Follow up

Detailed commentary on the conditions for BPR

[Memo]

Funding a company: avoid an IHT trap

Business property relief

Your entrepreneurial clients will probably be aware of business property relief (BPR). In the right circumstances, it can exclude 100% of the value of business assets, including unquoted company shares, from the inheritance tax (IHT) net. There are a number of conditions to satisfy, and other anti-avoidance rules which you need to make them aware of.

Tax Memo https://www.tips-and-advice.co.uk , Download Zone, yr.7, iss.5For detailed commentary on the conditions for BPR

Financial hardship

One of your clients is the director and shareholder of a trading company. The company is in desperate need of an injection of funds. The bank will not issue the company a loan, and the owner is not keen on having outside investment, as she feels this might interfere with her plans to pass the company on to her daughter when she retires. She has been approved for a loan with a charge over her main home. She intends to take this out, then put the money into the company by the issue of new preference shares.

IHT trap

The problem with this plan is that it can reduce the amount of BPR available due to the anti-avoidance rule that came into effect in 2013. This provides that where a debt is incurred to acquire an asset qualifying for an IHT relief, i.e. BPR in our case, the liability must first be deducted from that asset, i.e. the shares.

Example. Bixby has a country home worth £1 million. He takes out an interest-only mortgage of £500,000 and uses it to purchase AIM shares. Some years later Bixby dies. The AIM portfolio is valued at £600,000 for probate purposes, and the house £1.2 million. The mortgage debt is deductible in the estate, but it will offset the value of the AIM shares. The £100,000 not covered will qualify for BPR, and the full value of the property will be subject to IHT.

If the loan had not been used to purchase the BPR-qualifying assets, the £600,000 shares would have been covered by BPR, and the property value for IHT would only be £700,000 - a saving of £200,000 in IHT.

Pro advice. An apparent solution would be to lend the money to the company instead of acquiring shares, but this merely moves the restriction into the company value as the balance outstanding would not qualify for BPR.

Alternative

One way to avoid the problem where it is unlikely the loan will be repaid before a chargeable transfer, e.g. via the death estate, would be to disassociate the loan from funding the company as far as possible. In practice this would mean your client raising the funds from savings, or by selling other assets. They could then replenish these with a loan, but this would need to be much later on to avoid the link between the loan and the BPR-qualifying assets. Unfortunately, there is no hard and fast rule as to how long this will need to be.

Pro advice. If existing funds are not sufficient, but the intention is to repay the loan in the short term, advise the client to consider taking out term life insurance to cover the repayment period in case they die unexpectedly.