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Inheritance tax planning for business owners affected by divorce

By RJP LLP on 22 June, 2016

This month we continue our focus on the tax impact of divorce with another blog, in which we look at inheritance tax planning for business owners and highlight the important role that business property relief can play in helping to reduce inheritance tax liabilities.

In our first blog on CGT and divorce we explained the impact of separation and divorce on capital gains tax liabilities, which can be incurred when a share-owning spouse transfers a shareholding. Here the general rule of thumb is to try and seek agreement over assets as soon as possible whilst transfers between spouses remain tax free.

After this point, if capital gains tax is incurred, it may be possible to use entrepreneurs’ relief to reduce the amount payable if the shareholders involved satisfy the eligibility criteria. Alternatively, the couple may jointly elect for the capital gain to be held over by claiming gift relief.

Where assets are concerned, it is however useful to consider inheritance tax (IHT) alongside capital gains tax; because whilst IHT may not have an immediate impact, there may be opportunities to undertake longer term tax planning.

Where shares are transferred between husband and wife, for IHT purposes the gift is covered by the spouse exemption, but if the shares are transferred at a later stage, following divorce for example, this will not be the case, therefore IHT must be considered. A gift of assets made to a former spouse will be a potentially exempt transfer (PET) for IHT purposes, and provided the donor survives for 7 years following the gift, no IHT liability will arise. If they die within 7 years of the gift, the asset will fall back into their estate for IHT purposes, subject to tapering relief after 3 years.

 

How can this be used for tax planning purposes?

The starting point for inheritance tax planning where business assets are concerned, is that they qualify for business property relief (BPR). This relief is available for IHT purposes on the value of transfers of business property providing certain conditions as to length of ownership and type of business are satisfied. Where the business property is shares in a trading company, or interest in a trading business, relief is given at the rate of 100%

This relief is available on death and on lifetime gifts provided the donor survives 7 years following the gift, or, if they die sooner, provided broadly that the asset gifted is still owned by the person to whom it was gifted.

Therefore, qualifying shares can be transferred to a former spouse and even though the spouse exemption is no longer available, the gift can avoid the 7-year run-off period for IHT purposes because BPR is available.

For planning purposes, this means the shares can be transferred to anyone and the relief can still be claimed; this can be particularly useful where the shareholders have children, because this presents an opportunity to pass the shares down a generation with no IHT liability.

There are a number of alternative ways in which this can be achieved:

  • By transferring the shares directly to adult children;
  • By placing the shares on trust for adult children and grandchildren;
  • By holding on to the shares and bequeathing them on death to adult children and/ or grandchildren either outright or on trust.

Additional benefit can be achieved by bequeathing the assets on death because there will be uplift in the base cost of the shares for capital gains tax purposes, and no IHT to pay as a result of BPR. This approach also means a spouse can continue to own the shares if appropriate until death and potentially receive dividend payments, which can be an efficient way to manage ongoing income requirements.

 

Example: Inheritance tax planning for business owners - how business property relief works

The example below highlights how this planning can work in practice:

Bob and Helen are joint shareholders of a recruitment consultancy and each owns a 50% shareholding in the company. They have 2 children and plan to divorce. Helen requires an ongoing income and the couple has agreed that she will retain her shares in the company, entitling her to regular dividend payments. They also wish to undertake IHT planning at the same time and each shareholder has written a will leaving their company shares to their children. Upon the death of either Bob or Helen, their shares will be left to their children with no IHT liability because the shares will receive 100% BPR. Their children will inherit their shares at their market value on death for CGT purposes, and will only suffer CGT on disposal of the shares to the extent that their value exceeds probate value.

Business owners should always remember the availability of BPR when carrying out IHT planning; but perhaps they should also consider IHT planning at other times such as when separating or divorcing.

 

If you would like more information on the tax implications of divorce, please contact Lesley Stalker by emailing las@rjp.co.uk.

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