The inheritance tax (IHT) regime has long been a concern for family-owned businesses and private limited companies. With recent changes in tax policy, such as the extension of the IHT threshold freeze and the planned inclusion of inherited pensions in taxable estates from 2027, the pressure on business owners to protect their legacies has intensified.

Shares in private limited companies can form a substantial part of a business owner’s estate. If not planned for properly, these shares can trigger significant IHT liabilities upon the owner’s death, potentially forcing the sale of the business or its assets to cover tax bills.

Potential IHT Implications

When the owner of private company shares passes away, the shares become part of their taxable estate. Here’s how IHT can impact them:

• Valuation of Shares: The value of the shares at the time of death is included in the estate for IHT purposes, which can lead to a 40% tax liability on amounts exceeding the IHT threshold.
• Liquidity Issues: Private company shares are typically illiquid, meaning the heirs may face difficulties raising funds to settle the IHT liability without selling part or all of the business.

Reliefs and Exemptions

Some reliefs, such as Business Property Relief (BPR), can significantly reduce the IHT payable. BPR may allow up to 100% relief on shares in qualifying businesses, provided specific conditions are met (e.g., the company is not an investment vehicle). However, not all businesses qualify, and future reforms to BPR could tighten eligibility.

Business Property Relief: What’s Changing in the October 2024 Labour Budget?

Business Property Relief (BPR) has long been a cornerstone of inheritance tax (IHT) planning for business owners, offering up to 100% relief on certain business assets. However, the Labour Budget of October 2024 introduced significant reforms to BPR that will impact private company shares and small businesses.

What BPR Was Before

Previously, BPR provided:

1. 100% IHT Relief: On shares in unlisted trading companies or a sole trader/partnership’s qualifying business assets, provided the owner had held the asset for at least two years before their death.
2. Exempt Assets: Any assets used primarily for investment purposes (e.g., property letting or share portfolios) were excluded from relief.

This made BPR invaluable for small businesses, allowing them to be passed on without triggering crippling IHT liabilities, enabling continuity and stability for family-owned firms.

What’s Changing?

The Labour government has restructured BPR, effective April 2025, with the following changes:

1. Reduction in Relief for Large Estates: Businesses valued at over £5 million will no longer qualify for 100% BPR. Relief will taper down, with no relief available for businesses valued at over £10 million.
2. Stricter Criteria for Trading Businesses: BPR will now only apply to businesses with a minimum of 80% trading activity (up from 50%). Mixed-use businesses, such as those owning significant property portfolios, will lose a portion of their relief.
3. Cap on Relief: An overall cap of £2 million per estate will be introduced for BPR claims.

The changes will have significant consequences for business owners:

• Increased IHT Liability: Many family businesses valued over the new thresholds will face IHT bills of up to 40% on the excess value, potentially requiring the sale of assets or shares to cover the liability.
• Reduced Relief for Mixed-Use Companies: Businesses with a mix of trading and investment activities, such as pubs with letting rooms or property-rich enterprises, will find their eligibility for BPR drastically reduced.
• Administrative Challenges: Determining the proportion of “trading” activity will increase compliance burdens and disputes with HMRC.

For example, a business valued at £7 million might previously have qualified for full relief but will now face IHT on £2 million of its value (40% of £2 million = £800,000).

Mitigation Strategies

1. Shareholders’ Agreements

A well-drafted shareholders’ agreement can help plan for the transfer of shares in the event of a shareholder’s death. Such agreements can:

• Specify how shares will be valued.
• Set out rules for how shares will be bought or inherited.
• Prevent shares from being passed to individuals outside of the desired circle, such as family members or existing shareholders.

2. Cross-Option Agreements with Life Insurance

A cross-option agreement is a popular tool among business owners to ensure a smooth transfer of shares while mitigating IHT implications:

• How It Works: The agreement grants the surviving shareholders an option to buy the deceased’s shares while giving the estate an option to sell them.
• Funding the Purchase: To ensure liquidity, shareholders often take out life insurance policies with proceeds earmarked to fund the purchase of the shares. The insurance payout provides the necessary funds without burdening the estate or the company’s cash flow.
• IHT Benefits: If structured correctly, the shares are sold to the remaining shareholders, removing them from the deceased’s estate and potentially avoiding IHT.

3. Trusts and Family Investment Companies (FICs)

Trusts and FICs can help keep shares outside the taxable estate:

• Trusts: Shares transferred into a trust during the owner’s lifetime are no longer part of the estate, although the initial transfer may attract lifetime IHT if above the nil-rate band.
• FICs: These structures enable family members to hold shares in a company-like entity, reducing the direct ownership of assets and enabling tax-efficient distribution of income.

4. Holding Company Structures

Many business owners are looking at inserting a holding company, which is usually done with HMRC clearance by way of a share-for-share exchange.

5. Gifting Shares During Lifetime

Gifting shares to family members during the owner’s lifetime can reduce the taxable estate, but timing is critical. If the owner survives seven years after making the gift, it falls outside the IHT estate entirely.

6. Regular Estate Planning Reviews

With frequent changes to tax laws, reviewing estate plans regularly with professional advisers is crucial. This ensures compliance and maximises the use of available reliefs.

Conclusion

Planning for IHT on shares in private companies is essential for preserving family wealth and the viability of the business. Tools like shareholders’ agreements, cross-option agreements funded by insurance, and strategic use of trusts can provide robust solutions.

To navigate the complexities of IHT and secure your business legacy, consult with legal and financial experts. At Steven Mather Solicitor, we specialise in crafting tailored solutions to help business owners protect their assets and plan for the future.