By Daniel Hunter
Business owners who took out borrowing secured on a personal asset such as their home, in order to invest in a business are seeing their well-made plans unpicked by the Treasury. As a result their families could face significantly higher Inheritance Tax (IHT) bills in the future, which might require the sale of assets to fund the additional tax.
IHT alarm bells have been ringing ever since the Budget when new rules were proposed which are due to be law from as early as this July. Accountants and business advisers James Cowper are advising family businesses to review their position now or face a significantly higher tax bill.
“Up until now borrowings taken out to buy business assets, which qualify for relief from IHT are fully deductible when calculating the amount of IHT due. If the rules are enacted as proposed, ordinary business people and their families will be caught out. This is despite the fact that it may never have been the intention of the deceased to create a debt with the main aim of reducing IHT,” Stephen Barratt, Private Client Tax Director at James Cowper explained.
“IHT is currently charged on the total value of any assets less any debt. Where a loan is secured on a fully taxable asset, the value of that asset is reduced by the loan in calculating the IHT, leaving the business asset covered by relief. For example, if a family borrows, say £500,000 secured against a house worth £800,000, the value of the house is reduced for IHT purposes by the debt down to £300,000, while the new business asset worth £500,000 is not taxable, being covered by IHT reliefs.
"Under the proposals, the house in this example will remain fully taxable at 40% on £800,000, with £320,000 tax payable. Clearly this is a very different and less favourable outcome from that which was anticipated. Only in circumstances where the debt is greater than the value of the business, will any relief be given for the borrowing.
“This will come as a very unpleasant surprise to family business owners and some will unwittingly be faced with a stark choice of their heirs being obliged to sell either the family home or the business in order to settle the tax bill.”
Some businessmen are seeking to re-order their affairs now though others will prefer to wait until the Bill is enacted in July.
Stephen explained: “Individual circumstances will dictate what can be done to mitigate the effect of the major change, but it is critical that families at least understand the impact for them personally. There may also be a window of opportunity before it becomes law to explore alternative arrangements and potentially reduce the impact of the changes. Now would be a good time for anybody who thinks they may be affected to discuss their IHT planning with their accountant or financial adviser.”
The new arrangements will apply to deaths that occur after the Finance Bill becomes law, which is expected to happen in mid July.
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