This article is written by:

Jake Kelly

Senior Business Development Manager

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As a Business Development Manager regularly engaging with Financial Advisers across the UK, I've found that one question frequently comes up:  

"Can my client put their Business Relief investments into a Discretionary Trust to mitigate IHT liability when their spouse passes on our estate to their children?"  

This question underscores the complexity of estate planning and the keen interest in leveraging tax-efficient strategies to benefit clients.  

The short answer is, yes, but in this article, I aim to address this question, drawing on my experience and conversations with advisers.

I aim to shed light on the integration of Business Relief (BR) with Discretionary Trusts in estate planning and how it could benefit your clients.

First, let's understand the key terms:

Before we delve deeper, let's clarify some essential terms:

• Business Relief (BR): Business Relief (BR) is an established relief from inheritance tax. By purchasing shares in a company that qualifies for business relief, you could potentially lessen your inheritance tax liability. This is contingent on the type of business asset and how long you own the shares for. Shares in Business Relief qualifying companies, if held for a minimum of two years, and at time of death, might be eligible for Inheritance Tax relief. ‍

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• Discretionary Trust: A Trust arrangement where trustees have the discretion to decide the distribution of assets among beneficiaries, offering flexibility and control over the estate's future allocation.‍

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• Residence Nil Rate Band (RNRB): An additional IHT threshold available when a main residence is passed on death to direct descendants, potentially reducing the overall IHT liability. The RNRB is £175,000 per person and is frozen at this threshold until 2030.

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• Taper Threshold: The estate value limit above which the RNRB starts to decrease, affecting the IHT efficiency, especially in scenarios where assets are passed directly to a surviving spouse.

Why would clients be looking to put their BR investments into Trusts?

IFAs are always seeking innovative and effective ways to optimise their clients' estate planning, often, blending two types of estate planning may be the right approach when it comes to mitigating tax bills for both their clients and their clients’ beneficiaries.

This approach could be both tax efficient and align with broader financial goals, making it a recurring method of estate planning.

It can offer flexibility in asset distribution while potentially preserving the RNRB and avoiding the taper threshold's impact – which, if not addressed, can compromise tax efficiency when assets are passed directly to a surviving spouse.

Below I have broken down how IFA’s can approach this instance by using an example client scenario:

Background

John is a successful entrepreneur with an estate valued at £3 million in the UK. His estate comprises a primary residence worth £1 million and £2 million in BR-qualifying business assets.  ‍

John’s goal is to pass his wealth to his wife, Mary, and subsequently, to their children, aiming to optimise Inheritance Tax (IHT) mitigation, particularly concerning the Residential Nil Rate Band (RNRB) and its taper threshold.

Initial estate breakdown

• Primary residence: £1 million
• BR-Qualifying assets: £2 million

Total Estate Value: £3 million

Potential IHT liability without planning

If John passes his entire estate to Mary directly:

• The estate would benefit from Spousal Exemption, incurring no immediate IHT.
• However, upon Mary's passing, assuming she inherits the entire estate, and it remains unchanged, the combined estate would be subject to IHT, potentially losing the RNRB due to the taper threshold (£3 million - £2 million threshold = £1 million over, fully tapering away the RNRB).

Strategic use of a Discretionary Trust

John, advised by his financial adviser, decides to place the £2 million of BR-qualifying assets into a Discretionary Trust, with Mary and their children as beneficiaries. This action aims to:

• Maintain the RNRB for the primary residence by keeping the estate value below the taper threshold.
• Leverage BR to potentially reduce IHT on the £2 million in business assets.

IHT liability and savings with planning

• The primary residence (£1 million) could be passed to Mary, utilising the Spousal Exemption and preserving the RNRB since the estate value for IHT purposes is now below the £2 million taper threshold.
• The £2 million in BR-qualifying assets within the Discretionary Trust would not form part of John's estate for IHT purposes.
• Assuming John held the BR shares for two years before transferring to a Trust, they will be IHT exempt (if certain conditions are met*) and outside of his estate.
• As John is settling BR qualifying assets into a Trust, the potential lifetime transfer charge to IHT (usually 20%) is reduced to zero.
• While the assets held in the trust continue to be BR qualifying no periodic charges will apply.
• If the BR qualifying shares are subsequently sold by the Trustees and the settlor dies within seven years, the original transfer into the Discretionary Trust will become chargeable.

How did John benefit?

By strategically utilising a Discretionary Trust for the BR-qualifying assets, John effectively reduces the taxable estate value, preserves the RNRB for the primary residence, and removes the impact of tapering.  

This planning ensures that Mary and their children benefit from a more tax-efficient transfer of wealth, with the potential IHT savings being significant compared to the scenario where no planning is undertaken.

In conclusion, the integration of BR investments into Discretionary Trusts presents a compelling avenue for estate planning. For advisers seeking to enhance their clients' financial legacies, understanding this strategy's nuances and benefits is crucial.  

*Updates following the Autumn Budget 2024

With BR-qualifying investments, investors' shares become eligible for 100% inheritance tax relief after just two years, as long as the shares are held at the time of death.  

However, from April 2026 100% Business Relief will continue to apply to the first £1m of qualifying business and agricultural assets (in addition to the current nil rate band worth up to £500k per individual) and, there after, IHT will apply at half the normal rate, effectively reducing to 20%. This change will apply to unlisted inheritance tax solutions and private businesses that otherwise meet the Business Relief conditions.

For Business Relief qualifying companies listed on AIM, IHT will apply at the halved rate of 20% (irrespective of the size of investment).

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Opinions expressed represent the views of the author at the time of publication, are subject to change, and should not be interpreted as investment or tax advice.

Important notice: This video is for investment professionals only. This video is for information only and does not form part of a direct offer or invitation to purchase, subscribe for or dispose of securities and no reliance should be placed on it. No reliance should be made on this content to inform any investment of tax planning decision.   

Please note: The explanation of the 2024 Autumn budget changes is in accordance with our understanding of the law and our interpretation of it at the time of publication. The proposed reforms we will discuss have not yet been drafted in legislation; and are subject to change.

This content contains information that is believed to be accurate at the time of publication but is subject to change without notice. The explanation of all of the tax rules set out have been written in accordance with our understanding of the law and interpretation of it at the time of publication.

Whilst care has been taken in compiling this content, no representation or warranty, express or implied, is made by Downing as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified.