On 5 July 2019, the Office of Tax Simplification (OTS) published its second report as part of its review of the UK’s inheritance tax (IHT) regime.
BPR is a relatively costly relief. It is estimated to cost
the exchequer approximately £1bn per year. But, while there may have been some
concerns that the OTS might recommend the abolition of BPR entirely, it does
not. Instead the report recognizes the ‘important role’ that the relief plays
in ensuring that businesses can pass from one generation to another.
The report does, however, acknowledge that some aspects of
the BPR regime are distortive, overly complex and, at times, inconsistent with
other parts of the UK tax code. The report contains some specific recommendations,
which have caught the headlines – such as a proposal to withdraw the treatment
of shares listed on AIM as unquoted securities for BPR purposes, and so
benefiting from wider reliefs – but this article concentrates on the proposals
that affect shareholders in privately-owned companies and groups.
First,
the report suggests that the government should consider why the level of
trading activity for BPR is set so much lower than the comparable reliefs from
capital gains tax.
BPR provides relief for 100% of the value of shares
in unlisted trading companies and groups. For a company or group to be regarded
as trading, its business must not consist ‘wholly or mainly’ of holding
investments. While ‘wholly or mainly’ is not defined in the legislation, in
practice, this is a 50% or more test. On the other hand, the capital gains tax
reliefs which apply to disposals of shares in trading companies and groups -
holdover relief and entrepreneurs’ relief - apply to companies whose activities
do not ‘to a substantial extent’ include activities other than trading
activities. This test is treated by HMRC as satisfied where non-trading
activities do not amount to 20% or more of the activities of the company or
group.
The clear implication of the OTS report is that the
government should consider aligning the BPR test with the tests for capital
gains tax holdover relief and entrepreneurs’ relief. At first sight, this
proposed reform appears a logical one. There are clear simplification benefits
in aligning the tests in the various regimes; one test is simpler than two. In
addition, the BPR test has many idiosyncrasies which could be ironed out by the
adoption of the capital gains tax rules.
Such a reform may, however, not be welcomed by some
privately-owned groups. As well as the move from a 50% to a 20% threshold, the
change from a test which focuses on investment to a trading/non-trading test
also represents a significant narrowing of the relief. Some may argue that it
is not appropriate to align the rules for a relief from a tax charge which for
the most part occurs on the death of the shareholder, with the rules for relief
from a tax on profits which arise, for the most part, from a voluntary disposal
at a time chosen by the shareholder.
The BPR test is a long standing one. Many private groups
have been structured to reflect its provisions. A reform on this scale would
require a period of adjustment. Some careful thought would also need to be
given to other related parts of the IHT regime (such as the concept of ‘excepted
assets’). So, this is not a change which could or should be implemented in
haste.
The
second reform proposed in the report is that the government should review the
treatment of non-controlling shareholdings in unquoted trading companies which
are held indirectly to ensure the use of a holding company structure does not
inappropriately affect the scope of the relief.
At present, the treatment of minority stakes in
unquoted trading companies is inconsistent. If such a stake is held directly by
an individual, it may qualify for 100% BPR. However, if such a stake is held
within a holding company structure, it is likely to be treated as an investment
and may risk disqualifying the shares in the group holding company from BPR
entirely.
This makes little sense in the context of shareholdings in
closely-controlled joint venture companies. The capital gains tax holdover
relief and entrepreneurs’ relief rules recognize this and include appropriate
provisions under which shares in qualifying joint ventures are ignored and the
activities of the joint venture company treated as part of the activities of
the group as a whole when assessing whether or not the group is considered to
be trading.
This is a sensible proposal. It follows logically from the
proposed changes to the trading test for companies and groups, but it should be
adopted whatever the outcome of any consultation on that matter.
The
report also suggests that the government should review the treatment of limited
liability partnerships to ensure that they are treated appropriately for the
purposes of the BPR trading requirement.
The current wording of the IHT legislation suggests
that a corporate trading group that has an LLP rather than a company as its
holding vehicle may not qualify as ‘trading’ for BPR purposes. The effect is to
deny BPR for an interest in an LLP in circumstances where, if the holding
entity of the group were a company, relief would be available.
This again is a sensible reform. However, it is not the only
aspect of the treatment of LLPs which is inconsistent. Any review should also
extend to some of the other issues which arise from the presence of LLPs and
other entities (such as US LCCs) within groups. This is an issue, not just for
IHT, but for other UK grouping tests as well.
The report includes a discussion of the potentially
distortive effect of the current rule under which beneficiaries of an estate
acquire assets at their market value on the death of the testator, in particular,
in cases where the gift to the beneficiary also qualifies for a relief from IHT
such as BPR.
The
report recommends that, where a relief from IHT, such as BPR, applies, the
capital gains tax uplift should be removed, and the beneficiary should be treated
as acquiring the assets as the testator’s historic tax base cost.
The OTS argues that current regime incentivizes
business owners to hold on to shares which qualify for BPR until death at which
point the shares can pass to their beneficiaries free from IHT and with an
increased base cost for capital gains tax purposes. This does not promote the
transfer of family businesses between generations at the most appropriate time
for the business and allows the next generation to dispose of the business
tax-free immediately following the death of the original owner without having
carried on the business.
It is difficult to argue against the logic. However, this
will be an unpopular change. It might be slightly more palatable to
privately-owned groups if a broader trading activity test is retained. But
again this has been a feature of the IHT and CGT regimes for some time and any
change would require an adjustment to the succession plans of many family-owned
businesses.
The most accelerated timetable for any of these changes
would be for a government response at the time of the Budget in the Autumn with
possible legislation in Finance Act 2020 to take effect in April 2020. Perhaps
more likely is a formal HMRC consultation announced at the Autumn Budget with
legislation in Finance Act 2021 to take effect in April 2021.
This all assumes of course that the existing IHT regime
survives that long. The most recent Labour Party proposals suggested the
abolition of IHT and its replacement with a lifetime tax on gifts with a
relatively low threshold and charged at income tax rates.
It is clearly too early to be implementing changes to group
structures in response to these recommendations. But groups and shareholders
taking the long view will want to see what difference these types of reforms
could make and consider the potential effect on BPR claims, so that they are
prepared if and when the recommendations develop into firmer legislative
proposals.
On 5 July 2019, the Office of Tax Simplification (OTS) published its second report as part of its review of the UK’s inheritance tax (IHT) regime.
BPR is a relatively costly relief. It is estimated to cost
the exchequer approximately £1bn per year. But, while there may have been some
concerns that the OTS might recommend the abolition of BPR entirely, it does
not. Instead the report recognizes the ‘important role’ that the relief plays
in ensuring that businesses can pass from one generation to another.
The report does, however, acknowledge that some aspects of
the BPR regime are distortive, overly complex and, at times, inconsistent with
other parts of the UK tax code. The report contains some specific recommendations,
which have caught the headlines – such as a proposal to withdraw the treatment
of shares listed on AIM as unquoted securities for BPR purposes, and so
benefiting from wider reliefs – but this article concentrates on the proposals
that affect shareholders in privately-owned companies and groups.
First,
the report suggests that the government should consider why the level of
trading activity for BPR is set so much lower than the comparable reliefs from
capital gains tax.
BPR provides relief for 100% of the value of shares
in unlisted trading companies and groups. For a company or group to be regarded
as trading, its business must not consist ‘wholly or mainly’ of holding
investments. While ‘wholly or mainly’ is not defined in the legislation, in
practice, this is a 50% or more test. On the other hand, the capital gains tax
reliefs which apply to disposals of shares in trading companies and groups -
holdover relief and entrepreneurs’ relief - apply to companies whose activities
do not ‘to a substantial extent’ include activities other than trading
activities. This test is treated by HMRC as satisfied where non-trading
activities do not amount to 20% or more of the activities of the company or
group.
The clear implication of the OTS report is that the
government should consider aligning the BPR test with the tests for capital
gains tax holdover relief and entrepreneurs’ relief. At first sight, this
proposed reform appears a logical one. There are clear simplification benefits
in aligning the tests in the various regimes; one test is simpler than two. In
addition, the BPR test has many idiosyncrasies which could be ironed out by the
adoption of the capital gains tax rules.
Such a reform may, however, not be welcomed by some
privately-owned groups. As well as the move from a 50% to a 20% threshold, the
change from a test which focuses on investment to a trading/non-trading test
also represents a significant narrowing of the relief. Some may argue that it
is not appropriate to align the rules for a relief from a tax charge which for
the most part occurs on the death of the shareholder, with the rules for relief
from a tax on profits which arise, for the most part, from a voluntary disposal
at a time chosen by the shareholder.
The BPR test is a long standing one. Many private groups
have been structured to reflect its provisions. A reform on this scale would
require a period of adjustment. Some careful thought would also need to be
given to other related parts of the IHT regime (such as the concept of ‘excepted
assets’). So, this is not a change which could or should be implemented in
haste.
The
second reform proposed in the report is that the government should review the
treatment of non-controlling shareholdings in unquoted trading companies which
are held indirectly to ensure the use of a holding company structure does not
inappropriately affect the scope of the relief.
At present, the treatment of minority stakes in
unquoted trading companies is inconsistent. If such a stake is held directly by
an individual, it may qualify for 100% BPR. However, if such a stake is held
within a holding company structure, it is likely to be treated as an investment
and may risk disqualifying the shares in the group holding company from BPR
entirely.
This makes little sense in the context of shareholdings in
closely-controlled joint venture companies. The capital gains tax holdover
relief and entrepreneurs’ relief rules recognize this and include appropriate
provisions under which shares in qualifying joint ventures are ignored and the
activities of the joint venture company treated as part of the activities of
the group as a whole when assessing whether or not the group is considered to
be trading.
This is a sensible proposal. It follows logically from the
proposed changes to the trading test for companies and groups, but it should be
adopted whatever the outcome of any consultation on that matter.
The
report also suggests that the government should review the treatment of limited
liability partnerships to ensure that they are treated appropriately for the
purposes of the BPR trading requirement.
The current wording of the IHT legislation suggests
that a corporate trading group that has an LLP rather than a company as its
holding vehicle may not qualify as ‘trading’ for BPR purposes. The effect is to
deny BPR for an interest in an LLP in circumstances where, if the holding
entity of the group were a company, relief would be available.
This again is a sensible reform. However, it is not the only
aspect of the treatment of LLPs which is inconsistent. Any review should also
extend to some of the other issues which arise from the presence of LLPs and
other entities (such as US LCCs) within groups. This is an issue, not just for
IHT, but for other UK grouping tests as well.
The report includes a discussion of the potentially
distortive effect of the current rule under which beneficiaries of an estate
acquire assets at their market value on the death of the testator, in particular,
in cases where the gift to the beneficiary also qualifies for a relief from IHT
such as BPR.
The
report recommends that, where a relief from IHT, such as BPR, applies, the
capital gains tax uplift should be removed, and the beneficiary should be treated
as acquiring the assets as the testator’s historic tax base cost.
The OTS argues that current regime incentivizes
business owners to hold on to shares which qualify for BPR until death at which
point the shares can pass to their beneficiaries free from IHT and with an
increased base cost for capital gains tax purposes. This does not promote the
transfer of family businesses between generations at the most appropriate time
for the business and allows the next generation to dispose of the business
tax-free immediately following the death of the original owner without having
carried on the business.
It is difficult to argue against the logic. However, this
will be an unpopular change. It might be slightly more palatable to
privately-owned groups if a broader trading activity test is retained. But
again this has been a feature of the IHT and CGT regimes for some time and any
change would require an adjustment to the succession plans of many family-owned
businesses.
The most accelerated timetable for any of these changes
would be for a government response at the time of the Budget in the Autumn with
possible legislation in Finance Act 2020 to take effect in April 2020. Perhaps
more likely is a formal HMRC consultation announced at the Autumn Budget with
legislation in Finance Act 2021 to take effect in April 2021.
This all assumes of course that the existing IHT regime
survives that long. The most recent Labour Party proposals suggested the
abolition of IHT and its replacement with a lifetime tax on gifts with a
relatively low threshold and charged at income tax rates.
It is clearly too early to be implementing changes to group
structures in response to these recommendations. But groups and shareholders
taking the long view will want to see what difference these types of reforms
could make and consider the potential effect on BPR claims, so that they are
prepared if and when the recommendations develop into firmer legislative
proposals.
