Inheritance Tax Act 1984 gives relief from IHT on “relevant business property”. Relevant business property is stated as including “property consisting of a business or interest in a business”.

The legislation states; “A business or interest in a business, …, [is] not relevant business property if the business … consists wholly or mainly of … making or holding investments.”

Mrs Pearce owned a fishery at Fulling Mill on the River Itchen described as “one of the ‘classic’ chalk rivers of southern England”. The Itchen supports a variety of fish including brown trout, grayling and the occasional salmon.

Following her death, her executors claimed IHT business relief on part of her residence including an office from which she managed the business, a reception room, and a rod room where customers could store fishing equipment and kit. Additionally, relief was claimed on the value of an outbuilding and garage where mowers, strimmers and hand tools used for maintaining the land around the river were kept.

IHT business relief was also claimed on the river and the streams which fed it and the banks of the river and streams.

Mrs Pearce worked full time running the wild fishery, even though it was increasingly unprofitable. The riverbank had to be kept clear of vegetation so the fishermen had access to the river. Trees and other plants along the riverbank had to be managed to provide the right amount of shade and the right conditions to encourage the flies on which the fish fed. The river itself had to be kept clear and the banks protected from erosion.

It was common ground that Mrs Pearce was carrying on a business. The issue for determination by the Tax Tribunal was whether the business, at the date of Mrs Pearce’s death, consisted wholly or mainly of holding investments.

HMRC’s position was that the deceased’s business was the exploitation of land to produce income – which is an investment activity. The land was exploited by the granting of licences to people who wanted to fish in the river. The only income was from ‘rod fees’ – there were no sales of equipment or fees for tuition. HMRC accepted that Mrs Pearce took active steps in running the business and carried out a great deal of maintenance.

The Executors contended that the deceased’s wild fishery business could not be regarded as a property letting business. The income was derived, not from the exploitation of land but from the running of a fishery business. Looked at in the round, the deceased’s business was not one of the holding of investments but the provision of services and incidental facilities so as to take it out of the investment category.

The Tribunal adopted the following approach;

(1) The starting point is that the owning and holding of land in order to obtain an income from it is generally to be characterised as an investment activity.

(2) It is the nature of the activities, not the level of activity, which matters. Very active management of an investment does not prevent the business being an investment business.

(3) There is a spectrum of businesses involving the exploitation of land in order to generate income. At one end are property letting businesses which are clearly investments. At the other end are hotels, shops and farms which are clearly not investment businesses.

(4) Where on that spectrum a business falls can be determined by looking at the investment and non-investment activities as a whole, standing back, and looking at the business in the round.

(5) Where there are investment and non-investment activities, consider whether, looking at the business in the round, the non-investment activities are of sufficient importance that the business is not mainly an investment business.

The Tribunal concluded;

“Having considered matters in the round we have concluded that the business carried on by Mrs Pearce at the time of her death was mainly a business of holding investments. Although there were non-investment elements, they are not sufficient to outweigh the investment elements. Accordingly, the business is not eligible for Inheritance Tax Business Relief.”

The features of the eight types of death duty in force since 1694 varied considerably but they all had one thing in common – the domicile status of the deceased was vital to the scope of the tax and could be summarised as;

UK domicile – worldwide assets taxable

Non-UK domicile – UK assets taxable

The Labour party (and many others) has long been opposed to the tax advantages enjoyed by ‘non-doms’ and before the recent election stated that it would remove those advantages. (The rationale behind this approach is the belief that long term UK residents should be taxed on the same basis – whether UK domiciled or not.) The new Labour government intends to replace the current domicile-based system of IHT with a new residence-based system. It is intended that this will come into force from 6 April 2025.

This new system will affect the scope of assets brought into IHT for both individuals and trusts.

All UK assets will remain within the scope of IHT.

The basic test for whether non-UK assets are potentially liable for IHT from 6 April 2025 will be whether an individual owner has been resident in the UK for 10 years prior to the tax year in which death (or other chargeable occasion) arises.  In addition an individual will remain potentially liable, in respect of non-UK assets, for 10 years after leaving the UK.

In summary;

The government has announced that it will end the use of ‘excluded property trusts’ to keep assets out of the scope of IHT. It also intends to change the way IHT is charged on non-UK assets which are held in such trusts, so that everyone who is in scope of UK IHT pays the tax. Existing ‘excluded property trusts’ will lose their IHT advantages.

Confirmation of the new rules and their detailed application, including transitional arrangements, will be published in conjunction with the 30 October Budget.

Of course since the introduction of the Statutory Residence Test in 2013 it has, in general, been much easier to determine residence status.  Investigating domicile, in complex cases, can be time consuming (and thus costly) and will not always lead to an undisputed outcome.

One feature of the proposed system is the increase in the period in which an individual is potentially liable following arrival in, and departure from, the UK.

An individual will potentially be subject to IHT after 10 year’s UK residence and will remain within the scope of IHT for 10 years after becoming non-UK resident. (Of course UK assets will always be chargeable – subject to any available reliefs and the nil rate band)

Under the current, domiciled based regime, a non-domiciled individual will become ‘deemed domiciled’ after 15 years UK residence in any 20 year period and remain ‘deemed domiciled’ for 3 years after losing UK domicile (perhaps by moving permanently abroad).

The proposed changes will therefore bring an expansion of the IHT ‘net’.

One planning strategy is to become a non-UK resident and to maintain that status for 10 years. However such a strategy requires a consideration of much more than inheritance or indeed wealth taxes!

For those intending to emigrate, term assurance to cover the period from leaving the UK to leaving the IHT regime might be an attractive option.

For those who remain UK resident, traditional trust arrangements will still be attractive as will planning involving assets qualifying for IHT business relief or agricultural relief  (assuming these survive in current form).

As IHT will always impact UK assets (regardless of the residence status of the owner) it is well worth holding permissible UK investments in an ‘offshore’ bond.

It is unlikely that there will be any major shift in government approach. It has taken a ‘hard line’ on Winter Fuel Allowance and VAT on school fees. Non-doms can’t expect a softer approach.

In its election manifesto the Labour Party has promised not to increase income tax, national insurance contributions or VAT. No such commitment was made in respect to capital gains tax (CGT) beyond the exclusion of gains on an individual’s primary residence.

The Labour manifesto promised two tax measures with CGT implications.

The current regime for resident non-doms will be radically recast. This will mean the end of the remittance basis of taxation which applied equally to capital gains as well as income. It seems reasonably clear that some relief from UK tax for gains on non-UK assets made by ‘short term UK residents’ will be introduced. The details of this relief may have to wait until the first Labour Budget. Perhaps there will be some consultation exercise before legislation is introduced.

Labour has also promised to change the tax treatment of ‘carried interest’ moving the profits generated from the CGT regime (where the applicable rate would be 28%) to the income tax regime (where the applicable rate would be 45% with an additional 2% NIC charge). A ‘carried interest’ is an investment by private equity or hedge fund managers (alongside client investors) acquired at a preferential cost. It is effectively a performance fee. The tax analysis can be complicated. It may be that some of those affected would simply leave the UK should the current treatment change. It is claimed that the current treatment ‘costs’ the government approximately £600 million annually although the number of individuals able to take advantage of this beneficial treatment is believed to be small.

There are other aspects of the CGT legislation which might be changed by a new government. Business Asset Disposal Relief (BADR) is a relief (currently exempting gains of a cumulative lifetime amount of £1million) given on a disposal of a business or businesses. The rules surrounding entitlement to this relief are particularly complex. It has been argued that the relief has no economic justification – it does not encourage investment – and should be abolished. CGT reliefs on business disposals have been around since the introduction of the tax in the 1960s and BADR follows in the footsteps of retirement relief and entrepreneurs’ relief.

The interaction between capital gains tax and inheritance tax (IHT), in situations where assets owned at death qualify for 100% business relief, has been the subject of much discussion. The availability of business relief means that there is no IHT charge on death in respect of qualifying business assets and the deceased’s heirs inherit those assets with a CGT ‘cost’ of the market value at date of death. Growth in the value of those business assets has escaped both inheritance tax and CGT on the increase in value during the deceased’s period of ownership. It has been argued that this can’t have been the government’s intention when raising the rate of business relief to 100% in 1992. Previous administrations, of both political hues, have ignored this anomaly but perhaps a new, reforming, Chancellor will rectify it.

Finally our incoming Treasury team might want to look at the rates of CGT. We currently have five rates. Higher or additional rate taxpayers pay;
● 24% on gains from residential property
● 28% on gains from carried interest
● 20% on gains from other chargeable assets
The rate applying to basic rate taxpayers depends on the amount of the gain, the individual’s taxable income and the nature of the asset disposed of – residential property or other chargeable assets.

Is there scope for simplification?

By Gerry Brown, trust and estate planning consultant at QB Partners