Business property relief (BPR) is an extremely valuable relief from inheritance tax (IHT). It potentially provides relief at 100% (or 50%) on various types of ‘relevant business property’. For example, BPR at 100% can apply to a business or an interest in a business, and to shares in an unquoted company. However, BPR is subject to certain conditions. Failure to satisfy those conditions can result in business owners or shareholders inadvertently losing the benefit of BPR.
‘Binding contract’ trap
Some of the BPR rules are probably better known than others. For example, most advisers will be aware that BPR does not generally apply if the business consists wholly or mainly of making or holding investments. However, a pitfall which is perhaps less well known is that BPR will generally be denied if there is a ‘binding contract’ for sale of the business property at the time of its transfer (e.g. upon making a gift of the business property to a discretionary trust) (IHTA 1984, s 113).
This ‘binding contract’ trap is an anti-avoidance rule. The underlying principle is that BPR should be available in respect of ‘relevant business property’, but not cash. However, this anti-avoidance rule is subject to two statutory exceptions. The first exception applies to certain business incorporations, i.e. if the binding contract is for the sale of a business (or business interest) to a company which is to carry on that business, where the consideration is wholly or mainly the company’s shares or securities. Note that a business sale wholly or mainly for cash is not within this exception. The second exception relates to company shares or securities, where the sale is made for the purpose of reconstruction or amalgamation (IHTA 1984, s 113(a), (b)).
HMRC is likely to investigate cases where chargeable gifts of business property are made shortly before a sale, to establish whether BPR is properly due (IHTM25291). For example, if a chargeable lifetime transfer of shares (on which BPR is claimed) is followed shortly afterwards (i.e. within six months, or longer in certain circumstances) by a sale of the company, the BPR position will be “carefully checked” by HMRC to see if there was a binding contract for sale at the date of transfer. If there was a binding contract, BPR may be denied.
‘Buy and sell’ agreements
A potential trap exists for partners or director shareholders in respect of ‘buy and sell’ agreements. These are broadly arrangements whereby, in the event of the death of one of them before retirement, his personal representatives are obliged to sell, and the survivors are obliged to buy, his partnership interest or shares. The purchase price will often be provided through a life assurance policy.
HMRC's view is that ‘buy and sell’ agreements constitute a ‘binding contract’ for sale (within s 113) broadly where arrangements provide for the following:
- An agreement for the partnership interest or shares to pass to the personal representatives of the deceased partner or shareholder;
- 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 conditions apply, BPR will not be due on the business interest or shares (Statement of Practice 12/80 (SP 12/80)).
Following the Revenue’s publication of SP12/80, there was some uncertainty about the types of arrangement which would fall outside the BPR restriction, and whether ‘accruer’ or ‘option’ clauses (see below) would be effective. However, the Revenue published an article in the Law Society Gazette in May 1981, which stated: “[SP12/80] has caused a considerable amount of concern, but it is hoped that the following table will indicate the problem is in fact far more limited than has been feared.”
The table included five examples, and the Revenue confirmed that only in the following example would a binding contract for sale exist before the death of the partner (although the same would apply in respect of company shares and shareholders):
Example: ‘buy and sell’ agreement – No BPR
“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.” (Law Society Gazette, 6 May 1981)
What can be done?
Fortunately, arrangements can be structured in such a way that BPR remains available. For example, agreements may include the following:
- Accruer clauses, i.e. 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).
- Options, i.e. the deceased's business interest falls into his estate, but with an option for the survivors to purchase it.
HMRC accepts that these types of arrangement do not constitute binding contracts for sale (within s 113), and therefore do not prevent the business interest qualifying for BPR (IHTM25292).
If a company's Articles require the deceased shareholder’s personal representatives to offer his shares for sale to the company, other shareholders or directors, the above BPR restriction does not apply provided there is no obligation on the survivors, etc to buy the shares (SVM111120).
Some commentators have pointed out a possible problem with options. Agreements sometimes provide for two-way (‘put’ and ‘call’) options. There is a possible argument that ‘cross-options’ are equivalent in substance to a binding contract for sale. However, in McCutcheon on Inheritance Tax (Sixth Edition, Sweet and Maxwell), the authors state that HMRC have always accepted that put and call options do not, of themselves, constitute binding contracts for sale with the result that the BPR restriction in s 113 does not apply. The authors also confirm that HMRC maintain the view that ‘accruer’ arrangements do not constitute binding contracts for sale either.
Avoid binding contracts for sale for BPR purposes. Partners and shareholders should review the terms of any agreements or arrangements dealing with the sale of their business interests on death, and ensure that they are structured in a ‘BPR friendly’ way. If in doubt, seek expert professional advice.
Mark McLaughlin CTA (Fellow), ATT (Fellow), TEP
The above article was first published by Tax Insider (www.taxinsider.co.uk).