Capped relief on loans from individuals to a business in light of increased interest rates
Individuals often borrow money personally in order to introduce funds into their trading business. It is possible in some circumstances to obtain tax relief for the interest paid on the loan. There is however a cap on the amount of interest relief that is available, which equates to the greater of £50,000 or 25% of adjusted total income. Given recent increases in interest rates, those who have not fixed their borrowings may now be incurring much higher interest costs. Alongside increasing costs across the sector, they may not have sufficient income to allow the interest to continue to be fully relievable.
As an example, a loan of £5million at a historic interest rate of 2% would equate to annual interest of £100K. This would potentially require income of £400K to obtain 100% relief. However, with increased interest rates the interest payment might now be as high as £365K and therefore income of £1.46million would be required to obtain full relief.
Consideration should be given to loan structures to ensure they work for the business/family while also ensuring that the tax relief is maximised.
With an increase in housing demand, we are seeing a number of plots being allocated as having development potential. This often provides the opportunity for substantial revenue creation. The number of potential agreement structures, with potentially numerous landowners, or indeed different revenue recognition points, mean that without careful early planning there can also be a hefty and sometimes unplanned tax liability.
For example, there may be a straight land sale, but with an overage. Would the proceeds be subject to income tax or capital gains tax (CGT), and at what point is the overage taxable? Do infrastructure provisions create an income tax problem? The agreement may be a promotion agreement but what about the VAT on the promotion charge?
If there are multiple landowners, without careful planning there is a risk of double taxation on equalisation arrangements. Planning opportunities to avoid this risk are ideally put in place at the outset while values are low. Which party is taxable at what point, and what costs are deductible for tax?
Each deal is likely to come with its own tax nuances but early discussions with a tax professional regarding the structure of the agreement can often lead to a more favourable tax position. There are also a number of pitfalls that can often be avoided with careful planning.
Land earmarked for solar farms
The idea of diversifying to include a solar farm on your land is increasingly popular, potentially offering the attraction of a regular and long-term revenue stream. It’s important though that the tax implications are considered before any option or lease agreements are signed. Often land being considered for a solar farm has historically been protected from inheritance tax (IHT) by agricultural property relief and / or business property relief. However, once the solar land is leased to an energy company, these important tax reliefs may no longer continue to be available. How would a 40% IHT liability on the value of the solar farmland be paid by the family on the death of the landowner?
Similarly, valuable CGT rollover and gift reliefs may also no longer be available once the land is leased to an energy company.
It may therefore be best to implement succession planning strategies while IHT and CGT reliefs are available, before any agreements are signed. Even then though the family should be mindful of clawback provisions, as well as the loss of the beneficial CGT free uplift in value on death.
While the same principles apply to windfarms, it may be easier to structure these arrangements so that IHT reliefs can be maintained. Advice should be sought to ensure that this is the case.
Pre 2006 life interest trusts - consider locking in IHT reliefs
As is always the case with a general election approaching, there is a lot of uncertainty as to what future tax policy may look like. It may therefore be preferable to review current structures where the tax status is known and understood and if possible, lock into reliefs now. For example, if there is a pre-2006 life interest trust that is currently eligible for 100% IHT relief (agricultural property relief or business property relief), it may be possible to create a relevant property fund or trust for those assets without crystalising any taxes. Those assets could then be outside the life tenant’s death estate, potentially immediately, or at worst after 7 years, depending on the sums involved.
Consideration will need to be given to the timing, and potential IHT charges once the property is within the relevant property regime, however there are many scenarios where this could give some certainty and comfort around future IHT liabilities.
Ensuring your business structure is working hard enough for you for IHT
As was noted in the case of Balfour v IRC, where a business is not one of wholly or mainly making investments, the business may be eligible for business property relief. Therefore, it may be possible for the trading business to involve an element of an investment business and still qualify for the relief. We are still seeing a number of cases where businesses and assets are not being considered in the round to ensure that opportunities are maximised. Given the difference in IHT payable could be 40% of the value of the investment assets it is certainly worth reconsidering whether the trading business is working hard enough from an IHT angle.
Making the most of trusts
Trusts have long been used as a way to pass on assets, whilst not necessarily passing on control, and often can give a layer of protection through life events such as divorce. They can also be used as an effective method of passing on value and income to a younger generation. There can be complicated calculations surrounding tax charges on the creation of trusts, but as a general principle, if the donor has not made any gifts within the previous seven years, a gift up to the nil rate band could be made into a new trust without crystalising either IHT or CGT. The gift would then be outside of the donor’s estate for inheritance tax purposes in seven years. This could potentially remove £325K (equating currently to £130K of inheritance tax) from the donor estate.
The trust may then be subject to IHT charges on exits (withdrawing capital), and ten-year charge dates, however these are usually at a maximum of 6% above the value of the inheritance tax nil rate band (currently £325K).
With the changes to the subsidy regime, it is necessary for landowners to consider other options for cash generation and natural capital has become a hot topic in the sector. We have been closely involved in discussions with other professional bodies as well as DEFRA and HMRC regarding the uncertainties that deals in the natural capital market create. It is hoped that HMRC’s consultation may provide more clarity.
There are numerous, perhaps unintended, potential tax consequences for entering into the schemes. Detailed consideration would need to be given as to the different structures for the sale of the ‘credits’ and immediate tax implications, such as whether it is taxable to income tax or CGT, but also to longer term considerations such as the IHT status of the land, valuation and ongoing commitments.
Biodiversity net gain
Whilst this is still an emerging market, as it is now compulsory for a development to show a 10% biodiversity net gain (BNG) it is a market that will very quickly have to get up to speed. There are a lot of questions surrounding the agreements, how they will be taxed, who will be responsible for the success of the BNG, and indeed culpable if it is not successful. The Government has effectively put a cap on the price market by including a price per unit that is required to be purchased on a 2 for 1 basis should the scheme fail. However, this also draws a line in the sand for valuation which may mean we see the market start to move more.
Knowing whether to be an early entrant or hold out is a hard decision, however the number of BNG credits that are required will probably be linked to the local planning authorities. If the opportunity arises to enter into a discussion to sell BNG units, it is wise to ensure you enlist specialist professionals to assist from the outset.
You can read more on BNG and the tax issues for landowners in our article: Biodiversity net gain and the tax issues for landowners | Evelyn Partners
Carbon credits and nutrient neutrality
As with all natural capital agreements, people are still finding their way and there is no precedent as to how the agreements will look. Ensuring agreements and opportunities are reviewed early will minimise the chances of unexpected tax charges.
Rollover relief, reinvestment of proceeds and trusts
Rollover relief is available in specific circumstances where there is a sale and a purchase of a qualifying business asset. Where all the proceeds are reinvested within a permitted timeframe, it is possible to roll over up to 100% of the capital gain and therefore reduce the tax charge on sale to zero. In a scenario where a beneficiary sells a qualifying asset, it may be possible to utilise trust assets to access the rollover relief, meaning no external purchases are required.
Where land is subject to a compulsory purchase order (CPO), there are special rules that apply for CGT. This may apply to people affected by HS2 but also other landowners.
Generally, it is only possible to ‘rollover’ for CGT on the sale and purchase of assets used in a business. However, rollover relief is extended in the scenario of CPO, and can potentially include residential property. The extension of the relief gives the landowner more opportunity to minimise the tax paid on the CPO receipt, and therefore each CPO recipient should seek advice to ensure they are claiming the CGT reliefs that are available to them.
Furnished holiday lets and gifts
A numerical test applies to determine whether or not a property qualifies as a furnished holiday let (FHL) for income tax purposes. Once a property qualifies as a furnished holiday let, it is eligible for some reliefs that are more usually associated with a business such as capital allowances and CGT holdover relief. Holdover relief may be important if, for example, a parent wished to gift the property on to the next generation. A successful holdover relief claim could defer the CGT that would otherwise be payable on the market value of the gift. However, CGT holdover relief is restricted for periods of ownership where the asset was not used in the business. Therefore, if for example the property had at some point during the ownership period been let under an assured shorthold tenancy (AST) rather than as an FHL, the holdover relief may be limited. It some circumstances a new period of ownership can begin without crystalising a capital gain.
Obtaining business property relief on an FHL is a different test and requires a high level of input from the owner. It is therefore unlikely that most FHLs will obtain business property relief, and so the value of the FHL will be fully exposed to IHT apart from in very limited circumstances.
Risk of future changes to legislation
Tax planning is always at risk of future changes in legislation, and particularly so IHT planning which can be more long term. Although there have not yet been any confirmed policies, there have been rumours in the media that there could be changes to IHT reliefs which could of course impact any current planning.
Should you wish to discuss any of the points further please contact your usual Evelyn Partners contact.
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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. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication.
Tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. You should always seek appropriate tax advice before making decisions. HMRC Tax Year 2023/24.