A practical guide to using limited company to avoid Inheritance Tax

If you are a limited company business owner, then you need to consider passing your estate and wealth onto the next generation and the impact this has on how much your family will pay in Inheritance Tax.

Inheritance Tax (IHT) is a consideration for all individuals. However, for business owners it is more complex as you may have built up a complex range of assets, including properties, shares, stocks, and other investments. While businesses offer some protection for assets, it’s not as simple as keeping all your capital safe within your company.

Avoiding a 40% IHT bill on your hard earned assets is not always simple. Careful estate planning needs to be undertaken. In this blog, we look at how you may avoid Inheritance Tax or reduce Inheritance Tax.

What is Inheritance Tax?

Inheritance Tax is paid on net taxable assets at the rate of 40%. Individuals have a standard nil rate band of £325,000. Assets left to a spouse or civil partner are normally exempt from Inheritance Tax. If you give away your home to your children (including adopted, fostered and stepchildren) or grandchildren your threshold can increase to £500,000.

There’s normally no Inheritance Tax to pay if either:

• The value of your estate is below the £325,000 threshold.
• You leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club.

What assets are relevant for Inheritance Tax?

For Inheritance Tax purposes, the following assets are relevant and can be subject to IHT:

• Properties (both residential and commercial).
• Shares in companies (both trading and non-trading).
• Investments (stocks, bonds, funds, etc.).
• Cash holdings.
• Valuable personal belongings (art, jewellery, antiques, etc.).

Effective estate planning means you could move some of these into a structure that not only protects them from IHT, but also minimises risk and shelters them from unforeseen events in your business or your family.

Business Relief for Inheritance Tax

As a business owner, the value of your trading company is generally not subject to IHT, as it qualifies for Business Relief.

Many private limited companies, limited liability partnerships, and sole trader businesses or business interests will qualify for Business Relief.

Business Relief is an extremely valuable exemption for limited company business owners.

However, it can be more complex when your business holds surplus cash, investment assets, or non-trading assets, as these can affect the qualifying trading status of your company for IHT exemption. To qualify for Business Relief the following must apply:

• The company must be a trading business, not an investment one.
• The company must have been owned for at least two years before death, limiting the ability to pass on the company proactively.
• The company can be a limited company, partnership, unlisted company, or the relief can apply to significant shareholdings in listed companies.
• The assets must be necessary for the business, like property or machinery, rather than accumulated investments.

Business Relief reduces the value of a business or its assets for Inheritance Tax purposes.

Any ownership of a business, or share of a business, is included in the estate for Inheritance Tax purposes.

However, you can get Business Relief of either 50% or 100% on some of an estate’s business assets, which can be passed on.

A business owner may find that more of the value accrued can fall under the scope of IHT, this is where professional advice and good estate planning comes in as there is opportunity to separate your investment assets from your trading assets to save IHT.

Inheritance Tax on limited company shares

In some circumstances, limited company shares are liable to Inheritance Tax. It will depend on how much these shares are worth, the type of company they are held in and whether particular conditions are satisfied.

Business Relief (previously Business Property Relief) shelters certain types of company shares from Inheritance Tax. For example:

• 100% tax relief is available on shares in a private limited company or a limited company that is listed on the Alternative Investment Market (AIM).
• 50% relief is available on shares controlling more than 50% of the voting rights in a Public Limited Company (PLC).

You can get 100% Business Relief on:

• a business or interest in a business
• shares in an unlisted company

You can get 50% Business Relief on:

• shares controlling more than 50% of the voting rights in a listed company
• land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled
• land, buildings or machinery used in the business and held in a trust that it has the right to benefit from

You can only get relief if the deceased owned the business or asset for at least 2 years before they died.

What doesn’t qualify for Business Relief

You cannot claim Business Relief if the company:

• mainly deals with securities, stocks or shares, land or buildings, or in making or holding investments
• is a not-for-profit organisation
• is being sold, unless the sale is to a company that will carry on the business and the estate will be paid mainly in shares of that company.
• is being wound up, unless this is part of a process to allow the business of the company to carry on

Property investors should note that there is no Business Relief for a business that is wholly or mainly dealing in land or buildings or in the making or holding of investments. (See more IHT tips for property investors below).

You can’t claim Business Relief on an asset if it:

• also qualifies for Agricultural Relief. You may be able to get Business Relief on a transfer of agricultural property (e.g. farmland, buildings or farm equipment) which isn’t eligible for Agricultural Relief.
• wasn’t used mainly for business in the 2 years before it was either passed on as a gift or as part of the will
• isn’t needed for future use in the business

IHT and types of shares

Private company unquoted shares

You can pass shares in non–investment unquoted companies IHT free if held for at least two years. Shares in an investment company do not qualify for Business Relief. Shares listed on the Alternative Investment Market (AIM Listed) that are held for at least two years can also be free of IHT.

Public companies

Shares held in public companies (such as quoted on the FTSE) will normally be subject to IHT. However, shares controlling more than 50% of the voting rights in a listed company will qualify for 50% Business Relief.

Shares left to charity

Shares left to charities will generally be exempt from IHT.

Gifting shares while you are alive

Gifting shares whilst you are alive can help you to avoid some or all Inheritance Tax.

If you gift shares to your spouse or civil partner, they will be exempt from IHT irrespective of their value if:

• they permanently reside in the UK
• you are legally married to each other or in a civil partnership

Gifting of shares to others such as children or grandchildren can be more complex.

Some IHT may still arise on death if:

• they are unlisted shares that you have held for less than two years
• shares are in companies listed on the Stock Exchange.

Gifting can avoid IHT if you live for 7 years after the gift was made. If you die within the 7 year period, Business Relief can still provide exemption from IHT. But if Business Relief doesn’t provide exemption, then the Inheritance Tax payable will depend on when you gifted them.

A gift to an individual is a Potentially Exempt Transfer (PET) with no upfront IHT charge. Gifts into trust are chargeable, but no IHT will arise if 100% BR applies.

For example:

If they don’t qualify for Business Relief, the estate exceeds the IHT tax free threshold and they were given 3 to 7 years before you passed away, they will be taxed on a sliding scale (this is known as taper relief) and is as follows:

• 32% if there are 3 to 4 years between gifted shares and death
• 24% if there are 4 to 5 years
• 16% if there are 5 to 6 years
• 8% if there are 6 to 7 years

It is worth noting that when you gift shares, you may also have to pay Capital Gains Tax (CGT) or Income Tax, if they have increased in value during the time that you have owned them. Seek professional tax advice before gifting.

Family Investment Companies (FICs)

In recent years, Family Investment Companies (FICs) have become increasingly popular as a means of estate planning.

A Family Investment Company (FIC) is a private company that is controlled and run by its directors (usually the parents or grandparents), with the parents and other family members owning the shares.

Who would set up a Family Investment Company (FIC)?

Family investment companies are popular with business owners, high net worth individuals, entrepreneurs and directors that are higher or additional rate taxpayers with companies, portfolios of property and investments, where their estate may be subject to a large Inheritance Tax liability. Family Investment Companies also work well for family businesses.

The FIC can invest in various assets, such as properties, stocks, and shares, with the growth in value accruing to the trust rather than the founders’ personal estates.

Those with only a small potential IHT liability are unlikely to set up and use a family investment company.

Seek advice from a professional tax advisor, such as dns accountants before deciding on setting up a FIC.

Family Investment Companies and IHT

One of the main advantages of family investment companies are the IHT benefits.

For inheritance tax purposes, shares gifted during a shareholder’s lifetime will be treated as potentially exempt transfers (PETs) and will escape an IHT charge if the donor survives seven years.

In contrast, a gift to a trust will give rise to an immediate IHT charge at 20% (to the extent it exceeds the donor’s nil rate band).

Inheritance tax planning with FICs can be an extremely tax-efficient way of passing on the shares in the FIC to other family shareholders or new family members. The shares in the FIC will ultimately not benefit from any Inheritance Tax (IHT) reliefs upon death, such as Business Relief, due to it being an investment company, not a trading company.

Discretionary trusts

Discretionary trusts can be another great tool for managing and reducing IHT exposure. They provide flexibility that allows for more effective tax planning and asset protection.

A discretionary trust gives the trustees the discretion to distribute income and capital to the beneficiaries as they see fit.

There are several ways to utilise discretionary trusts in your estate planning:

• Placing assets directly into the trust (e.g., rental income, investments).
• Using capital from the trust to acquire assets (e.g., properties, shares).
• Assigning shares in your business to the trust before a sale, allowing the sale proceeds to flow into the trust.

You can maintain control and protect assets within a trust them from potential risks, such as divorce or family conflicts, while also mitigating your IHT exposure.

Life insurance

It is possible to take out a life insurance policy to cover your IHT liability. You need to understand your assets, their value and what will qualify for Business Relief. You can then take out an insurance policy to cover any potential future IHT bill.

IHT and property investors

For property investment companies, IHT is a complex area. With no Business Relief being available for companies that are ’wholly or mainly’ dealing in land or buildings or in the making or holding of investments.

Using a limited company to hold buy-to-let properties can provide a more tax-efficient way to pass on wealth to future generations. However, you have to ensure that the company undertakes an activity that qualifies for Business Relief (for example, property development). This then provides a way to avoid or minimise IHT.

However, there are still some IHT tips for people that own property investment companies such as:

• Giving properties away before you die (see details of gifting above for more information).
• Set up a trust (see above about discretionary trusts).
• Set up a Family Investment Company (FIC) (see above more details on FIC’s).
• Take out an insurance policy to cover the IHT bill (see above).

Seek professional advice if you hold property in a limited company and want to undertake estate and IHT planning.

Summary

There are tax planning and estate planning strategies that can be adopted to avoid Inheritance Tax or at least mitigate some of the IHT bill your family may face.

Business Relief is an extremely valuable exemption for limited company business owners. However, IHT planning can be more complex when your business holds large amounts of surplus cash, investment assets, or non-trading assets, as these can affect the qualifying trading status of your company for IHT exemption.

You should seek advice on IHT planning from qualified tax advisors such as dns accountants to help you to reduce your IHT bill. Contact our IHT experts today on 0330 088 6686 or e-mail us at enquiry@dnsaccountants.co.uk

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