Investing in a business to avoid Inheritance Tax

Inheritance tax (IHT)  is often called a voluntary tax. The possibility of avoiding or reducing IHT by just giving away assets and surviving seven years seems pretty attractive on the surface but can have implications if income is required or if the beneficiaries divorce.In some cases (especially if the planning is left until late in life) the most difficult part, is the risk of dying before seven years so the gift drops back into the estate. Therefore, making financial gifts later in life in the context of planning for reducing inheritance tax (IHT) bills usually comes with the strong caveat that it will take seven years for it to be effective.There are many commercially-run business property relief (BPR) arrangements and they can be useful in certain circumstances. These are usually considered high investment risk products and so experienced advice is essential. An alternative simple and relatively cheap method of obtaining BPR for assets (turning the assets into one which is 100% IHT free) is to invest them in a trading business run by a beneficiary of your will. By becoming a shareholder or partner in the business you can reduce the seven years to two.In either case, provided the business is trading at the date of death of your death as the investor and you have held the investment for at least two years, then on the basis of the existing rules BPR at 100% will be available –thus eliminating the IHT on the value of the investment.Bearing in mind that a claim will be made for BPR will only be made on your death, it is very important that the investment is properly documented. This is usually something that should be dealt with by the person advising on tax planning and the accountant of the business.Bearing in mind the amount of Inheritance tax that can be at stake, it is well worth getting the documentation correct. In addition keeping any eye on the trading status of the business is also a must.In the right circumstances (you need to be confident in the ongoing viability of the business) this is one of the few arrangements where keeping an asset instead of giving it away can be IHT effective.During your lifetime you can benefit from dividends or drawings from the business in which you have invested without risking the BPR. This will of course affect your income tax and so once again experienced advice is essential. For those with a limited life expectancy and in the right circumstances, this method of avoiding Inheritance tax can be very useful.