Can you recycle Business Relief?

The issue

Business Relief (BR) is a very valuable relief which can reduce inheritance tax (IHT) on death. Perhaps the most common asset class that it relates to is shares in an unquoted trading company (and these can be ordinary shares or preference shares). The main qualifying requirement for such shares is that they have been held for two years at the date of death. Given that spousal transfers are automatically exempt from IHT, from a tax perspective it seems a bit of a waste to transfer BR qualifying assets to a spouse. There is always a risk that the spouse will end up disposing of the BR asset so that its value is not covered by BR on the second death. Also, the deceased may wish to get some value to other members of the family without tax.

Example

Ged has a £4m estate of which £1m is made up of shares in an unquoted trading company, a £1m house and a £2m investment portfolio. He therefore leaves the shares to his two sons on the basis that these will benefit from BR (and that his wife may end up selling the shares before her death) with the remainder of the estate going to his wife, Nancy. There will be no IHT here because £1m of his estate will have benefitted from BR and the remaining £3m will have passed IHT-free because of the spouse exemption.

A recycle?

After Ged’s death, Nancy takes some IHT advice of her own. She now has a chargeable estate of £3m but with assets rebased to their value at the date of Ged’s death. Nancy is advised to sell some of her investments and use the proceeds to buy the shares in the trading company off her sons to hopefully hold exempt assets on her death. Here, because of the market value uplift on Ged’s death there should be no capital gains tax liability on disposal of the assets. Furthermore, after two years the shares in the trading company will be outside her estate for IHT purposes. In this way, double BR relief has been obtained for a single asset.

Our view

Typically, this planning was undertaken using a discretionary trust to receive the family company shares on death with the expectation that the trustees would sell the shares to the surviving spouse. However, there is plenty of professional commentary on the potential for attack by HMRC under various anti-avoidance routes, including DOTAS.

Using individuals, rather than trusts, provided there is no evidence of preordained steps could change this into a relatively low risk tax planning strategy.

In any case, this only works if the family company continues to be held by the surviving spouse until death, unless she chooses to reinvest the proceeds in other BR qualifying assets, AIM portfolio shares, for example.

Indeed, this planning would also work with AIM portfolios held at the start. Here, in the above example, Ged would have bought £1m of AIM portfolio shares a few years before death and then Nancy would have realised cash from other assets after death to buy the shares off the sons. Although AIM portfolio shares carry a lot of commercial risk, in this example, a £1m portfolio is a mechanism for saving £800,000 of IHT. The main concern for this to be effective is that the surviving spouse survives for two years.