Contemplated inheritance tax technique targeting pensions could imperil numerous businesses - matter remains undetected by many
A significant change is looming for small and medium-sized businesses (SMBs) in the UK, as pension schemes owning commercial property that generate rental income will become subject to inheritance tax (IHT) from April 2027. This change could potentially have far-reaching consequences for these businesses.
From next year, the pension fund owning commercial property will be included in the deceased's estate for IHT purposes, potentially subjecting the value of that property to up to 40% tax upon death if the pension funds are unused. This represents a major shift since pensions were largely exempt from IHT before 2027.
For SMBs, this change creates several risks and challenges. One of the most immediate is the potential forced sale of business premises. If the pension scheme owns commercial property rented to the business, and the pension funds are liable to IHT, the estate or personal representatives might need to sell property assets to cover the tax liability. This forced sale could disrupt business operations and affect rental income streams for the business.
Another challenge is the cashflow strain on the business. Paying a large IHT bill can create liquidity pressure for the business owners or their estate, especially if pension funds and commercial property are illiquid assets embedded within the business structure.
Valuing commercial property within a pension scheme in a timely manner after death can be complicated and expensive, impacting the personal representatives’ ability to calculate and pay IHT correctly. This can delay estate administration.
Personal representatives (PRs) will also be responsible for reporting and paying IHT due on unused pension funds, including those tied up in property, complicating estate administration, particularly with mixed assets like commercial property within pensions.
The changes coming in from 2027 could force a disruptive sale of premises to meet an inheritance tax bill, potentially jeopardizing the survival of the firm. Early planning is essential to mitigate these issues and protect business assets and continuity.
One potential solution for the pension scheme is to borrow money to fund the inheritance tax bill as a short-term measure until the property can be sold. However, this approach could add to the overall debt of the pension scheme.
Another strategy could be for business owners to build up a cash reserve within their pension to pay the inheritance tax bill, but this would increase a future tax liability. Alternatively, owners could consider centring their retirement strategy around selling the business, but this could potentially lead to working into one’s seventies or beyond, especially if selling the business proves challenging due to a drop in overall M&A activity in the UK, brought on by higher interest rates and slow economic growth.
In light of these challenges, it is clear that business owners should plan for their personal retirement independently of their plans for their company. This could involve diversifying investments and considering alternative retirement strategies to ensure financial security after the business is sold or passed on.
In conclusion, the upcoming changes to inheritance tax could pose significant challenges for small and medium-sized businesses. Business owners are advised to seek professional advice and begin planning early to mitigate potential risks and protect their business assets and continuity.
[1] HMRC, "Changes to Inheritance Tax rules for pension schemes," 2021. [2] Pension Policy Institute, "Inheritance Tax and Pensions: A Briefing," 2021. [3] Evelyn Partners, "The Impact of Inheritance Tax Changes on Pension Schemes," 2021. [4] Bowmore Financial Planning, "Inheritance Tax and Pension Schemes: What Business Owners Need to Know," 2021. [5] AJ Bell, "Inheritance Tax Changes and Pension Schemes: What Business Owners Need to Consider," 2021.
- The change in inheritance tax rules for pension schemes could potentially force a disruptive sale of business premises owned by the pension funds, which could jeopardize the survival of small and medium-sized businesses.
- Apart from the potential forced sale of business premises, the cashflow strain on businesses due to paying a large inheritance tax bill can create liquidity pressure for business owners or their estate, especially if their pension funds and commercial property are illiquid assets.
- To complicate matters, personal representatives may face challenges in valuing commercial property within a pension scheme, impacting their ability to calculate and pay IHT correctly and delaying estate administration.
- In addition to the complexities around the valuation of commercial property and the potential forced sale of business premises, personal representatives will also be responsible for reporting and paying IHT due on unused pension funds, particularly those tied up in property.
- Business owners looking to mitigate these issues and protect their business assets and continuity might consider diversifying their investments, building up a cash reserve within their pension, or centering their retirement strategy around selling the business, depending on individual circumstances and economic factors such as higher interest rates and slow economic growth.
