Mark McLaughlin highlights a potential pitfall for inheritance tax business property relief purposes, touching upon buy and sell agreements, acceptable terms and HMRC enquiries, among other things.
Business property relief (BPR) potentially provides inheritance tax relief at 100% (or 50%) on various types of ‘relevant business property’, including a business or interest in a business, or shares in an unquoted company.
However, BPR is subject to certain conditions and restrictions. Failure to satisfy those conditions can result in unincorporated business owners or shareholders inadvertently losing the benefit of BPR. For example, most tax advisers will be aware that BPR does not generally apply if the business consists wholly or mainly of making or holding investments.
Binding contract pitfall
In addition, BPR will generally be denied if there was a binding contract for sale of the business property at the time of its transfer (eg, upon making a gift of the business property to a discretionary trust, shortly prior to a sale of the business that was already agreed at the time of making the gift) (s113, Inheritance Tax Act 1984 (IHTA 1984)).
This binding contract provision is an anti-avoidance rule. The underlying principle is that BPR should be available in respect of ‘relevant business property’, but not cash.
However, it should be noted that BPR is not denied if the reason for the binding contract is the incorporation of a sole trader or partnership in which the sale proceeds are wholly or mainly shares or securities in the company (note that an incorporation for cash is therefore precluded), or in the case of company shares or securities if the purpose of the sale is a reconstruction or amalgamation.
‘Buy and sell’ agreements
A potential pitfall for business owners relates to ‘buy and sell’ agreements. These are broadly arrangements whereby, in the event of the death of one of the owners, his personal representatives are obliged to sell and the survivors are obliged to buy his partnership interest or shares in a company. The purchase price will often be provided through a life assurance policy.
It is important to recognise the types of agreement that constitute a binding contract for sale. HMRC considers that there are three main elements (see HMRC’s Inheritance Tax Manual at IHTM25292):
- an agreement for the deceased’s partnership interest or shares to pass to their personal representatives;
- a requirement for the personal representatives to sell the partnership interest or shares to the surviving partners or shareholders; and
- an obligation for the surviving partners or shareholders to buy the asset under the terms of the agreement.
Where these elements are present, BPR will not be due on the business interest or shares (SP 12/80), even on the death of the business owner. Following that statement of practice, the Inland Revenue (as it then was) published an article in the Law Society Gazette in May 1981, which noted that SP 12/80 had caused “a considerable amount of concern”.
The article included five examples, of which the Revenue confirmed that a binding contract for sale before the death of the partner would only exist in the following example (note the same would apply in respect of company shares and shareholders):
“Partnership continues and partnership share falls into deceased’s estate but partnership agreement provides obligation for executors to sell and for surviving partners to buy partnership share either at valuation or in accordance with formula.”
Acceptable terms
Fortunately, arrangements can often be structured in such a way that BPR remains available. For example, agreements may include:
- accruer clauses (ie, the deceased’s interest passes to the surviving business owners, who are required to pay the personal representatives a particular price (commonly an arm’s length valuation of the business interest)); and
- options (ie, the deceased’s business interest falls into his estate, but with an option for the survivors to purchase it).
HMRC accepts that the above types of arrangement do not constitute binding contracts for sale, and therefore do not prevent the business interest qualifying for BPR.
If a company’s Articles of Association require the deceased shareholder’s personal representatives to offer the individual’s shares for sale to the company, or other shareholders or directors, the BPR disqualification does not apply, provided there is no obligation on the survivors to buy the shares. However, care is needed to ensure there is no mutual obligation to do so.
There has been some uncertainty about the effectiveness of options in preventing the loss of BPR under the binding contract rules, particularly where agreements provide for two-way (‘put’ and ‘call’) options. Some commentators have suggested that ‘cross-options’ are equivalent in substance to a binding contract for sale.
However, this view is not widely accepted. For example, in McCutcheon on Inheritance Tax (Seventh Edition, Sweet and Maxwell), the authors state that HMRC has always accepted that put and call options do not, of themselves, constitute binding contracts for sale, with the result that the BPR restriction in s113, IHTA 1984 should not apply. Furthermore, parallels may perhaps be drawn with J Sainsbury plc v O’Connor [1991] EWCA Civ TC 64 208 concerning put and call options (albeit in the context of corporation tax group relief).
HMRC enquiries
HMRC often checks claims for BPR by the personal representatives on the business property of a deceased individual, to ascertain (among other things) whether the business property was sold following the individual’s death, and whether there was a ‘buy and sell’ agreement in place upon death. HMRC’s valuation specialists may also be called upon to value the business where there is a potential BPR restriction.
Where it is not apparent whether a sale of the business property has taken place, and the value transferred appears likely to exceed £250,000 before BPR, HMRC’s valuers are instructed to enquire whether the transferred shares have been sold and, if so, the date of the sale and when negotiations first commenced. If such a sale has taken place, or where a sale pursuant to a ‘buy and sell’ agreement comes to light, the case is likely to be referred to HMRC’s Litigation and Technical Advice Team (see HMRC’s Shares and Assets Valuation Manual at SVM111120).
Gifts before business sales
Aside from business property held on death, lifetime gifts of business property (for example, shares in a family trading company) are, in practice, sometimes made in anticipation of a business sale. HMRC is likely to investigate cases where chargeable lifetime transfers of business property are made shortly before business sales, to establish whether BPR is properly due (see IHTM25291).
For example, HMRC states that if a chargeable lifetime transfer of shares (on which BPR is claimed) is followed within six months by a sale of the company (or a sale of the gifted shares), the BPR position will be “carefully checked” by HMRC to see if there was a binding contract for sale at the date of transfer. The same applies if the sale occurred more than six months later, but the circumstances suggest that the sale may have been in prospect at the time of the lifetime transfer. If there was a binding contract, BPR will generally be denied.
Conclusion
Business owners should review the terms of any agreements or arrangements dealing with the sale of their business interests on death, with a view to ensuring that they are structured in a ‘BPR friendly’ way.
In addition, careful thought is needed where a chargeable lifetime gift of business interests is being considered, as depending upon the circumstances BPR may not be available if the business is sold shortly afterwards.
About the author
Mark McLaughlin, CTA (Fellow), ATT (Fellow), TEP is a consultant with The TACS Partnership LLP