Buy-to-let companies won’t protect you from inheritance tax
companies rarely qualify for Business Property Relief for inheritance tax (IHT) purposes.
That is why individuals with such buy-to-lets need to consider alternatives in order to protect the assets from IHT.
Generally, this will involve direct disposals of company shares, but the extent to which this can be done is restricted by capital gains tax (CGT) considerations for direct gifts, and IHT considerations for gifts into trust.
This is because a gift of such assets in your lifetime direct to a family member is a potentially exempt transfer for IHT purposes and if you survive the gift by seven years it is exempt from IHT.
However, it could be liable to CGT at a rate of 28 per cent.
If you make the gift through a trust you avoid the CGT liability but you could find yourself exposed to an immediate charge to IHT at the lifetime rate of 20 per cent depending on the amount gifted.
As an alternative to making direct gifts of the whole value of the company, the current low value of properties can be frozen for IHT purposes and future growth passed on to the next generation, avoiding IHT of 40 per cent.
This can be achieved either by way of direct gifts or by gifts into trust where assets need to be “protected”.
The first step is to create a separate class of growth shares in the property investment company by way of a bonus issue.
These new shares will only be entitled to dividends and to a capital distribution on a winding up once the current value has been distributed to the original shareholders.
The rights attaching to the original shares need to be altered to restrict their future dividends and winding up proceeds to their current value. This has the immediate effect of freezing their value for IHT purposes.
The new shares are worth very little at the outset but will grow in value once underlying property values increase.
This future growth in the shares might be due to increases in property values generally or might simply be because existing borrowings are being repaid out of rental income and thus increasing the net value of the property which is then out of the donor’s estate for IHT purposes.
The new growth shares are then gifted to the next generation either directly or through a trust. Because of their low initial value this can be done with no CGT or IHT implications.
If trusts are used it could be advantageous, depending on the value of the company, to use a number of trusts set up over consecutive days to create more than one nil-rate band, as each trust is entitled to its own nil-rate band.
If five trusts are used then each has a nil-rate band of £325,000 and could therefore potentially save a considerable amount of IHT.
The original shareholders must be aware that any future return from the company will be capped to its current value and future dividends and capital returns will be restricted and will cease once the current value has been completely drawn out. There is therefore the risk that the income and capital value will cease at some point in the future.
As with most tax planning opportunities it is important to ensure the legal documentation is completed correctly and therefore detailed professional advice is required to ensure the arrangement is fully taxeffective.
Robert Peel is a tax specialist at Garbutt & Elliott Leeds. tel: 0113 273 9600 and York, tel: 01904 464100, www.garbutt-elliott.co.uk