Selling a business – inheritance tax pitfalls

If you are selling a business, when shares in a qualifying trading business are sold, they move from being an inheritance tax (IHT) free asset, to being cash which forms part of the vendors Estate for IHT purposes, potentially resulting in a tax charge of 40% on death.

Why are the shares IHT free?

Qualifying shares (which are broadly shares in unquoted companies which carry on a qualifying trade) are eligible for Business Relief of up to 100% for IHT in the event of the death of the shareholder.

Once the shares are sold however, the vendor would receive cash in to their Estate and the Business Relief will cease to apply. Should the Estate value be over the threshold for IHT, then tax would be due on death.

Whilst there are many ways of reducing a potential IHT liability, many of these, such as making gifts or setting up Trusts, can take 7 years to be effective.

How can Business Relief be retained?

Business Relief may be available if qualifying shares have been held for a cumulative period of 2 years in the 5 years prior to death, provided they are held at the time of death.

In principle, this means that a business vendor has a period of 3 years following the business sale to buy new qualifying shares and immediately get back the IHT exemption, using the Replacement Property Provisions.

Does this mean you need to start a new business?

Whilst this is an option, many business vendors are selling because they wish to retire and may not want to deal with the stress and demands of running a business forever just to get the IHT benefit.

There are in fact many alternative options which are available, where it is possible to buy in to qualifying investments which are professionally managed with a view to delivering a return on your investment, but most importantly, preserving the Business Relief.

The added benefit of using Business Relief is that the assets remain under your control and can be accessed should you require them for your own purposes, such as to provide additional income, or to meet care costs in later life should the need arise. This removes the worry of giving away too much (either directly or to a Trust) and leaving yourself short if things do not work out as planned.

What does this mean for you?

If you are thinking of selling a business, or you have recently sold and you are concerned about inheritance tax and how much tax your children will have to pay on your Estate in the event of your death, this could be a useful way of immediately removing capital from your Estate for inheritance tax purposes.

However, you don’t have to be selling a business to benefit from Business Relief. Anyone can invest in a qualifying plan and once the new investments have been held for just 2 years, Business Relief would apply provided the investments are still held on death. This means there could be less inheritance tax to be paid on your Estate, which is currently taxed at a rate of 40% over your available nil rate band.

What if I am advising clients on business sales?

If you are a professional service provider such as an accountant or a solicitor, there could be repercussions if you fail to address the loss of Business Relief and the potential to benefit from the Replacement Property Provisions. After all, nobody would like to think that they were not told about the option to save 40% tax.

It would therefore be best practice to address this with all vendors prior to sale and, where sales have completed in the last 3 years, to go back to vendors to raise awareness of their options if this was not done at the time.

Get in touch

I hope that this has given you an indication of the potential IHT problems which could arise from selling a business and what can be done to help. The key aspects are to have a clear understanding of what a business vendor may need for themselves now, then to consider how best to use assets to mitigate future IHT.

If you need any guidance on tax savings when selling a business, please get in touch and we can talk about you (or your clients!).

Lee Smythe MSc