Chancellor Rachel Reeves with a sweeping stroke has slashed the long-standing favourable inheritance tax reliefs (IHT) for small businesses in the Autumn Budget, limiting 100% agricultural property relief (APR) and business property relief (BPR) to the first £1m of value. Above that threshold, there will be 50% relief on qualifying assets, giving an effective IHT rate of 20%. At the time of writing, it appears that the full impact of the decision on small businesses has not been realised given much of the media’s focus has been placed on farmers. Farming is perhaps unique in that the majority of farmers “die with their boots on” whereas most other small business owners are likely to step back from their business, sell up and enjoy the proceeds before it gets to that point. Whilst they may therefore be more concerned with the capital gains tax (CGT) changes rather than passing down the generations, the IHT reality looms for all small business owners that have built up capital and should not be dismissed.
We have to consider the valuation of the business on death. It is the executor’s responsibility to obtain valuations at Market Value.
With the drop in APR and BPR from 100% to 50% above £1million there is more likely to be an IHT liability which could impact the terms of the Will as shown by the case of Hall (N Hall and another (as trustees of Carolina Raboni Deceased) v HMRC (TC 8691)). The funding of IHT liabilities will be critical. Share valuations of small businesses will be more important in terms of bringing assets into the IHT range. Rollover Relief for Capital Gains Tax (CGT) still exists so there could be willing buyers still wanting to shelter gains for those who want to sell.
So much of future IHT liability could depend on valuation. The new rate of BPR will result in many more unquoted share valuations being negotiated with HMRC. The changes mean that some shares held on death that hitherto required only a probate valuation will now fall into charge together with some lifetime gifts where the donor does not survive seven years. As a consequence, Shares and Assets Valuation (SAV) will oversee increased revenues flowing to the exchequer and small businesses must be prepared.
In this new IHT environment it is important to ensure that any valuation which could come under scrutiny for IHT is in a format best designed to achieve credibility with SAV. Therefore, when preparing a valuation of trading company shares it is a good idea at the outset to run through the factors involved.
In reality, most business activities carry no specific format as regards valuation. The first step regarding the valuation will be to record for up to the five previous completed financial years the turnover, gross profit, directors’ remuneration, operating profit, EBITDA (earnings before interest, taxes, depreciation and amortisations), net profit before and after tax, dividends and net assets. Any significant exceptional items should be noted. Management figures plus any budget, forecasts and profit plans available at the valuation date should also be recorded and understood.
The valuer can transcribe and should arrive at:
Surviving spouse exemption remains so there are lots of opportunities to use inter-spousal transfers and planning. Holdover Relief for CGT has also survived the Labour Budget of 30 October 2024 for those wanting to pass down rather than across generations, and advisers have therefore seen a flurry of lifetime transfers discussions. The problem is that the potential Inheritance Tax (IHT) saving that can be achieved with the transfer could be outweighed by the potential future CGT liability. It is therefore essential to ensure there is a full understanding of the future plans for the small business and tax calculations as to what is the best choice. Against this background is the concern that the Budget on 30 October was only the “starter pack” of tax changes and there is worse to follow so there is a degree of gambling/crystal ball.
There were also no changes to the potentially exempt transfer (PET) rules, the rules covering relief for heritage property, or for gifts being made as part of normal expenditure out of surplus income. Historically, the interaction of IHT and CGT rules on death has encouraged older generations to retain assets qualifying for relief until death when not only would there be no IHT, but there would also be the benefit of a potential uplift in base costs for CGT purposes to market value. These behaviours for small businesses may in future change in favour of lifetime giving, particularly if there is unlikely to be a future sale. In these cases, a transfer to trust may be preferable, as a 3% charge every ten years may be far more palatable and affordable than an effective 20% charge on death, with the added benefit that control can be retained via a trustee role.
Splitting ownership of the small business is another option, as each individual owner would have a £1m tax-free band. Again, this would be subject to the seven-year rule and the gifts with reservation of benefit (GROB) issues need to be considered. The donor must not retain any benefit from the gift, complicating the position where the older generation still needs income.
There will need to be consideration as to how the IHT liabilities are funded. The option to pay IHT on qualifying assets by instalments remains; however, some instalments are subject to interest. IHT is generally due for payment at the end of the sixth month after the chargeable event, whether this is a death, a principal charge, or a proportionate charge. In the case of a chargeable lifetime transfer payment, this is due at the end of the sixth month for a transfer made between 1 October and 5 April, otherwise payment is due at the end of April after the transfer. Interest on late paid IHT dropped to 7.25% on 25 November following the reduction in the Bank of England base rate earlier in the month. From 6 April 2025 this will increase to 8.75% (assuming no further changes in the base rate). The increase in interest rate will also affect those making instalment payments. Where these instalments relate to non-qualifying property, interest is due from the original due date to the date the instalment is paid. The full interest rate position must be understood.
These Budget changes are the subject of various tax consultations. A consultation on the application of the £1m APR/BPR allowance and charges on trust property will be published in early 2025. The IHT changes in the Budget are likely to increase taxes for those affected by the reduction in reliefs, as well as bringing more estates into the scope of IHT when the values of pensions are included. What remains to be seen for small businesses is the detail in the legislation, and any changes as a result of the consultation processes.
The changes to BPR means that business owners should be speaking and planning for IHT liabilities earlier in their lives. They will need to balance the availability of these reliefs against the availability of an uplift in base cost on their death, and the long term plans for the business and the individual family members. Those with significant pension funds will also need to plan, as pensions will soon no longer be the IHT efficient investment wrapper that they have become.
All Wills of those who own small businesses will need reviewing with regard to the choice of Executor and the provision for IHT liabilities and increased lifetime gifting. This will have to be done as part of full succession planning. It is vital that the £1m threshold is one of the first considerations for all those involved in small business ownership now or in the future. These tax changes will drive the structure and ownership model of the business moving forward. One notable change post Budget is that the small businesses are very focused. With relatively low increases in CGT there is lots to do.
