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Business Property Relief can be one of the most valuable Inheritance Tax reliefs available to business owners. In the right circumstances, it can reduce Inheritance Tax on businesses by up to 100%. And that can make a huge difference when passing a business down to the next generation.
However, one area that can catch people out is the way business shares are held. In particular, holding company shares through a Limited Liability Partnership(LLP) can sometimes prevent Business Property Relief from applying, even where the company itself is a genuine trading business.
Emma Walker, Senior Tax Adviser explains how many business owners don’t realise this issue exists until they start looking at succession planning or dealing with an estate after death.
Why would shares be held through an LLP?
There are often perfectly sensible commercial or family reasons for using an LLP. For example, a family running a company may decide to hold shares through an LLP because:
- they want flexibility over how profits are shared between them;
- they want a structure that’s easier to adapt over time than direct personal ownership;
- they want to bring children or other family members into the ownership structure gradually;
- they use the LLP as a family investment or business vehicle for holding a range of assets;
- they have been advised that an LLP offers administrative or commercial advantages in their wider planning.
In many cases, the LLP may have been set up for entirely practical reasons and with no intention of creating a tax problem.
Why can an LLP cause a problem?
Where an individual owns shares directly in a trading company, those shares will often qualify for Business Property Relief, assuming the usual conditions are met. But where the shares are owned by an LLP, the position can be very different.
The key point is that the LLP interest is looked at in its own right. If the LLP is mainly acting as an investment-holding vehicle, rather than carrying on a qualifying trade itself, relief may not be available. That can be the case even if the company underneath is a successful trading company.
In simple terms, the tax analysis does not stop at the company whose shares are being held. Instead, attention turns to the LLP and what the LLP itself is doing. If its main role is simply to hold shares as an investment, that can block the relief.
A practical example
Take James and Sarah, a married couple who are equal partners in an LLP, each owning 50%. The LLP owns 100% of the shares in a family trading company. The company is worth £10 million.
They may have chosen this structure years ago because it gave them flexibility.
On the face of it, this may seem entirely reasonable. The company trades actively, employs staff and generates profits. James and Sarah may assume that because the company is a genuine trading business, the value should qualify for Business Property Relief on death.
But if the LLP’s main activity is simply holding the shares in that company, there is a risk that the LLP interest will be treated as an investment-type holding rather than a qualifying business interest.
That can have a dramatic tax impact.
If James dies owning his 50% interest in the LLP and passes his share to his children, the value attributable to his share of the underlying company may be around £5 million.
If Business Property Relief applies in full, £2.5 million could be relieved from Inheritance Tax in full, and the other £2.5 million would then be relieved at 50%, giving an Inheritance tax charge of up to £500,000.
If relief is not available, however, the full £5 million may be exposed to Inheritance Tax. And at 40%, that could mean a tax cost of up to £2 million, subject of course to any available exemptions, nil-rate bands etc.
The same issue could then arise again on Sarah’s death if planning is not reviewed. Meaning that in this example, we’re looking at a £4 million total Inheritance Tax bill , versus £1 million if Business Property Relief is available.
This example shows why the ownership structure matters just as much as the nature of the business itself.
Why this catches families out
LLPs are commonly seen as flexible and tax-efficient structures that are see-through for many taxes, including income tax. It’s this that can lead people to assume they are also suitable for Inheritance Tax purposes.
And whilst the underlying company may be clearly trading, this gives a false sense of security, as business owners focus on what the company does, rather than on how the ownership is structured.
Complex structures are often put in place many years before anyone starts thinking seriously about succession, estate planning or a future sale. So, by the time the issue is identified, a lot of value may already have built up inside the LLP.
Does this mean LLPs are always a bad idea?
No. An LLP can still be a very useful structure in the right circumstances.
The point is not that LLPs are inherently wrong, but that they need to be reviewed carefully where Business Property Relief is important.
In some cases, the LLP may be carrying on wider activities that support a stronger argument for relief. In others, it may be clear that the LLP is mainly just holding investments, in which case the risk is much greater. Everything depends on the facts.
That’s why it is dangerous to assume that a structure which works well commercially will automatically produce the desired (and assumed) Inheritance Tax result.
What should business owners do?
If you hold shares in a company through an LLP, it’s worth asking some straightforward questions:
- What is the LLP actually doing in practice?
- Is it carrying on a business of its own, or mainly holding investments?
- Was the structure created for commercial flexibility rather than tax planning?
- Would direct ownership, or a different structure, produce a better Inheritance Tax outcome?
These are important questions, particularly where substantial value is involved.
Regular reviews are essential
Business Property Relief can be extremely valuable, but it is not just the business itself that matters. The ownership structure matters too.
That’s why regular reviews of ownership structures are so important. A structure that made sense when it was created may not be the best one once Inheritance Tax and succession planning are taken into account.
We’re here to help
If you or your family hold business shares through an LLP, it’s worth taking advice early to understand whether valuable relief could be at risk.
If you have questions or would like further advice on this topic, get in contact with Emma or one of the team by calling 0330 058 6559 or by emailing hello@scruttonbland.co.uk
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