IHT pitfalls on timing of asset transfers – what farms need to consider
© artisteer_Istockphoto Under changes to the inheritance tax (IHT) regime from April next year, each individual’s estate will have 100% agricultural property relief (APR) or business property relief (BPR), or a combination of the two, only on £1m worth of qualifying assets.
After that, relief will be available on qualifying assets at 50%, giving an effective tax rate in the region of 20%.
This is in addition to each person’s current £325,000 IHT-free personal nil rate band.
See also: Budget highlights need for inheritance document housekeeping
As a result, it will make sense for many with qualifying assets of more than £1m to transfer some assets to a spouse, civil partner or other beneficiary.
This is assuming the nil rate band will be unavailable for transfers of qualifying business assets and will be used elsewhere.
This has been one of the main elements of advice since the IHT relief changes were announced in the October 2024 Budget.
However, there are some tripwires in terms of timing and qualifying for the relief on transferred assets.
“It’s sensible to consider maximising the available £1m 100% IHT business asset thresholds by transferring some assets to others who do not already hold a business interest worth up to £1m,” says Mike Butler, a partner in the rural and landed estates team of accountant PKF Francis Clark.
“This includes considering a spouse’s position, provided such options maintain asset security and don’t, in the short term at least, actually potentially increase the IHT exposure.
“Based on the draft Finance Bill, the £1m 100% APR/BPR allowance is not transferable between spouses, so it’s a question of use it or lose it.
Tax v asset security
The fear of tax is driving many decisions, and Mike Butler of PKF Francis Clark advises cool heads rather than hasty action.
For example, there is pressure to make spousal transfers to make use of each person’s £1m 100% IHT relief. With an eye on the divorce rate, he says:
“Remember, the tax saving is worth 20%, the asset is worth 100%, so if you’re giving away 100% of something, be sure that it’s the right thing to do.”
The same caution applies for transfers to other family members, where the potential for disputes, or someone leaving unexpectedly, even bankruptcy, can disrupt what seems at the time to be a careful plan.
“Where lifetime gifts are being contemplated, there is benefit in considering whether gifts can be made by both spouses.
“This may reduce the risk of IHT being clawed back in the following seven years if either donor dies within that period.
Securing term life cover may also be easier or more cost effective if the risk of an IHT claw-back is spread over two lives, as the level of cover needed for each spouse will be lower and one of the spouses may present a lower risk by virtue of age or health.
Qualifying periods
Mike points out that depending on the type of asset, it can take up to seven years for the receiving spouse to gain the same APR or BPR IHT reliefs that were available to the person transferring the assets.
This is particularly important if the receiving spouse wishes subsequently to gift the land or property to their children, to others or even into discretionary trust.
In the case of agricultural land that is rented out to a third party or the family company, a receiving spouse will need to hold that land, and ensure it is used for agriculture, for a full seven years before APR will apply should they then wish to pass it on to the next generation.
This applies even if the occupier of the land is the family farming company, where the spouses who are party to the gifts do not control that company.
Two-year qualifying period
“This period can be reduced to two years if the spouse is personally one of the occupiers of the land.
“Where the business is a farming partnership, this reduced ownership period may be achieved by bringing the spouse into the partnership.
“This can apply where the land is either a partnership asset or held outside of the partnership but used by a partnership.
However, instant relief can be achieved in some circumstances.
“For example, where a spouse is already a partner in the partnership occupying the land [and has been a partner for at least two years running up to the interest being transferred] but has not so far owned an interest in the farmland, a transfer of an interest in that land will attract instant APR.
Where a spouse receives an interest in qualifying assets but not with an intention to then make a further gift, providing the spouse transferring the interest also qualified at the time of the transfer to their spouse, the transferee will qualify for APR from the date of the transfer, if the event that triggers a test for the relief is the death of the receiving spouse.
This is the case even if that death happens shortly after the initial transfer.
Gifts out of regular income
Regular payments can be made IHT-free to another person – for example, to help with their living costs – points out Luke Cochrane.
There has been recent media speculation that this autumn’s budget may reduce the ability to do this, but for the time being, it is an option for those who can afford it.
“There’s no limit to how much you can give tax free, as long as you can afford the payments after meeting your usual living costs and you pay from your regular income,” he says.
“As long as these conditions are met, there are no restrictions as to who you make these payments to or what they are for.
“Examples include paying rent for your child, paying into a savings account for a child under 18 or giving financial support to an elderly relative.
“If you’re giving gifts to the same person, you can combine ‘normal expenditure out of income’ with any other allowance, except for the small gift allowance.
“The exemption is not tested until death, so it is important there is sufficient evidence at this point to claim the exemption when making the IHT return.
“Usually, HMRC would look back over a number of years to check regularity.”
Farming company shares
“Where shares in a trading company qualify for BPR, a spouse receiving shares will need to have owned those shares for two years before they can in turn make a gift without that gift attracting APR or BPR in their estate.
“Short-term life cover could provide a solution to the risk of IHT arising in this critical period.”
Beware potential SDLT liability on land transfers
Land transfers to individuals can trigger a stamp duty land tax (SDLT) charge, warns Luke Cochrane, tax director at tax adviser Land Family Business.
“Farmland gifted with a charge would usually not give rise to a capital gains tax liability as reliefs should apply.
“However, on SDLT, the main point to watch out for would be charges or mortgages on land, as these would be deemed consideration as part of the transfer, so could cause an SDLT liability when one wasn’t expected.”
Any amount of the charge being transferred could cause an SDLT liability on that value, the value of the remaining debt.
Pensions subject to IHT – what changes may be needed
Pension funds will be subject to IHT at 40% on the death of the fund holder after 5 April 2027, according to the draft Finance Bill published at the end of July.
“From a tax perspective [rather than investment advice], many will now be looking at the merits of liquidating and drawing down on pensions in anticipation of the loss of IHT efficiency,” says Mike Butler of PKF Francis Clark.
Some farmers have planned for their personal pension fund, regardless of what type of investment it holds, to benefit non-farming children on the death of the pension fund holder.
“Now that there is pressure to release and spend or invest those funds elsewhere because of the IHT threat, the intended beneficiary may find there is a far smaller fund left for them to benefit from,” says Mike.
“However, if the parent now draws more on the pension in later life and less on the business, how to provide some form of legacy for non-farming children from the business can be considered.”
Self-managed pensions
Those with a self-managed pension owning farmland and buildings need to recognise that the asset will effectively be exposed to 40% IHT as pension fund assets attract no APR or BPR.
This compares with personally owned assets or those which are part of a trading company where the maximum effective IHT rate would be 20% if the assets qualify for the reliefs, points out Mike.
There are several options for farmers with land and buildings in self-managed pensions, he says.
“These include whether to buy out these assets back into the business to improve the potential IHT position, especially if the liquidated fund then goes on the provide a source of income to the stakeholder as an alternative to drawing on business profits.”
He points out there can still be tax advantages to investing in a pension, including tax relief on contributions at up to 40%, also tax-free growth and the ability to withdraw 25% of the fund as a tax-free lump sum.
“However, with pensions now heading for 40% IHT, many will want to view a pension as a pot to draw on in one’s lifetime, a fund for retirement, rather than a way to pass wealth down tax efficiently.”