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We have a client who, for some 35 years, held shares in a company which in latter years was traded on the Alternative Investment Market. In October 1998, the company was admitted to the Stock Exchange Official List and as a result its shares ceased to qualify for inheritance tax business property relief.
In May 2000, the company was taken over and our client received a substantial cash sum with consequent capital gains tax payable of about £120,000.
We have a client who, for some 35 years, held shares in a company which in latter years was traded on the Alternative Investment Market. In October 1998, the company was admitted to the Stock Exchange Official List and as a result its shares ceased to qualify for inheritance tax business property relief.
In May 2000, the company was taken over and our client received a substantial cash sum with consequent capital gains tax payable of about £120,000.
Primarily in order to avoid capital gains tax, but for other good commercial reasons, our client invested in a small privately owned trading company in June 2001, which should qualify for capital gains tax referral relief under the enterprise investment scheme. This much is straightforward and so is the income tax position.
We would like readers' views as to whether the new investment in June 2001 will qualify for business property relief immediately, or whether the two-year qualification period will have to be served.
(Query T15,846) – Latest News.
The key provision is section 107, Inheritance Tax Act 1984, which deals with 'replacement property'. This provides that property satisfies the 'two year ownership condition' for business property relief if 'it replaced other property and it, that other property and any property directly or indirectly replaced by that other property were owned by the transferor for periods which together comprised at least two years falling within the five years immediately preceding the transfer of value'.
'Two out of the last five years' means that replacement within three years will give rise to immediate entitlement to business property relief on the new asset. If the gap between owning the two assets is over three years, the test will not be satisfied. In this case, the dates appear to 'work', because the first company became quoted in October 1998 and the new investment is made in June 2001.
However, there are potential difficulties. It is not clear that section 107 applies simply to add together periods of ownership of relevant business property. There is a further condition: 'any other property concerned was such that, had the transfer of value been made immediately before it was replaced, it would (apart from section 106) have been relevant business property in relation to the transfer'.
Once the first company became quoted, it ceased to be relevant business property altogether, and the fact that it had previously qualified for the relief would not have counted for anything if a transfer had been made between October 1998 and June 2001. It is peculiar that the second condition appears to consider the status of the first asset 'immediately before it was replaced' (apparently June 2001) rather than when it was disposed of (May 2000), but in neither case does it appear possible to use the unquoted status of the asset up to October 1998.
It therefore seems likely that two years will have to pass before the new holding qualifies for business property relief, unless there is any other relevant business property which could be used to provide an earlier ownership period.
Note that it is also necessary to consider the relative values of the assets, if it is possible to count the two periods. Section 107(2) restricts the relief on the second asset to the amount that would have been given if there had been no replacement. It is therefore not possible to enjoy business property relief on a very large asset in under two years by adding in an ownership period of a previous very small asset. However, because of the way that reinvestment relief operates, it is likely that the new asset is actually worth less than the original asset – capital gains tax of £120,000 implies a gain of £300,000, which in turn implies a larger value. Only the gain of £300,000 needs to be invested to defer the capital gains tax charge, so section 107(2) would not pose a problem unless more than the minimum was put into the new asset. – Castlegate.
The two-year minimum period of ownership imposed by section 106, Inheritance Tax Act 1984 is designed to prevent deathbed purchases of relievable assets.
Section 107 provides that replacement property is treated as satisfying the two-year ownership condition in section 106 if (1) it replaced other property; and (2) that other property, and any property directly or indirectly replaced by that other property, was held for periods which together comprised at least two years falling within the five years immediately preceding the transfer; and (3) the replacement property qualifies for business property relief (apart from the two-year rule). So far so good.
The problem here is the requirement in section 107(1)(b), Inheritance Tax Act 1984 that the replaced property must have been relevant business property immediately before it was replaced. Accordingly, in this case the admission to the Stock Exchange Official List precluded the application of the 'replacement' provisions because the shares then lost their status as business property and the new shares will have to be held until June 2003 before business property relief will be available.
In correspondence last year with the Capital Taxes Office it was confirmed that the entire proceeds of disposal need to be reinvested; that the 'replacement' cannot be made in advance of the disposal. The Capital Taxes Office also confirmed that, at that time, its Advanced Instruction Manual at paragraph L83 was incorrect in its assertion that section 107(1), Inheritance Tax Act 1984 does not apply to minority holdings of unquoted shares: the subsection can apply to shares within section 105(1)(bb) of that Act. – Lacuna.
