An update on the proposed changes to business property relief – draft legislation released

It is almost nine months since the Chancellor announced the reform of business property relief (BPR) from inheritance tax (IHT). The reforms present huge potential challenges for family-owned businesses, significantly increasing their IHT exposure.  

Further details on the proposed reforms emerged in January with the release of the consultation. Advisers, sector bodies and taxpayers hoped to effect a reassessment of the policy as a result of the consultation responses, industry engagement with the Government, and wider public scrutiny. 

On 21 July, the draft legislation was released. Although it may be some time until it receives Royal Assent, the Bill represents the Government’s continued commitment to its Budget day announcement. Those hoping for significant concessions will be disappointed; the draft legislation follows the trailed policy, other than on two points:

• The £1m 100% allowance will be indexed from 6 April 2030 in line with the consumer prices index. This is a new (and welcome) development, although relatively minor.
• The consultation had asked for views on introducing an anti-fragmentation rule which would have valued any BPR assets settled by the same settlor into multiple trusts as a single holding, thereby negating any valuation discounts which arise as a result of joint ownership of assets. The Government has confirmed that it will not proceed with this proposal. The importance of value fragmentation, particularly to trading companies, is discussed below.

Implications for individuals

With effect from 6 April 2026, 100% BPR will be capped at £1m.  Any BPR assets in excess of this allowance will benefit from 50% relief. This means that, above the available allowances, BPR assets will be subject to an effective 20% IHT rate on death.  

Individuals should consider their estate planning.  Whereas to date, it has not been a priority to hand-on IHT relieved assets, now it is likely to be a regular agenda item for business owners (and board members). For those who are able to give away IHT relieved assets, the options are broadly:

• Transfer into a trust before 6 April 2026 – an immediate IHT charge can arise on gifts into trust. However, transfers made before 6 April 2026 can still benefit from unrestricted 100% relief. If the settlor survives the transfer by seven years no IHT will be chargeable in respect of the gift into trust. Any capital gains can be heldover, meaning that although the gains remain capable of being brought into charge at a future date, no charge is triggered on the gift itself.
  
  Once 6 April 2026 arrives, gifts into trust in excess of the £1m allowance and any available nil rate band will trigger an effective upfront IHT charge of 10% (or slightly higher if the settlor pays the tax). There is therefore a limited window of opportunity to undertake this planning.  
• Outright gifts – 6 April 2026 is not a relevant date for making outright gifts. However, (as is currently the case) earlier gifts increase the chances of the donor surviving them by seven years. Careful advice will need to be taken on the availability of capital gains holdover relief which may not cover all the gains for various technical reasons.

In each case, life insurance could be considered. Due to anti-forestalling rules, a death within seven years, but after 6 April 2026, will still be subject to the new rules regardless of the date of the gift.

The sensitivities of succession conversations, given family dynamics and the emotional and financial importance of a family business, will mean this topic will need to be approached with care. Clearly one does not want to give away assets to avoid tax but introduce other forms of risk into the equation.

For those who are unable or unwilling to make lifetime gifts, a plan should be put in place for funding the IHT on death. BPR assets will qualify for interest-free instalments which will enable the tax to be paid over 10 years.  Life assurance is likely to play an increasingly important role in meeting this liability.  

A very important point arises for companies where the funding for the IHT will be met by assets currently held within the company. In these cases, there is a potential extra layer of tax which will apply when extracting the cash from the company.  For example, if a dividend is declared, the top rate of dividend tax is 39.35%; factoring in this charge means that the effective rate of tax on the shareholder’s death is closer to 30% than 20%. There may be ways to mitigate this “extraction” cost using, for example, capital reductions or buy-backs. In addition, if assets need to be liquidated within the company to pay the IHT, corporation tax may arise. It is therefore critical for shareholders to work with their professional advisers, and the board of directors, to put in place a plan which does not prejudice the commercial operations of the business.

Despite heavy lobbying, the Government has continued with its policy that the £1m allowance should not be transferable as between a married couple / (registered) civil partners. This means that it is vitally important for all married couples / civil partners to review their existing Wills.  Wills which leave assets outright to the surviving spouse / civil partner will waste the first to die’s £1m allowance. Even if Wills do make express provision for BPR assets, the drafting is unlikely to be optimally tax-efficient in light of the proposed reforms. Some couples may need to reorganise their ownership of BPR assets to ensure that each spouse / civil partner owns at least £1m of relieved assets in order to make use of all available allowances.

The £1m allowance will, like the nil rate band, refresh every seven years. We may therefore see a growing interest in individuals making regular trusts; it would be possible to transfer £1.65m of business assets every seven years without triggering an immediate IHT charge.

Implications for trusts

Broadly speaking, pre-Budget trusts should each benefit from a £1m allowance so long as they held assets which, under the new rules, would have qualified for 100% BPR on 29 October 2024 (ignoring the two-year ownership condition). Trusts set up on or after 30 October 2024 by the same settlor will share a £1m allowance, allocated on a chronological basis.

Trustees should take steps now (when the information is most readily available) to identify if the trust is a “qualifying pre-commencement settlement”; trusts which held no BPR (or agricultural) assets or held assets which only qualify for 50% relief (such as AIM shares – more on this below) will not fall within this category. Trustees of new trusts will need to understand if their trust has a 100% allowance and, if so, how much. This may require liaison with the settlor and trustees of other settlements.

Some trustees have kept historic trusts going, in light of the Budget announcements, on the basis that they may benefit from a £1m allowance each. If these are not “qualifying pre-commencement settlements” these may now be wound up.

Trusts subject to the relevant property regime

Trusts will also need to consider how IHT is funded on BPR assets. Trusts within the 10 year charge regime (known as the “relevant property regime”) will face an effective rate of IHT of 3% on these assets on a 10 year anniversary (to the extent they exceed the trust’s allowance) and when assets leave the trust.  

The IHT can be paid in interest-free instalments. However, trustees should consider their powers under the trust deed to pay capital expenses from income, or to retain income in order to meet expenses. Changes may need to be made to enable tax-efficient payment of the IHT from available cashflow. The potential “double-tax” on extraction discussed above, will apply equally to the trustees.

The reforms also amend how exit charges from relevant property regime trusts will be calculated. These are technical amendments which go beyond the scope of this note, but underline the need for trustees to take advice on how BPR will apply to trusts.

“Qualifying pre-commencement settlements” will only become subject to the new regime from the first anniversary after 6 April 2026 which could fall as late as 29 October 2034.  The first 10 year charge will also include relief for the quarters in the preceding decade which fell before 6 April 2026. These transitional provisions provide a much longer window of opportunity for trustees to consider tax planning. For example, trustees who do not find ongoing 10 year charges palatable might consider winding the trust up by taking advantage of the fact that 100% relief for these trusts will remain unrestricted until the first post April 2026 10 year anniversary.

Trusts subject to the beneficiary regime

Trusts subject to IHT on the death of the life tenant will be subject to an effective rate of IHT of 20% on BPR assets (over and above the £1m allowance, to the extent that is available to the trust, taking account of any BPR assets personally owned by the life tenant).  Preparing a funding plan will be equally important for these trusts and may also involve the use of life assurance and consideration of the potential extraction costs where companies are involved.

Trustees should also consider undertaking restructuring in order to remove these assets from the life tenant’s estate for IHT purposes. Prior to 6 April 2026, it will be possible to terminate the beneficiary’s interest, whilst leaving the assets in trust, and benefit from unrestricted 100% relief. No capital gains tax would become due in these circumstances.

As with relevant property trusts, pre-Budget trusts may be “qualifying pre-commencement settlements” which will be relevant to the calculation of relevant property regime charges following the life tenant’s death. Taking advice on this point, when the information is most readily available, would be helpful.

AIM shares

The reforms also reduce the amount of BPR available to shares which are not listed on recognised stock exchanges. This will affect shares traded on AIM and other foreign exchanges. These shares will now only qualify for 50% relief and the £1m 100% relief allowance is not in point.

Value fragmentation

Following the restriction of 100% relief, it is likely that more creative planning will become common; most likely that which focuses on value fragmentation. This may be of particular relevance to trading companies, where discounts on minority shareholdings can be substantial. We expect to see a growing interest in fragmentation of shareholdings, and the use of difference classes of shares. However, any tax benefits must be weighed against the additional administrative burden of split ownership, and risks to management and control.  Furthermore, as shown by these reforms (and the now-shelved anti-fragmentation rule), any planning around value fragmentation could be rendered less effective by future statutory changes.  

The valuation of private businesses is very difficult. It would be sensible for business owners to undertake a “dry-run” valuation of their existing business interests in order to quantify their IHT exposure under the new regime. For families who already have fragmented ownership, the valuations (and their IHT exposure) may not be as significant as might be inferred from simply looking at the business’ balance sheet. Other factors, such as contingent tax liabilities, may also affect valuation. The key point is that quantifying the IHT exposure will be key to determining what estate planning should now be undertaken.

Pensions

It was confirmed that BPR will not apply to assets held within pension scheme which, from 6 April 2027, will also form part of a person’s estate for inheritance tax purposes. The personal representatives will be primary liable for the reporting and payment of these liabilities.