Business owners often hold a large proportion of their wealth in a single trading business. This can create difficulties when planning their estates. The value of the business may change significantly, its future ownership may be uncertain and a sale before or after death could affect the inheritance tax position.
This case study is based on recent advice relating to a business owner who wished to review a Will that left almost his entire estate to a younger colleague. The business had increased substantially in value and a potential corporate purchaser had shown an interest in acquiring it.
The circumstances illustrate how Business Property Relief, discretionary trusts and careful Will drafting can provide flexibility while managing a potential inheritance tax liability.
Background
The client was single, in his late sixties and had no children. He owned a successful trading business with an estimated value of approximately £2 million. Its value could increase significantly, particularly as a potential corporate purchaser had shown an interest in acquiring it.
Under his existing Will, almost the whole estate was left to a younger employee. Although the client was still willing to consider the employee as a beneficiary, he no longer wanted them to inherit the entire business and estate automatically.
The main points to consider were:
- whether the business would qualify for Business Property Relief;
- the potential inheritance tax liability;
- whether the Will should include a discretionary trust; and
- whether professional executors and trustees should be appointed.
What Is Business Property Relief?
Business Property Relief, commonly known as BPR, reduces the value of qualifying business property when inheritance tax is calculated. The relevant rules are contained in Part V, Chapter I of the Inheritance Tax Act 1984.
Depending on the type of business property, relief may be available at either 100% or 50%.
For example, if qualifying business property worth £100,000 attracts relief at 100%, its value is reduced to nil for inheritance tax purposes. If relief is available at 50%, only £50,000 is taken into account.
The business owner will generally need to have owned the relevant property for at least two years before death. There are some limited exceptions to this requirement. The structure and activities of the business must also satisfy the statutory conditions.
Historically, qualifying trading business assets could receive BPR at 100% without an overall limit. From 6 April 2026, the 100% rate is limited to the first £2.5 million of qualifying agricultural and business property. Any qualifying value above the available allowance receives relief at 50%. An unused allowance can also be transferred to a surviving spouse or civil partner.
Will the Business Qualify?
BPR is principally intended to apply to trading businesses. It is not available where a business consists wholly or mainly of dealing in securities, stocks or shares, land or buildings, or making or holding investments.
The distinction between trading and investment activity can be difficult to determine. This may be particularly relevant where a business owns valuable land or buildings.
Before reaching a view on whether BPR may be available, the following would need to be established:
- whether the business operates as a sole trade, partnership or limited company;
- whether its activities are predominantly trading rather than investment-based;
- how long the client has owned the relevant business interest;
- whether any land or buildings are owned by the client personally or through the business; and
- whether negotiations for a corporate sale have progressed beyond an initial expression of interest.
We can provide general advice on the BPR rules. However, it would not be possible for us to confirm definitively whether relief will apply, or the rate at which it will apply.
The Effect of a Possible Sale
Interest from a potential purchaser does not, by itself, prevent BPR from applying. The position can change if negotiations progress and result in a binding contract for sale.
BPR may be restricted where business property is subject to a binding contract for sale at the date of death. If the client sells the business during his lifetime, cash received from the sale will not normally qualify for BPR merely because it arose from a business that previously qualified.
For example, if the client dies while still owning a qualifying business worth £2 million, its value may potentially be covered by BPR at 100%. If he sells the business for £2 million and retains the proceeds in cash, that sum may instead form part of his taxable estate without the benefit of BPR.
The timing and terms of any proposed sale would therefore need to be considered carefully.
The Potential Inheritance Tax Position
A single person will ordinarily have a nil rate band of £325,000. This is the amount that can generally pass without inheritance tax, subject to any lifetime gifts or other transfers that have used the allowance. Inheritance tax is normally charged at 40% on the remaining taxable estate.
The residence nil rate band is unlikely to assist this client. It generally requires a qualifying residential interest to pass to direct descendants, such as children or grandchildren. The client has no children.
If the £2 million business qualifies fully for BPR, its taxable value could be reduced to nil. The client’s remaining assets would then be assessed separately, with the nil rate band applied where available.
The position could be significantly different if:
- the business does not qualify for BPR;
- its value increases beyond the available allowance for relief at 100%;
- only part of the business qualifies; or
- the business is sold and converted into cash before death.
The inheritance tax position should therefore be reviewed alongside any changes to the business or proposed sale.
Planning the Will
There are a number of options the client could consider when deciding how the business and the rest of his estate should pass under the Will.
Option One: An Outright Gift
The client could replace the existing Will with one making fixed gifts to the employee and any other chosen beneficiaries.
This would be a relatively straightforward approach. However, it would provide limited flexibility. The beneficiaries would become entitled to the business or the proceeds of sale in the shares specified in the Will, even if the value of the business, the tax rules or their personal circumstances had changed significantly by the date of death.
The client would also need to decide now which beneficiaries should benefit and the exact share each should receive.
Option Two: A Discretionary Trust
An alternative would be for qualifying business assets to pass into a discretionary trust under the Will.
A discretionary trust does not give any beneficiary an automatic entitlement to the trust assets. Instead, the trustees decide who should benefit, when distributions should be made and whether assets should be retained or sold. The colleague could remain within the class of potential beneficiaries alongside relatives, friends, employees or charities.
This structure could allow the trustees to review:
- the business’s value at the date of death;
- whether BPR is available;
- any pending corporate offer;
- the financial and personal circumstances of the beneficiaries; and
- whether the business should be retained or sold; and
- whether the business, or its proceeds, should be retained in trust or not.
A further advantage is that the business and, any sale proceeds retained within the trust, would not form part of any beneficiary’s estate for inheritance tax purposes. This can be particularly useful if BPR is lost after the client’s death as the loss of BPR will then not impact a beneficiary’s own inheritance tax liability.
Discretionary trusts are instead subject to their own inheritance tax rules, known as the “relevant property regime”. This may produce inheritance tax charges on each ten-year anniversary of the trust and when assets leave it. Where the trust continues to hold qualifying business property, BPR may reduce or eliminate those charges. If the trustees sell the business, the cash proceeds will not retain BPR unless the statutory replacement property rules apply. The trust may therefore face future relevant property charges, but these can still be preferable to adding the whole fund to a beneficiary’s personal estate and exposing it to inheritance tax on that beneficiary’s death.
The client could prepare a letter of wishes explaining how the trustees should exercise their powers, including whether the priority should be to preserve the fund, support particular beneficiaries or consider future distributions. The letter would guide the trustees but would not legally bind them.
Professional Executors and Trustees
Given the value of the business, the potential inheritance tax issues and the possibility of corporate sale negotiations, the appointment of professional executors and trustees may be appropriate.
Conclusion
In this case, a discretionary trust could provide greater flexibility than an outright gift to the employee. It would allow decisions to be made after death when the value of the business, the availability of BPR and the beneficiaries’ circumstances are known.
The Will and business structure should nevertheless be reviewed regularly, particularly if a sale becomes more likely.
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This article is provided for general information only and does not constitute legal advice. Any advice, wording or clauses referred to are illustrative and should not be relied upon as precedent without full consideration of the client’s circumstances, the will as a whole, and the law in force at the relevant time.
