The long awaited second instalment of the Office of Tax Simplification’s (OTS) Inheritance Tax Review hit the shelves (well HMRC’s website) on Friday 5 July 2019. For those of us advising on Inheritance Tax (IHT) we can at least sleep a bit easier now we have the OTS’ list of 11 recommendations!

The engagement from the public and professional bodies on the review of IHT has been unprecedented according to the OTS and has seen interaction from over 3,600 interested parties. It is fair to say IHT is a tax that to date has been largely untouched (some 25 years post inception) and one which is unpopular given the timing of when the tax hits, being largely at the time of a bereavement. In terms of tax take, the Exchequer make about £5.37bn (18-19) from IHT, a not insignificant number but it pales in comparison to the main tax ‘breadwinners’ being income tax at over £190bn and VAT and National Insurance, each around £130bn.

For the OTS’ part, their remit was set out by Philip Hammond, Chancellor of the Exchequer back in January 2018. The magnitude of the task, coupled with the overwhelming public engagement, resulted in the review being a tale of two halves. The first report was released in November 2018 and focused purely on the administration of the tax, with the second instalment getting ‘under the bonnet’ of the tax.

These are purely recommendations from the OTS and as to whether or not all or any of these recommendations will be legislated for in the future will depend on the appetite within the UK Government and the wider Parliament.

Of the 11 recommendations, two stand out as potential areas of concern for family businesses which it’s important to be aware of.

Removal of the capital gains tax uplift on death

Under the existing tax legislation, there is no Capital Gains Tax (CGT) charge upon death. This is known as the CGT uplift and it effectively resets the clock on any gains for CGT purposes. Assets held upon death are then passed on to the family member at market value. 

If we think about this in practice, the asset could be farmland or shares held in a trading company. The value of these assets will get rebased to market value on death for CGT purposes. For IHT purposes these assets would qualify for either agricultural property relief (APR) or business property relief (BPR) which would mean the full value of these assets is reduced to nil and no IHT is due and the potential gains from a CGT perspective have been washed out. 

The OTS noted within their review that they believe, based on evidence provided, that such reliefs could put people off passing assets on during their lifetime to the next generation. In essence, it is more tax beneficial to hold on to these assets until death, banking the uplift to market value for CGT and also not incurring any IHT. Shortly after death the asset can then be sold by the recipient with no tax incurred.

What does this mean for family businesses?

The OTS recommends in the report that the government considers removing the CGT uplift at death, where an IHT exemption or relief has been given, and instead in these circumstances the asset would pass to the recipient on death at only its historic base cost. Where family businesses are concerned this is often an extremely low base cost. In the case of the multi-generational family business you will often be looking at a March 1982 value, at best, for the asset. This change would see assets passing onto the next generation on death at a low base cost from a CGT perspective, therefore if the asset or business was then to be sold in future, CGT would payable.

What the report doesn’t allude to though is the fact that tax is but one factor that is taken into account when determining whether to pass assets on. Other factors which arguably play a more important role in the decision making process is that of holding on to financial security by retaining the asset until death. Likewise protecting the asset from perhaps family members who are not yet ready to take on the responsibility that comes with owning the business or who could be impacted by life events, such as divorce, bankruptcy and so on. Certainly, where these are concerns for the family, there are other vehicles that can be considered for passing on assets in lifetime whilst retaining the flexibility and protection desired, such as a Trust structure operating with or without a Family Company.

There is a passing remark from the OTS within the review that APR and BPR be abolished and a reduced rate of IHT applied, no further comment is made regarding this. Certainly, such a move would be detrimental to family businesses, as in most cases, the money is unlikely to be available to meet the IHT charge that would arise and selling the family business may be the only option to meet the charge.

Businesses and farms

An entire chapter of this tax thriller is given over to focusing specifically on businesses and farms. It is disappointing that yet more change is potentially around the corner for family businesses who currently find themselves navigating rafts of new legislation, both within the tax system and beyond, as well as preparing for Brexit which continues to float just beyond the UK’s grasp.

To recap, the IHT regime operates extremely favourably for ‘trading’ businesses and farming enterprises, even where the farming undertaken is that of letting the land. These types of assets can qualify for generous IHT reliefs such as agricultural property relief (APR) and business property relief (BPR). The OTS has positively flagged up within their review the current harsh approach of HMRC where APR is denied in some instances on the farmhouse, if for example the farmer has moved into a care home prior to death. The OTS has asked HMRC to review their approach and broaden their guidance. However, on the flip side, they have brought the spotlight to bear on business property relief (BPR).

Business property relief

The OTS has questioned why the test in determining a ‘trading’ company for CGT reliefs, such as Entrepreneurs’ Relief and Holdover Relief, differs to the test in place for determining if a business qualifies for BPR. The test for CGT is a higher bar, requiring a business to be ‘substantially’ trading, this is taken to be an 80% trading vs 20% investment test, whereas for BPR the legislation refers to the business being not ‘wholly or mainly’ a non-investment business. HMRC guidance and caselaw alludes to this being a 50% plus "trading" test. From an IHT perspective you can have quite a mixed business, with significant investment activities, such as income from let properties and still the overall value of the business qualifies for 100% BPR, so long as the investment activities make up less than 50% of the overall business, when looked at in relation to a number of factors.

Diversified businesses

The OTS recommends that the IHT test be aligned with the 80:20 CGT test going forward. This could have quite a significant impact on family businesses which have previously been able to be passed on to the next generation without incurring an IHT cost on the death of the owner. Often family businesses, especially those which have diversified over the generations, may have diversified into trading and non trading assets, the latter whilst falling on the investment side of the fence for BPR purposes, often still plays an integral part in the overall business.

Next steps – what should you do?

There is much food for thought within this latest IHT review in terms of the direction of travel for family businesses. It does certainly bring the whole question of succession planning for the business back up to the top of the list as well as considering how best to manage that whilst ensuring flexibility and protection of the family’s core assets.

Now is a good time to review your succession plan and structure for your family business, before these recommendations are acted upon. Our Private Client Tax team are here to help. Get in touch with me Alex Docherty at alex.docherty@jcca.co.uk or another member of the team for an initial chat.