By Nadine Walton and Duncan Cathie, Brodies LLP.
Huge changes were announced to Agricultural Relief (AR) and Business Relief (BR) from Inheritance Tax (IHT) in the October 2024 budget. They are due to take full effect on 6 April 2026.
Ahead of that deadline, it is critical that farmers and owners of any businesses, plan ahead. The need to review wills, consider lifetime succession planning (and indeed pre-sale planning) becomes more pressing as that deadline approaches.
There will however be other, more practical implications of the changes, which have received less attention. One of these is the problem of funding the tax upon death of a business owner.
An existing problem, only bigger
Where an individual is in business with others (for example, as a shareholder in a company), the value of their shares will often be left to family members upon death. The surviving shareholders must therefore pay the family (or, really, ‘the estate’) for the deceased’s shares, if the family has no interest in staying involved.
If surviving shareholders or company funds don’t allow this, problems can result. The family may have to wait for payment, and financial stability of the business may be compromised.
HMRC has now taken the problem up a notch.
Funding HMRC’s bill
For decades, unlimited relief from IHT has been granted on trading businesses, on the basis that such a payment may lead to their break-up given the sums involved.
From 6 April 2026, that will change, and relief will be limited. For the first time in a generation, business interests which exceed £1m on death will face 20% IHT (above that £1m threshold). This is true whatever ‘form’ the interest takes (e.g.. a partnership share, or shares in a company). The first instalment of tax must be paid within six months following the month of death, to prevent interest accruing at eye-watering rates. That applies even where there has been no “transaction”, and where those who have inherited the business interest have no means of raising the required funds.
The potential for conflict between the family and the remaining business owners will inevitably increase. The new pressure of paying HMRC within a short timeframe is liable to cause additional stress on both sides; and potentially irreparable damage to the business.
The solution
Where business owners do not want to pass the business interest itself to the next generation, the sensible step is to agree to:
(i) take out life insurance, equal to the value of their business interest, payable upon death; and
(ii) place the policy in trust for the benefit of the remaining business owners.
This will provide funds to quickly pay the value due to the deceased’s estate, without impact upon the business. The family can settle the IHT on time and the business isn’t vulnerable to interference from third parties who aren’t working in it.
The importance of properly drafted contractual terms and trusts in this arrangement cannot be understated.
Cross-option agreement
Where this arrangement is put in place, a contract must be drawn, obliging all the business owners to retain a life insurance policy of appropriate value. The agreement will provide for the mechanism for sale of the deceased’s business interest by his/ her estate, to the remaining owners or in such other way as is agreed. The provisions must be drafted extremely carefully. Without proper structure of each party’s ‘option’, eligibility for even partial relief from IHT on the business interest will be compromised.
Trust
Settling each policy into a well-drafted trust at inception is key. A trust structure prevents IHT on the policy funds, and properly controls who receives them. It therefore protects both your business legacy, and those who matter most.
Nadine specialises in trust, estate and tax planning for individuals while Duncan advises businesses and the individuals within them on their governance arrangements, succession planning and cross option agreements.
For more information visit brodies.com