For many years, the rules for Inheritance Tax (IHT) have remained the same. Essentially, IHT is a tax on the wealth someone has at the date of their death. Capital Transfer Tax was replaced by Inheritance Tax (IHT) in 1986. Since then, there have been both legislative and HMRC practice changes however, in principle, the rules have remained unchanged.
As time has gone on, and house prices have increased, more people have come into the IHT net and its complexities affect a greater number of people. Without specialist advice it is very easy to think the tax is straightforward, but the legislation has become littered with an increasing number of anti-avoidance rules over the years. It is very hard for families to suddenly find out that the IHT liability due to HMRC is very much more than they previously thought.
With this in mind, the Office of Tax Simplification (OTS) went out to consultation last summer and has now issued the second section of their report with suggested recommendations.
This article concentrates on the potential impact on farms and other businesses. The report is well set out and is worth reading for those who are interested in knowing more about IHT.
Put simply, the current rules for business and agricultural property mean that a sale post death can be made with no Capital Gains Tax (CGT), having received 100% Business Property or Agricultural Property Relief (APR and BPR) on the value of the property at the date of death. It has to be recognised that this can cause the older generation to hang onto properties until their death, rather than handing the agricultural or business property on to the next generation. Equally, the report does acknowledge the importance of APR and BPR in enabling succession.
Further complications can arise where a gift is made during lifetime. For example parents make a gift of land to their children. As the land has been used in the stud business the gain on the gift can be held over, so the children take the property at the original base cost. The land did have some hope value, which was thought might come to fruition in 20 years’ time. After four years a developer makes an offer which cannot be refused. In year six both parents die in a car crash. As the gifted land was not still owned by the donees (children) at the earlier date of the donors’ death or seven years from the date of the gift, there is no APR or BPR on the original gift. To make it worse, CGT is due on the gain as though the parents had sold it in their lifetimes. Contrast this with the position where the parents had held onto the land until their death – where no tax is due at all.
The OTS has recommended that, to encourage people not to hang onto assets until their death, to take advantage of both IHT and CGT reliefs, that where a land or business is passed down to the next generation with IHT reliefs, the CGT uplift be removed and the property passes at no gain, no loss. The effect will be same as the holdover relief in the paragraph above.
When looking at a company for assessing whether Entrepreneurs’ Relief or holdover relief is available on the disposal of the shares by way of sale or gift respectively, the trading side of the business has to make up at least 80% of the company’s activities for the relief to be available on the sale of shares or assets (such as land) owned by the shareholders but used in the company.
Contrast this with the wholly or mainly test for BPR for a business (either incorporated, partnership or sole trader) where provided less than 50% of the assets, sources of income and profits over a reasonable period relate to non-trading activities, BPR is available on the entire value of the business.
The OTS believes the government should consider whether the different requirements of trading levels are appropriate. Specifically, they ask whether the lower level of 50% for BPR continues to be the correct level.
A perennially thorny question is whether farmhouses qualify for APR. One of the tests is whether the farmhouse is occupied for the purposes of agriculture at the date of death.
The house may have been occupied by the farmer for the last 50 years, but if at the time of his death he has been hospitalised for six months, HMRC can seek to argue that the house was not occupied for the purposes of agriculture at the date of death and deny APR. The OTS has recommended that HMRC is more sensitive in these cases.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.
The tax treatment depends on the individual circumstances of each client and may be subject to change in future.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.