Following the Autumn 2024 Budget changes proposed by Rachel Reeves, there has been a lot of uncertainty around how existing, well-considered succession planning has been affected when it comes to inheritance tax (IHT). Whilst we are still waiting for a number of consultations, and final legislation, to set out how the proposed changes will work in practice, there are still things to consider at this stage.
If the proposed changes are implemented in respect of business property relief (BPR) it will be important to consider the value which will be attached to shares when a person passes away. Previously shares in a trading company could attract 100% BPR and no IHT was payable in respect of such shares regardless of their value; however, if the availability of BPR is limited and IHT will be payable in respect of such shares, the value of private company shares will become more important. It will be important that any submission to HMRC of a person’s estate properly takes into account the value of the shares held by them so that the appropriate amount of IHT can be applied.
HMRC’s Valuation Assessment
When HMRC are considering the value of shares for IHT purposes, instead of looking at what the deceased shareholder would get for their shares if they were sold on death, they look at what a hypothetical person would be able to sell the deceased’s shares for if they “stepped into the shoes” of the deceased. This is an important distinction because this effectively ignores the fact that a hypothetical person may not have actually been able to get hold of the deceased’s shares because of restrictions contained within the articles. Restrictions on transfer are therefore not enough alone to limit the value of a deceased’s shares.
In looking at what a hypothetical person would be able to sell shares in the company for, it will be necessary to consider a range of factors. Often a company’s articles of association will set out what “Fair Value” would be if shares were to be sold and in the absence of an expression in the articles of association HMRC have default rules.
One question that will need to be asked in valuing shares is whether a minority discount applies to the relevant shares or not.
What is a minority discount?
If we consider a theoretical scenario of a shareholder (Shareholder) who holds 20% of the shares in a trading company worth £5,000,000 (Company). For the purpose of calculating the value of the Shareholder’s estate, the value of their shareholding in the Company will need to be assessed and calculated to work out what their potential IHT bill may be.
A very simple approach would be to simply take 20% of £5,000,000 (equalling £1,000,000) and to take this as the value. However, this may not consider the full picture of what a willing buyer may be willing to pay for the shares in the Company. A buyer will need to consider factors such as what level of control such a shareholding would give -in this scenario, not a lot given they wouldn’t have a veto over any resolution and wouldn’t have the ability to pass any resolution themselves. This is where the concept of minority discount applies – a discount applied to the value of shares to reflect the size of the shareholding, as opposed to just valuing shares as a percentage of the Company as a whole. In this scenario, you may see a significant discount applied to the value of the shareholding because of the minority level of shareholding bringing the value of the shareholding down. If shares are worth less it follows that the IHT bill would be lower.
Does a minority discount always apply?
To an extent this depends upon the company’s articles of association. HMRC’s default position is to apply a minority discount unless there is something within the company’s constitution which disapplies it. This is positive news in terms of the IHT position, but needs further consideration when looking at what a person may want to be able to sell their shares for during their lifetime.
What about if we want to sell shares during lifetime?
There is often good reason why a company’s articles of association say that shares are to be valued on a pro-rata basis without applying a minority discount. For example, in a professional business where each shareholder has put in significant effort and resources, a shareholder is likely to feel that they would want to receive a pro-rata proportion of the value of the business when they retire.
There is a balancing act to be done and much depends on whether a person is likely to sell shares during their lifetime. For family businesses where shares are likely to be handed down from generation to generation maximising the price at which a person might sell their shares is unlikely to be as important in businesses where retirements are expected.
Given the changes to BPR now introduced, you can see why is it as important as ever to ensure that your articles and shareholders’ agreements are up to date and reflect the circumstances for each company and the individuals holding shares. As above, there is a balancing act in terms of valuation and it will need to be considered as to which is a lesser of two evils – a shareholder not being able to realise a proportionate value of their shares on any retirement, or a higher IHT bill if their shares are valued on a pro-rata basis.
If you would like to review your articles of association or shareholders agreement to check the valuation provisions that apply and any other appropriate amendments please contact our Corporate team.