Reform of the inheritance tax Business Property Relief has been on the cards for several years in fact since the cross party All Party Parliamentary Group on Inheritance Tax and Intergenerational Fairness published their recommendations in January 2000. The question was always what form would the changes take and who would they impact?
The answer came during the Autumn Statement on 30 October 2024 (although they do not come into force until April 2026) and has impacted every privately owned business in the UK.
Why, I hear you say, are you saying that it affects every privately owned business? Because if you die after 6 April 2026 whilst owning private business shares your Business Property Relief (“BPR”) will either be capped at £1m or you will need to be able to evidence that your business is under the cap. How many businesses will be worth more than £1 million? Well, more than you would have thought!
Valuation is a specialist skill and according to Harvard Business School there are six valuation methodologies which include enterprise value, discounted cash flows and net assets. The business sector as well as the maturity of the business will determine the most appropriate valuation methodology. This can mean that a business is worth a fortune without generating a profit or making any return to its shareholders. The most famous example would be Facebook, which had an estimated value of $15bn in 2008, when it still hadn’t generated a profit.
Using these principles even a small business could be worth £1m on paper or at the very least the executors of the estate would have to be able to evidence that it was not worth £1m pushing even more cost onto family businesses.
So, what are the current rules? If you own shares in an unquoted trading company (which doesn’t include property or investment companies) then generally the shares are exempt from IHT on your death.
The benefit of the current rules is that it doesn’t create a big IHT liability when a shareholder dies, which as we know the timing of which is not possible to predict.
Typically, IHT charges are funded by the company as the shares are usually the majority of the wealth in the shareholders estate. Personally, I think that we should all view these IHT charges as a company tax rather than a shareholder one. The trouble is that it isn’t. To fund an IHT liability of £100, the company needs to pay a dividend of £170 so that there are sufficient funds after tax.
Under the proposed cap, from 6 April 2026 BPR will be capped at £1m and IHT will be charged at 20%, i.e., half of the main rate, on amounts above £1m.
To give an example, a business worth £10m held between husband and wife. Under current rules, BPR enables them to pass the business onto their children without a significant IHT cost on second death. The children may decide to continue the business and to pass this onto their children. Or they could decide to sell the business and pay capital gains tax at 24% at which point they will have sufficient cash to fund the tax bill.
Under the proposed rules, on second death there would be an IHT liability of £1.6m. This assumes that each parent has their £1m BPR allowance and their nil rate band is used elsewhere perhaps on their home or undrawn pension (which have also been brought into the IHT net post the Autumn Statement 2024).
If the business is worth £10m, many would argue it is easy to find £1.6m to pay the IHT. Not necessarily easy.
Firstly, the tax needs to be paid within six months of death which is short notice so they may opt to spread the payment over 10 years. I would expect this to be interest-free under existing rules, but we need clarification.
Secondly where does the cash come from? As I said earlier, the business usually funds it by way of dividend which makes the IHT even more expensive. This is even more tricky where there are multiple shareholders as you may need to pay an even bigger dividend to ensure that the cash ends up in the right pocket.
If I am a privately owned business with cash reserves, I would be looking at these new rules carefully. Should they invest in a new system or technology or keep money available for IHT? The answer will depend on the profile of the shareholders and perhaps the outcome of annual medical health check-ups.
Some businesses might seek advice from actuaries to be more precise whereas others might be over-conservative. I know some businesses are finding this alongside other tax changes just one step too far, so will look to sell their business to private equity before these rules come into force.
So, what would I recommend? In my view, if there needs to be a cap, £1m is far too low and should be at least £10m to take a greater proportion of family businesses out of these rules. I also think that if the IHT needs to be funded from the business, it should be received tax-free in the hands of the shareholder or the dividend tax paid should be available as a tax credit against the IHT. Whilst this would raise less IHT, the BPR and Agricultural Property Relief changes together were only intended to raise £500m in 2027/28 which makes these changes even more painful for families.
Family businesses cannot wait and see how this plays out as there is a window of opportunity between now and 5 April 2025. It is time for a re-think of succession planning and, as always, please contact us to discuss further.