Taxation in business - Inheritance Tax (Business Property Re...

Learning Outcomes

This article covers inheritance tax (IHT) and business property relief (BPR) for business assets, including:

• Statutory categories of qualifying business property and the trading versus investment test
• The two-year ownership requirement, replacement business property, and successive ownership for spouses/civil partners
• The effect of binding contracts for sale and how option arrangements can preserve relief
• Identification and treatment of excepted assets and their impact on the value qualifying for relief
• The level of relief (100% or 50%) and when each applies to sole trades, partnerships, shareholdings, and personally owned business assets
• Control requirements for quoted companies and the treatment of unquoted and AIM-listed shares
• Application to land, buildings, and machinery used by controlled businesses and the business-use/future-need tests
• Computation of IHT with BPR, including interaction with spouse/charity exemptions and sequencing
• Conditions for, and withdrawal of, BPR on lifetime gifts, including replacement and post-transfer changes
• Common pitfalls in SQE2 problem questions and practical drafting points in buy-sell agreements

SQE2 Syllabus

For SQE2, you are required to understand the application of inheritance tax and business property relief as it relates to business structures, with a focus on the following syllabus points:

• the basic charge to inheritance tax on business assets (sole trader, partnership, company)
• the fundamental requirements for business property relief (BPR) and how to identify qualifying business property
• the conditions and exceptions affecting BPR eligibility (minimum ownership, trading status, exclusions)
• the effect of BPR on direct ownership, shareholdings, and interests in partnerships or companies
• how to accurately advise on BPR claims and common pitfalls on exams

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. In relation to business property relief, which of the following assets will usually qualify?
   1. A 60% shareholding in a trading company, held for 3 years
   2. A residential let property
   3. Land let to an unrelated trade
   4. A 10% holding in a quoted investment company
2. What is the usual minimum period an asset must be owned before a claim for BPR can be made?
   1. 1 year
   2. 2 years
   3. 5 years
   4. 7 years
3. If a person dies while owning a controlling shareholding in a trading company, which percentage of business property relief normally applies?
   1. 0%
   2. 25%
   3. 50%
   4. 100%

Introduction

Inheritance tax (IHT) can apply when a person dies owning business assets. However, business property relief (BPR) is available to reduce the IHT liability on qualifying business interests. BPR is a critical avenue for reducing the impact of IHT on family businesses, partnerships, and shareholdings in trading companies. This article explains the core requirements, qualifying assets, conditions, and practical application of BPR for the SQE2 exam. It also sets out where relief is restricted (e.g., investment businesses, excepted assets and binding sale contracts), how the minimum ownership period works (including replacement property rules and spouse/civil partner treatment), and the impact on different business structures.

Key Term: inheritance tax (IHT)
Inheritance tax is a tax charged on transfers of value made by an individual on death and on certain lifetime transfers. Broadly, transfers are charged at 40% on death and 20% on chargeable lifetime transfers, subject to reliefs, exemptions and the nil-rate band.

Key Term: business property relief (BPR)
Business property relief reduces the value of relevant business property for IHT purposes by 100% or 50% on qualifying transfers (on death or by lifetime gift), subject to statutory conditions.

Key Term: transfer of value
Any disposition that reduces the value of a person’s estate, either on death (deemed transfer of the whole estate) or by lifetime transfer (e.g., gifts to individuals or trusts).

The IHT Charge on Business Assets

Inheritance tax applies to property within the deceased’s estate, including sole trade businesses, interests in partnerships, and shares in companies. On death, there is a deemed transfer of value of the entire estate immediately before death. In many business contexts, BPR can significantly reduce or extinguish the IHT on qualifying assets, thereby avoiding the need to sell core business assets to fund tax.

Where lifetime gifts of business assets are made, BPR may also be available to reduce the IHT exposure on chargeable transfers and potentially exempt transfers that later become chargeable due to death within seven years.

Key Term: spouse exemption
Transfers between spouses or civil partners are exempt from inheritance tax. Consider this before BPR: if spouse exemption applies, IHT is already eliminated for that transfer, though later changes may affect future BPR availability if the asset ceases to qualify.

Qualifying for Business Property Relief

For BPR to apply, all the following must usually be satisfied:

• The asset must be qualifying business property (sometimes described as relevant business property).
• The asset must have been owned for at least 2 years before the transfer (or satisfy replacement/successive ownership rules).
• The business must not consist wholly or mainly of investment activities.
• The asset must not be an excepted asset (e.g., surplus non-business assets held in a company).
• The property must not be subject to a binding contract for sale at the relevant time.

What Counts as Qualifying Business Property?

The statutory categories include:

• A business or interest in a business (including a partnership share) – up to 100% relief.
• Unquoted shares and securities in a trading company – up to 100% relief.
• Controlling shareholdings (over 50% voting control) in quoted trading companies – 50% relief.
• Land, buildings, or plant/machinery used in a business or in a company controlled by the transferor – 50% relief (provided the use condition is met).

Key Term: qualifying business property
Statutory defined property eligible for BPR, such as an interest in a trading partnership, a sole trade, unquoted shares/securities in a trading company, and certain assets used by a controlled company or partnership.

Key Term: relevant business property
Property falling within the statutory BPR categories, including interests in businesses and certain shareholdings and business assets.

Key Term: trading company
A company carrying on substantive trading activities. Holding investments, letting property, or dealing in shares/securities/land as a main activity generally disqualifies BPR.

Key Term: controlling shareholding
A shareholding conferring over 50% of the voting rights in a company. For quoted trading companies, BPR at 50% may be available where control exists immediately before the transfer.

Key Term: AIM
The Alternative Investment Market is not a recognised stock exchange for BPR purposes. Shares traded on AIM are treated as unquoted, and if the company is trading, they can qualify for 100% BPR.

Practical points on categories

• Unquoted “securities” (e.g., debentures) can qualify in certain trading company situations; however, always verify that the issuer is a trading company and the securities fall within the statutory definitions.
• For quoted trading companies, minority shareholdings do not attract BPR. Only controlling holdings may receive 50% relief.
• For personally owned assets used by a business controlled by the transferor, relief is limited to 50% and is contingent on the asset being used wholly or mainly for business purposes in the relevant period.

Duration of Ownership Requirement

Generally, BPR is unavailable unless the transferor owned the property for at least 2 years before the transfer (death or gift). Key mechanisms can satisfy this rule:

• Replacement property: If relevant business property replaces other relevant business property, periods of ownership are aggregated, broadly provided replacement occurs within the specified window (commonly three years).
• Successive ownership: Where a spouse or civil partner inherits relevant business property, the survivor may be deemed to have owned it from the deceased’s original acquisition date, helping satisfy the two-year rule for a later transfer.
• Converted interests: Incorporating a sole trade or partnership into a company and receiving shares can preserve ownership continuity for BPR if the business remains qualifying.

Key Term: replacement business property
Property acquired to replace other relevant business property. The original and replacement ownership periods can be aggregated to satisfy the two-year rule, subject to statutory time limits.

Excluded Assets and Businesses

BPR does not apply where:

• The business is one of dealing in securities, stocks, land, or buildings, or making or holding investments (e.g., a company primarily deriving income from property letting).
• The asset was not used wholly or mainly for the purposes of the business in the previous two years or is not required for future use in the business.
• There is a binding contract for sale at the date of transfer.

Key Term: excepted assets
Assets within a business or company not used wholly or mainly for business purposes in the relevant period (typically the previous two years) and not required for future business use. The value attributable to excepted assets does not qualify for BPR (e.g., surplus investment portfolios or excess cash not needed for trade).

Key Term: binding contract for sale
A contract obliging sale of the business property at the time of transfer. If such a binding contract exists (commonly in buy-sell provisions), BPR is denied. Use of options to purchase or sell (rather than binding obligations) may preserve BPR.

Worked Example 1.1

Amil owns 70% of the shares in a private company carrying on a manufacturing trade. He dies owning the shares after 15 years. The company owns an investment property that it lets out. Do the shares qualify in full for BPR?

Answer:
The shares qualify for 100% BPR only if the company is not ‘wholly or mainly’ an investment company (i.e., not more than 50% of its business is investment activity). If the manufacturing activity dominates, all the shares, including attributable value of investment property, qualify. If the letting activity dominates, BPR will be denied. Even if the company is trading overall, any value attributable to excepted assets (such as surplus investment property not used for business purposes) would be excluded from relief.

Restrictions on Business Property Relief

Investment Companies and Activities

Relief is unavailable if the company’s main activities are holding investments, letting property, or dealing in shares, securities, or land. Property development and trading can qualify; routine property investment and letting generally will not. Furnished holiday letting is treated as an investment activity for BPR, even if it is treated as a trade for certain income tax purposes.

Binding Contract for Sale

BPR does not apply if the business property is subject to a binding contract for sale at the date of death or transfer. This can arise in shareholder or partnership agreements requiring sale/purchase on death or retirement. Drafting buy-sell arrangements as options (rather than binding obligations) helps preserve BPR.

Excepted Assets Within a Business

Even in qualifying trading businesses, BPR will not cover the value attributable to excepted assets (e.g., surplus cash, investment portfolios, personal-use assets held by the business). Relief is restricted to the business-use value.

Replacement Business Property

Where an individual replaces one qualifying business asset with another, periods of ownership are aggregated if the replacement is made within prescribed time limits (usually three years). Ensure the original asset was relevant business property and the replacement remains qualifying at transfer.

Worked Example 1.2

Jyoti held a partnership interest for 5 years, then replaced it with shares in an unquoted trading company 18 months before death. Does BPR apply?

Answer:
If the company is a qualifying trading company and the previous partnership interest would have qualified, BPR is available provided the combined period of ownership is at least 2 years and the replacement is within the permitted time span. Any excepted asset value within the company will be carved out.

The Level of Relief: 100% and 50%

Full (100%) Relief

This applies to:

• A business or share in a business (e.g., partnership interest or sole trade)
• Unquoted shares or securities in a trading company (including AIM-listed shares if the company is trading)

50% Relief

This applies to:

• Land, buildings, or machinery used for business by a partnership or company controlled by the transferor
• Controlling holdings in quoted trading companies (>50% voting control held immediately before the transfer)

Where spouses or civil partners both hold shares, in certain circumstances their holdings may be aggregated to assess whether voting control exists for 50% relief on quoted trading company holdings.

Application to Different Business Structures

Sole Traders

The entire value of a substantive trading business, not comprising mainly investment assets, qualifies for 100% BPR. Watch for non-trading assets within the business (e.g., a personal investment portfolio) that would be treated as excepted and excluded from relief.

Partnerships

A share in a trading partnership is eligible for 100% relief. Land or property used by the partnership but owned personally only qualifies for 50% relief. If the partnership itself owns investment assets not used in trade, value attributable to those may be excluded under the excepted assets rule.

Shareholdings in Companies

Shares in unquoted trading companies are eligible for 100% relief. Shares giving control (over 50% voting rights) in quoted trading companies attract 50% relief. Minority holdings in quoted companies, even if trading, generally receive no BPR.

Property Used in Business

If an individual owns land, buildings, or machinery personally and they are used by a partnership or company they control, only 50% relief is given. The use test must be satisfied: the asset should have been used wholly or mainly for business purposes in the relevant period and required for future use.

Calculation and Impact of BPR

Where relief is available, the value of the business property is reduced by either 100% or 50% before calculating the inheritance tax charge arising on death or gift. For example, with 100% BPR the asset’s value is reduced to nil for IHT. With 50% BPR, only half of the asset’s value is brought into the IHT computation. Relief is claimed after applying spouse/civil partner and charity exemptions; consider the sequence because exemptions may already remove IHT on certain transfers.

Worked Example 1.3

Samira owns a 55% shareholding in a trading company and also owns a warehouse personally, which the company uses for its trade. On her death, how does BPR apply to her estate?

Answer:
Samira’s 55% holding in the trading company qualifies for 100% relief if the company is unquoted and trading; if quoted, her controlling holding would qualify for 50%. The warehouse held personally and used by the company (which she controls) is eligible for 50% relief, assuming it was used wholly or mainly for the company’s trade in the relevant period and required for future use.

Worked Example 1.4

Dylan dies owning 20% of the shares in a quoted trading company, and £500,000 of surplus cash within his wholly-owned trading company that is not required for working capital. What BPR applies?

Answer:
The 20% minority holding in the quoted trading company does not qualify for BPR (no control). In the wholly-owned trading company, surplus cash not required for trade is an excepted asset: the proportion of share value attributable to that surplus cash will be excluded from BPR even if the company is trading overall.

Worked Example 1.5

A partner’s will contains a clause obliging the remaining partners to buy the deceased’s share and the PRs to sell it at market value. How does this affect BPR?

Answer:
A binding contract for sale at death prevents BPR. Such buy-sell provisions should be drafted as options (e.g., “the PRs may offer to sell and the remaining partners may elect to buy”) rather than binding obligations, to avoid denying BPR.

Restrictions Following Transfer or Death

Where property qualifying for BPR passes to a spouse or civil partner, it is usually exempt from IHT under the spouse exemption. However, future BPR eligibility can be affected if the asset is later sold or ceases to qualify (e.g., a trading company becomes an investment company). If the surviving spouse later transfers the property, consider whether the two-year ownership requirement is satisfied (successive ownership rules often help) and whether the business still meets trading tests.

Loss and Withdrawal of BPR

BPR on lifetime gifts is conditional. Relief may be withdrawn (clawed back) if, within the statutory period (currently up to seven years for lifetime gifts), any of the following occur:

• The donee disposes of the property and does not acquire replacement relevant business property in time.
• The property ceases to be relevant business property (e.g., company becomes investment-focused).
• The asset becomes an excepted asset (e.g., repurposed to non-business use).
• A binding contract for sale arises in relation to the property within the critical window.

On death transfers, relief is tested at death; subsequent changes do not claw back relief on the death event, but may affect BPR on later transfers.

Exam Warning

Many BPR exam questions turn on whether the company or partnership passes the trading/investment test. Always check that the business is trading, not mainly investment. Read the scenario carefully to avoid applying BPR where it is not available. Be alert to excepted assets and binding contracts for sale.

Practical Issues and Common Pitfalls

• Check the “wholly or mainly” test. Mixed activity companies (trade plus investment property) require careful analysis of turnover, profit, asset base, management time and business purpose. If trading predominates, BPR can still apply; otherwise, relief fails.
• Identify excepted assets within otherwise trading entities (e.g., surplus cash balances, investment portfolios). Relief is restricted to the portion of value used for business purposes.
• Confirm control for quoted company holdings. Without control, no BPR applies to quoted shares.
• Review pre-existing agreements. Binding buy-sell obligations on death or retirement can deny BPR; recommend option-style mechanisms instead.
• Verify the two-year rule and replacement property timing (usually three years to aggregate periods). Use successive ownership rules for spouses/civil partners where relevant.
• For personally owned assets used by a business, ensure genuine business use and future need; otherwise, the 50% relief will be denied.
• Sequence exemptions and reliefs correctly in the IHT computation. Apply spouse/charity exemptions before claiming BPR, then compute any remaining tax.
• For lifetime gifts, advise recipients on retention and qualifying use to avoid clawback.

Revision Tip

Always check ownership periods, trading status, and the use of assets. Watch for property owned outside the business but used by a company or partnership – this often qualifies only for 50% relief. Confirm there is no binding contract for sale; look for excepted assets inside companies (surplus cash or investments).

Key Point Checklist

This article has covered the following key knowledge points:

• IHT may apply to business property on death or certain lifetime transfers (transfers of value).
• BPR provides 100% or 50% relief from IHT for qualifying business property; AIM shares in trading companies are treated as unquoted for BPR.
• Relief depends on asset type, period of ownership (usually two years), trading status, and absence of a binding contract for sale.
• Excepted assets do not qualify; relief is restricted to value used wholly or mainly for business.
• Replacement property and successive ownership (e.g., between spouses/civil partners) can satisfy the two-year rule.
• Controlling holdings in quoted trading companies attract 50% relief; minority quoted holdings generally do not.
• Personally owned assets used by a controlled business attract only 50% relief if use and future need tests are met.
• Lifetime BPR can be clawed back if conditions fail (e.g., disposal without replacement, ceasing to trade).
• Sequence exemptions (spouse/charity) before BPR, then compute IHT on any remaining value.
• Draft buy-sell arrangements as options, not binding contracts, to preserve BPR.

Key Terms and Concepts

• inheritance tax (IHT)
• business property relief (BPR)
• transfer of value
• qualifying business property
• relevant business property
• trading company
• controlling shareholding
• AIM
• excepted assets
• binding contract for sale
• replacement business property
• spouse exemption