Mark McLaughlin considers the inheritance tax treatment of a rental property business within a trading company.
Many individuals would like to have a rental property business, but may be concerned (among other things) about the possible eventual inheritance tax (IHT) liability on the value of the property portfolio. However, a valuable IHT relief may be available to alleviate the problem in certain circumstances.
Business property relief (BPR) applies to various types of ‘relevant business property’. For example, BPR can apply to a business (or an interest in it), or to shares in an unquoted company, if certain conditions are satisfied. The rate of BPR on these categories is up to 100%.
The ‘right’ business?
However, a business (or business interest) and unquoted company shares are not eligible for BPR if the business, or the business carried on by the company, consists wholly or mainly of dealing in securities, stocks or shares, land or buildings, or making or holding investments (IHTA 1984, s 105(3)). These BPR exclusions are subject to certain exceptions (in s 105(4), (4A)), which are not considered in this article. The ‘wholly or mainly’ test applies to both unincorporated businesses and companies, but this article concerns single companies.
The exception from BPR for businesses wholly or mainly of making or holding investments means that (for example) the shareholders of a family or owner-managed company operating a rental property business (and nothing else) would generally not be eligible for BPR in respect of their shares.
The above ‘wholly or mainly’ exclusion from BPR in respect of investment businesses, etc., is an ‘all or nothing’ test. For example, shares in an unquoted company with business activities comprising 51% qualifying trading and 49% investment may qualify for BPR in full (although in practice it might be difficult to measure the respective activities accurately). On the other hand, the company’s shares would be eligible for no BPR at all if its business activities are 49% trading and 51% investment.
A separate potential BPR problem is an anti-avoidance provision for ‘excepted assets’ (IHTA 1984, s 112). The general rule is that an asset is an ‘excepted asset’ if either of two alternative tests applies. The first test is that the asset was not used wholly or mainly for the purposes of the business throughout the whole or the last two years of the relevant period. The second test is that the asset was not required for future use in the business.
If ‘caught’ by the excepted asset provisions, the effect is broadly that BPR (e.g. on a lifetime transfer of shares into a discretionary trust, or on death) is restricted by the value attributable to the excepted assets. Only that part of a transfer of value which relates to ‘relevant business property’ is reduced by BPR; the other part relating to the excepted asset is not reduced by BPR and is chargeable to IHT as normal.
Thus (for example) using an unquoted trading company as a ‘money box’ for surplus cash (i.e. cash not required for present or future trade use) is unlikely to shelter those funds from IHT, as cash which is an excepted asset will generally restrict BPR on the shares. HMRC does not consider that holding surplus cash on deposit constitutes an investment business activity (see HMRC’s Shares and Assets Valuation manual at SVM111220).
A ‘hybrid’ business
By contrast, if the trading company was engaged in secondary rental property business activities, it may be possible for BPR to be available in respect of its shares, without restriction. HMRC accepts that a ‘hybrid’ company (i.e. trading and managing investments) that is mainly trading will not be subject to the excepted assets rule in respect of assets used in the investment element of the business (e.g. rental properties).
Consideration could, therefore, be given to the company operating an investment business that is ancillary to its qualifying trade, such as a rental property business. As mentioned, shares in a hybrid trading and investment company may be eligible for BPR in full (but see below). However, it is important that the rental property business activities are conducted as an integral part of the company’s hybrid business.
It will probably be necessary to satisfy HMRC that a ‘business’ is being carried on in respect of the rental properties, as opposed to being excepted investments (see IHTM25272). For example, HMRC guidance states: ‘A degree of activity is required to constitute a business, and whether investments involve sufficient activity must depend on their nature and the particular facts’ (SVM111220).
It is vitally important that the company does not breach the ‘wholly or mainly’ excluded activities test, by ensuring that the company’s investment business activities do not predominate over its qualifying trading activities (see HMRC guidance at IHTM25265 and SVM111150). Otherwise, BPR may be lost in its entirety. The other conditions for BPR (e.g. the period of share ownership) should also not be overlooked. Expert professional advice is strongly recommended where necessary.