
This will give you the time to groom your business to show its best face, maximise buyer interest and take advantage of valuable tax planning opportunities. In addition, a clear exit plan gives you a framework to guide decision-making and helps develop a coherent strategy for building your business.
Some entrepreneurs want to sell their business during their lifetime, taking advantage of the generous tax rate of 10% under Entrepreneurs Relief. This may leave them cash rich, but Inheritance Tax (IHT) planning is advisable together with considering the funding of long-term care when elderly. For those that want to retain a business to pass to the next generation, planning for IHT and checking the availability of Business Property Relief would be wise.
However, where the plan is to pass the business down to the next generation, there will be a need to consider IHT.
Inheritance Tax is a tax at 40% on estates above the nil rate band of £325,000 on death. Your estate for IHT purposes will include a valuation of your company shares/business interests on death for tax purposes, together with certain gifts made within 7 years of death.
However, for entrepreneurs, there is a valuable Business Property Relief (BPR) of 100% or 50% against the valuation of relevant business property, which reduces the chargeable estate.
Business property qualifying for the 100% relief rate includes:
- A trading business, i.e. a sole trader or a partnership
- Shares in an unquoted trading company, including shares listed on AIM
This relief covers family companies. There are various conditions which pose traps for the unwary, including;
- It must be a trading business or company rather than one whose business is the holding of investments or dealing in securities
- The business or shares must have been owned for two years before death
- A business with excessive cash balances or other assets not fully deployed or necessary in the business, will also not qualify
Business property qualifying for the 50% relief rate includes:
- Shares or securities giving more than 50% of the voting rights of a quoted company
- Land, buildings, plant and machinery which was used for the purposes of a business carried on by a company of which the deceased then had control or by a partnership of which they were a partner
- Land, buildings, plant and machinery which, was used for the purposes of a business carried on by the transferor and was settled property in which he had a beneficial interest
Key takeaway: don't assume that your business will qualify for BPR.
Seven Common BPR Pitfalls
Many entrepreneurs are aware of BPR, but are ignorant of the many pitfalls, meaning their IHT bill may be significantly higher than they have planned for when it comes to their business exit. The seven most common BPR pitfalls are set out below.
1. Is it a qualifying “business”?
A business or company will not qualify automatically if it includes elements of:
- Dealing in stocks and shares, or
- Dealing in land or buildings, or
- Making and holding investments
The legislation does not directly refer to the situation where some of these activities may be present in an otherwise qualifying business or company. The legislation refers to “wholly or mainly”, which is usually understood to be more than half. In practice, HMRC’s interpretation will turn on the facts and the writer has seen them argue that more than 20% is the tipping point, so expert advice is essential.
For example, a business investing or dealing in property would not qualify for BPR, but confusingly, a property development business would. The difference being the act of development, rather than just buying and selling.
This lack of clarity presents a planning opportunity. For instance, if a trading company owns an investment property, then in some circumstances 100% BPR will be available on the whole value of the shares in the company. However, if the investment property is owned outside the company, no BPR would be available.
2. Are there any “Excepted Assets?”
BPR is not available on the value of certain assets owned by a business but not essential to the business.
Excepted assets often include:
- Property partially used by the business and partially let to other occupiers
- Assets used mainly for the benefit of the business owner or his family such as a holiday home
- Cash balances surplus to those needed for trading. However, if the excess is say, part of a sinking fund for future investment or replacement, or can otherwise be shown, as needed for some future business use then BPR will be available. Expert advice is essential.
3. Directors loan accounts
Directors’ loan account credit balances, also can be a trap for the unwary. Typically, when the company has borrowed money from a director shareholder, or where a business and its goodwill is transferred to the owner’s company, creating a large credit balance in favour of the owner.
This is often to allow the extraction of cash from the company without suffering income tax. The problem here is that the director shareholder’s estate includes this balance as an asset. However, it is not one that normally qualifies for BPR. Where the balance has little likelihood of repayment, it might be worth considering converting the loan to shares, which would qualify for BPR.
4. Resolutions to wind up a company
A resolution to wind up the company, before death will prevent BPR applying, unless they are part of an insolvency procedure to allow the business of the company to carry on post restructuring.
5. Binding contracts for sale
Property that would otherwise qualify for BPR does not qualify if it is subject to an unconditional contract for sale at the time of the owner's death.
6. Shareholder agreements
Shareholder’s agreements or partnership agreements often provide for surviving shareholders or partners to take over the deceased’s interest in the business. These “double-option” or “cross-option” type arrangements need checking. Properly drafted, they should form a “binding contract” for the deceased’s share to be sold to the survivors, which allows BPR to apply. However, the writer has seen some poorly drafted ones where BPR would be lost. Your lawyer can give advice on this.
7. Property owned outside the business
It is common in family companies to find key business assets owned outside the business. Often the shareholder personally owns the business premises or the intellectual property rights and receives a rent for their use.
There are good risk avoidance and tax planning reasons for this type of structure, but the applicability of BPR is often forgotten. Because the assets are owned outside the business the BPR rate is 50% rather than 100%. However, that only applies if the owner of the property had a controlling interest in the business or company. If there is only a 50% partnership share or shareholding, this does not give control and no BPR is available on those outside assets.
Top tip: make sure there is a casting vote in the partnership agreement or in the company’s articles for shareholders, as case law has confirmed that this does confer a controlling interest and will preserve the BPR!
BPR is an extremely valuable tax relief for family businesses, but don’t just assume it applies, get advice from an experienced FinanceHead. For guidance in selecting the right FinanceHead for such a job please contact Michael Cartwright.
N.B. These are general guidelines, always take advice from an expert before proceeding.