Case Study: The Hidden Tax Burden of Business Property Relief Reform for Family Businesses

The proposed reforms to Business Property Relief (BPR) scheduled for April 2026 have created waves across the business community. While much attention has focused on agricultural implications, the impact on trading companies presents an even more intricate challenge that many business owners are yet to fully comprehend.

At first glance, the mathematics seems straightforward. Consider James, who heads a successful manufacturing company valued at £15m, held within a family trust. Currently, his business enjoys complete protection from Inheritance Tax (IHT) through 100% Business Property Relief (BPR). The upcoming changes, however, paint a different picture.

Post-April 2026, only the first £1m will receive full relief, with the remaining value subject to 50% relief. The surface-level calculation suggests a manageable scenario. With a reduced relief structure, James's estate faces an IHT liability of £2.8m. However, this figure masks a more complex financial reality that many business owners haven't considered: the challenge isn't just calculating the tax liability - it's funding it.

The real complexity emerges when considering how to extract funds from the company to meet this liability. Corporate structures create an additional layer of taxation that many analyses overlook. Whether through direct company payment or dividend distribution, moving money from the business to cover IHT triggers substantial additional tax implications.

Consider the practical reality: to net £2.8m for the IHT payment, the company must distribute approximately £4.6m to account for dividend tax at 39.35%. This creates a cascade of tax obligations - £1.8m in income tax followed by £2.8m in IHT. What started as an apparent 20% effective tax rate transforms into a burden approaching 31% of the business value.

Further complications arise when companies attempt to prepare for these liabilities. Creating an "IHT reserve" within the company might seem prudent, but such funds risk classification as excepted assets - potentially losing BPR entirely and increasing the overall tax burden. Additionally, liquidating such reserves could trigger corporation tax on any gains realized.

The timing and mechanism of tax payment add another layer of complexity. While executors might benefit from basic rate dividend tax (8.75%), this advantage could diminish if IHT payment is spread through interest-free instalments. Later instalments might face higher tax rates as shares pass to beneficiaries in higher tax brackets.

For business owners contemplating succession planning, these changes demand immediate attention. The traditional approach of relying solely on BPR needs reconsideration. Alternative strategies might include external funding sources, life assurance policies, or restructuring business ownership models. Each option requires careful evaluation against both immediate tax implications and long-term business viability.

The situation becomes even more nuanced for companies held in relevant property trusts. The standard ten-year charge of 3% could effectively increase to 5% when considering the additional tax burden of dividend distributions. Trustees face the additional challenge of ensuring their powers align with using dividend income for capital tax obligations.

This reform represents more than a simple tax rate adjustment - it's a fundamental shift requiring comprehensive strategic planning. Business owners must look beyond immediate tax calculations to consider the full spectrum of implications for their companies' financial health and succession planning.

The key to navigating these changes lies in early preparation and holistic planning. Business owners should consider conducting detailed financial modeling of various scenarios, exploring alternative funding mechanisms, and potentially restructuring their businesses to optimize for both operational efficiency and tax effectiveness.As we approach 2026, the message is clear: understanding these implications and planning accordingly isn't just prudent - it's essential for business survival and successful succession planning.