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Taxation of Unincorporated Businesses by Malcolm James

Malcolm James, author of 'Taxation of Unincorporated Businesses' outlines business property relief, agricultural property relief and woodlands relief for IHT purposes.

Business Property Relief (BPR)

Qualifying Assets

Relief is given on relevant business property by reducing the value of the property included in the estate or the value of the lifetime transfer, by the appropriate percentage. There is no upper limit to the amount of relief, which is given before any other exemptions, such the annual exemption and any grossing-up (IHTA 1984 s 104(2)). The relief is automatic if the conditions are satisfied and no claim need be made.

The appropriate percentage is 100% for a business or interest in a business (i.e. sole trader or interest in partnership), and 50% for assets owned personally, but used by a partnership of which the deceased was a partner (IHTA 1984 ss 104 & 105). The value of a business is reduced by the amount of any business liabilities (IHTA 1984 s 110(a)& (b)), but no deduction is available for any liabilities arising as a result of the transfer (IHTA 1984 s 110(c)).

Qualifying Period of Ownership

The property must have been owned by the individual for at least two years in order to claim BPR (IHTA 1984 s 106) except:

1. if the property was inherited from a spouse. In this case the total period of ownership by the individual and spouse must be at least two years (IHTA 1984 s 108);

2. if the business property replaces other relevant business property. In this case the total period ownership must have been at least two of the last five years (IHTA 1984 s 107). BPR is given on the lower of the two property values;

3. if the property was acquired on a transfer qualifying for BPR and was either acquired as a result of death or is now chargeable on death (IHTA 1984 s 109).

Example

1. John died on 23 August 2003 and passed relevant business property to Peter. Peter makes a lifetime transfer to Sarah on 14 May 2005. The property will qualify as relevant business property on the occasion of the second transfer, since the assets were originally acquired on the death of John.

2. John made a lifetime transfer of relevant business property to Peter on 23 August 2003.
Peter dies on 14 May 2005 leaving the assets to Sarah. The property will qualify as relevant business property on the occasion of the second transfer, since the transfer to
Sarah was made on the death of Peter.

3. John made a lifetime transfer of relevant business property to Peter on 23 August 2003.
Peter makes a lifetime transfer to Sarah on 14 May 2005. The property will not qualify as relevant business property on the occasion of the second transfer, since both of the transfers were lifetime transfer.

Where the relevant business property was comprised in either a potentially exempt transfer which subsequently becomes chargeable, or a chargeable lifetime transfer on which additional tax becomes payable on the death of the transferor, BPR is only available if the following further conditions are fulfilled.

1. The original property must be owned by the donee until the earlier of the donor's death or the donee's death or, if the donee has disposed of the original property, he must have re-invested the entire proceeds within 3 years of the disposal.

2. The original or replacement property must still be relevant business property at the earlier of the donor's death and the donee's death. (IHTA 1984 s 113A & 113B)

Excluded Businesses

Certain types of businesses and certain types of assets are excluded from the BPR provisions:

1. Dealing in shares, stocks and securities;

2. Dealing in land and buildings;

3. Making or holding investments (IHTA 1984 s 105(3)).

The business of a 'working landlord' is treated as that of making and holding investments, therefore BPR will not be available (Martin and Horsfall (Executors of Moore deceased) v IRC (1995) (SpC 2)). A similar decision was reached in Hall (Executors of Hall deceased) v IRC (1997) (Sp C 120) where a mobile home park was held to be a business of the making and holding of investments, since the business consisted largely of the receipt of rent and pitch fees. This can be contrasted with IRC v George (2004) (STC 147) in which a caravan park was held on the facts of the case to be a business asset. The distinction with the earlier case was made on the grounds that the extent of the ancillary services provided meant that the business amounted to more than one of simply making and holding investments.

Exclusions

BPR may not be claimed:

1. On any assets of a business which have not been used wholly or mainly for business purposes throughout the preceding two years, and which will not be needed for future use by the business, e.g. let property (IHTA 1984 s 112).

2. In the case of land, buildings, plant or machinery where the asset has neither been used wholly or mainly for business purposes throughout the preceding two years, nor replaced another asset which has been so used with the combined period of use being at least two years in the five years preceding the transfer.

3. If at the date of transfer there is a binding contract for sale of business or interest in business unless the sale is to a company which will carry on the business as a going concern, and the consideration is wholly or mainly shares in the company. This restriction will apply to partnerships where there is an agreement that provides that the remaining partners will automatically take over the partnership share of a partner who dies. Relief will, but, be available where there is an agreement that the personal representatives of a deceased partner are obliged to offer his partnership share to the remaining partners, who are obliged to purchase the share (SP 12/80). An option agreement where the remaining partners have an option to purchase the partnership share of a deceased partner will not prevent the partnership share being treated as relevant business property (Law Society Gazette, 4 September 1996).

Gift with Reservation

Where the property is a gift subject to reservation, the property may be treated as still being the property of the transferor in giving relief. The eligibility of the property for relief and the applicable is determined as if the transfer had been made by the donee, rather than the donor.

Agricultural Property Relief (APR)

Qualifying Assets

APR is given on the transfer of the following agricultural property situated in the UK, Channel Islands or the Isle of Man (IHTA 1984 s 115(5)).

1. farms; and

2. farm buildings, including the farmhouse, provided that they are of a character appropriate to the property;

3. cottages, provided that they are of a character appropriate to the property.

APR operates in a similar fashion to BPR and many of the same conditions apply. Relief is given at 100%, except where land is occupied as a tenancy beginning before 1 September 1995 and the transferor does not have the right to vacant possession with 12 months following the date of the transfer, where relief is given at 50% (IHTA 1984 s 116; FA 1995 s 155).

APR is given on the agricultural value of the property, i.e. the value of the property on the assumption that it is subject to a perpetual covenant forbidding its use for any purpose other than agriculture (IHTA 1984 s 115(3)). If the property satisfies the relevant conditions, BPR is available in addition to APR, with APR being given before BPR, thus, where the market value exceeds the agricultural value BPR may be claimed on the excess of the market value over the agricultural value.

Qualifying Period of Ownership

If the individual farmed the property himself, the minimum period of ownership is two years and if the property is let, the minimum period of ownership is seven years (IHTA 1984 s 117).

If the agricultural property replaced other agricultural property, the minimum period of ownership is:

a) two years out of the last five to meet the two year test.

b) seven years out of the last ten to meet the seven year test. (IHTA 1984 s 118)

The other exceptions to the ownership rule and conditions are identical to the rules for BPR.

Woodlands Relief

An election may be made within two years of death, or such longer period as HM Revenue & Customs may allow, to defer a tax charge by excluding the value of any land (other than agricultural property) on which trees or underwood are growing from the estate. The deceased must have either been beneficially entitled to the land throughout the five years before death, or must have obtained the interest otherwise than for money or money's worth.

Inheritance tax is payable on the sale of the trees or underwood by the person entitled to the sale proceeds (IHTA 1984 s 126), unless the sale is made by the spouse of the person making the disposal, at the full rate of tax applicable at the date of death of the transferor (IHTA 1984 s 128). Where the sale has been made at full market value, the tax payable will be based on the sale proceeds. In other cases the inheritance tax will be based on the market value of the trees or underwood at the date of disposal, ignoring plantings since death (IHTA 1984 s 127(1)). In both cases a deduction may be claimed for any expenses incurred in making the disposal and the costs of replanting incurred within three years of the disposal, or such longer period which HM Revenue & Customs may allow. No deduction may be claimed for expenses for which an income tax deduction may
be claimed, even if the income is insufficient to offset all the expenses. Where BPR would have been available on the original transfer, relief is available on a subsequent disposal at a rate of 50% (IHTA 1984 s 127(2)). Where the person making the disposal is entitled to claim BPR, the deduction is calculated after the payment of the tax on the original transfer (IHTA 1984 s 114(2)).

Where a tax charge arises on a chargeable transfer, rather than a sale, the value of the chargeable transfer is calculated after deducting the deferred tax payable (IHTA 1984 s 129).

October 2005

Malcolm James

Malcolm James is a Senior Lecturer in Accounting and Taxation at the University of Wales Institute, Cardiff.

The above article is adapted from 'Taxation of Unincorporated Businesses' published by Spiramus Press Ltd. To order Taxation of Unincorporated Businesses click here