Inheritance tax - Eligibility criteria

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Overview

Inheritance Tax (IHT) and Business Property Relief (BPR) are key concepts in UK estate planning and taxation law. For aspiring legal professionals preparing for the SQE1 FLK1 exam, a thorough knowledge of these topics is essential. This article examines IHT and BPR, focusing on eligibility criteria, strategic applications, and their relationship with broader tax regimes. Proficiency in these areas will not only improve exam performance but also provide a strong basis for future legal practice in estate planning and wealth management.

Inheritance Tax Basics

Inheritance Tax is imposed on the value of an individual's estate upon death and certain lifetime transfers. Key aspects include:

Threshold and Rates

  • The nil-rate band is currently set at £325,000.
  • Estates exceeding this threshold face an IHT rate of 40% on the excess.

Transferable Nil-Rate Band

  • Married couples and civil partners can effectively increase their nil-rate band to £650,000.
  • Any unused portion of the deceased partner's nil-rate band can be transferred to the surviving partner.

Residence Nil-Rate Band

  • An additional allowance of up to £175,000 applies when a main residence is passed to direct descendants.
  • This allowance is subject to specific conditions and decreases for high-value estates.

Business Property Relief: An Important IHT Mitigation Tool

Business Property Relief is a powerful strategy for reducing IHT liability on qualifying business assets, helping to preserve family businesses and prevent forced asset liquidation.

Qualifying Criteria for BPR

  1. Business Activity: Relief primarily applies to trading businesses, not investment companies.
  2. Ownership Period: The deceased must have owned the business or asset for at least two years immediately prior to the transfer.
  3. Control and Voting Rights: For unquoted company shares, the deceased must have held more than 50% of the voting rights for full relief.
  4. Binding Contract for Sale: Assets subject to a binding contract for sale at the time of transfer are generally ineligible.

Levels of Relief

BPR offers two levels of relief:

  • 100% Relief: Applies to a business or interest in a business, unquoted company shares, and quoted shares giving company control.
  • 50% Relief: Available for quoted minority shareholdings, and land, buildings, or machinery owned by the deceased and used in a business they were a partner in or controlled.

The 'Wholly or Mainly Trading' Requirement

An important aspect of BPR eligibility is the 'wholly or mainly trading' test, requiring that the business must be predominantly engaged in trading activities rather than investment.

Example: XYZ Ltd owns commercial properties (value: £4 million) and operates a manufacturing division (value: £6 million). As trading activities constitute 60% of the business value, it meets the 'wholly or mainly trading' requirement, potentially qualifying for BPR.

Lifetime Transfers and BPR

BPR can apply to lifetime transfers, offering planning opportunities:

  • If the transferor survives seven years after the gift, it becomes exempt from IHT.
  • If death occurs within seven years, BPR can still apply if the asset remains qualifying property at the time of death.

Example: Sarah transfers her 100% shareholding in her trading company to her son. She dies five years later. The shares still qualify for BPR at her death, potentially eliminating IHT on this transfer despite occurring within seven years of her death.

Interaction with Other Tax Regimes

Knowing how BPR interacts with other tax reliefs is key for comprehensive estate planning:

Capital Gains Tax (CGT) Considerations

  • Assets qualifying for BPR may be eligible for CGT holdover relief on lifetime transfers.
  • The relationship between BPR and CGT can influence the timing and structure of business transfers.

Example: John wishes to transfer his business (value: £2 million, base cost: £500,000) to his daughter. By using BPR and CGT holdover relief, he can potentially transfer the business free of both IHT and CGT, with his daughter inheriting the original base cost for future CGT calculations.

Agricultural Property Relief (APR)

For estates including both business and agricultural assets:

  • APR takes precedence over BPR where both could apply.
  • Planning may involve structuring assets to maximize the benefits of both reliefs.

Complex Scenarios and Recent Developments

Hybrid Businesses

Businesses with both trading and investment activities require careful analysis:

Example: A family-owned company operates a hotel (75% of business value) and holds a portfolio of residential properties for letting (25% of business value). While the overall business qualifies as 'wholly or mainly trading', only the hotel portion would likely qualify for BPR.

International Considerations

For businesses with international operations:

  • Double taxation agreements may impact the application of BPR to overseas assets.
  • The location and nature of business activities can affect BPR eligibility.

Recent HMRC Consultations

Recent consultations by HM Revenue & Customs have proposed potential changes to the BPR regime:

  • Stricter interpretation of the 'wholly or mainly trading' test.
  • Potential limitations on BPR for Furnished Holiday Lettings.

Conclusion

Understanding Inheritance Tax and Business Property Relief is vital for the SQE1 FLK1 exam and future legal practice. The interaction between IHT, BPR, and other tax regimes demands an in-depth understanding and the ability to apply these concepts in diverse scenarios. Key points to remember include:

  1. The importance of understanding IHT thresholds and available reliefs.
  2. The criteria for BPR eligibility, including the 'wholly or mainly trading' requirement.
  3. The strategic use of lifetime transfers in conjunction with BPR.
  4. The interaction between BPR and other tax regimes, particularly CGT and APR.
  5. The need to stay informed about potential changes to BPR legislation and HMRC interpretations.

By acquiring these skills and their practical applications, aspiring solicitors will be well-prepared to excel in estate planning and provide effective counsel to clients in their future careers.