Business Relief Changes Could Spell Trouble For Entrepreneurs

With political parties searching for revenue raising policies ahead of the election, Chris Etherington Private Client Partner in the Leeds office at audit, tax and consulting firm RSMUK looks at the potential implications of a policy highlighted in recently published commentary from the Institute of Fiscal Studies in restricting certain inheritance tax reliefs. What might the real-life consequences be for taxpayers of such a move and could it genuinely raise much needed funds for general election spending pledges?

Recent commentary from the Institute of Fiscal Studies suggests that there is a “strong economic case” for completely abolishing certain inheritance tax reliefs for agricultural property and certain business-related assets and has calculated the potential tax revenue receipts of doing so. However, one particular policy explored in the paper is likely to send some business owners into a tailspin if the idea gathers momentum.

One of the authors has previously published research which has arguably formed the basis for the recent announcements in the Budget to reform the non-dom regime. Whilst that work appears to have informed party policy on both sides of the political chamber, these most recent suggestions appear to cross a dividing line that a Conservative chancellor may not be able to cross.

In particular, the tax policy explored in the research that is likely to cause particular concern for larger business owners is the capping of business relief at £500,000 per person. This would effectively place a cap on the value of trading businesses, above which point inheritance tax could potentially be charged at a rate of 40%.

In capping agricultural relief and business relief at this level, it is suggested that tax revenues could be increased by £1.4bn in the current tax year and further rise to £1.8bn in the 2029/30 tax year. There is an important caveat however to these calculations that revenues could be lower if it “led to greater use of other avoidance strategies”.

The economic arguments behind reforms to inheritance tax reliefs can be found in previous research by the authors last year. They include that it would simply be more equitable if the reliefs did not exist and that inheritance tax should apply to all forms of wealth. It also suggests economic efficiency is a factor and that these inheritance tax reliefs could be distorting the investment decisions made by people, arguably meaning some investments with a higher societal benefit are foregone. That in turn could mean that uncapped inheritance tax reliefs could be having a wider economic impact.

Those arguments appear to be more clearly relevant to those making investments. For example, individuals who are looking for a passive return on their funds and choose to invest into farmland or AIM listed shares, as opposed to other asset classes, in order to benefit from inheritance tax relief. But what of those still running unlisted trading businesses?

The previous research paper suggests that there is an economic benefit if family businesses had non-family management. It also seemingly suggests a common rationale for business relief is that it is for the benefit of smaller businesses. What it does not appear to consider in depth are the potential consequences for privately-owned and family businesses if these reliefs were abolished or capped.

The potential impact of such a cap could be significant for larger unlisted businesses. It places the estate of a deceased business owner into a position of distress as it could have a significant tax liability and no means of funding it due to the illiquid nature of the assets. Rather than continuing under surviving management, it may be that the business has to be wound up and its assets sold, distorting the economy in a different way.

The big winners could be insurance companies. Some businesses already take out insurance policies to effectively buy out a deceased business owner’s interest but introducing a cap on business relief could make this more of a critical business continuity decision.

There would be a need for family businesses to consider succession earlier and arguably pass shares down to the next generation too soon in order to mitigate tax risks. With previous rumours that Labour were exploring the possibility of making changes to business relief, we have already seen the decision making of family businesses distorted with some looking at taking steps now to transfer shares. Important commercial decisions are already being driven by the fear of potential inheritance tax changes.

We might also see economic distortions, as we have due to the VAT thresholds, with a cap on inheritance tax relief resulting in a cap in ambition. A business relief cap would introduce another cliff-edge into the tax system that could act as a disincentive for someone to grow their business beyond a certain value.

Ultimately that could lead some entrepreneurs to consider whether the UK is the right place to start and grow their business in the first place. Following the previous research paper on non-doms, one of the outcomes is that the UK is unlinking the concept of domicile from inheritance tax. As a result, it will arguably become easier for individuals to become non-UK resident and avoid UK inheritance tax altogether.

It is too simplistic to categorise business relief as a loophole to justify chasing potential tax revenues for election spending pledges. If major reforms are to be introduced to business relief then it needs to be consulted on, with further research on its potential economic impact, as all that glitters is not gold.