Investment, inheritance tax and business relief

Much of my time is spent advising clients on how to grow their investments. This involves protecting clients’ capital from various threats that can gobble it up, as fast as my Cocker Spaniel devours her supper. There is not a lot of point in planning for growth if you do not plan for protection of capital. Threats include stock market crashes, taxes, no longer suitable investment strategies and under-performing fund managers. That is why investment reviews are important.

In this blog I want to continue on the theme of alternative investments, specifically one that addresses one of the greatest threats to capital, inheritance tax (IHT). You can spend years building an investment portfolio only to find after your death it is decimated by a tax that wipes 40% off its value after various allowances. An antidote to IHT is legislation called Business Relief (BR). This was previously called Business Property Relief (BPR) and was introduced in 1976 to exempt business owners from IHT on business assets.  It also applies to shareholders in certain qualifying smaller companies. Providing the assets are relevant business property* investors are exempt from IHT after two years providing they are held at the date of death. The government is naturally keen to encourage investment in small UK companies, which is why tax incentives are provided.

The use of BR has become a mainstay of good IHT planning. It has two distinct advantages over other tax mitigation strategies notably outright gifts or use of trusts. These require a seven year waiting period for IHT exemption and the donor must relinquish all control of the asset gifted. There is no recall. In contrast BR applies after just two years and investors retain full rights over their investment. So if their circumstances changes and they need access to their money they can sell their shares and spend the money as they see fit, although of course they will lose the IHT exemption. BR address perhaps the most important reason why people don’t undertake IHT planning, the fear of losing access to capital. It also avoids the complexity of trusts.

Over the years a good competitive market has developed in tax efficient investments using BR. There are a host of providers including Octopus, Blackfinch, Time and Foresight and two types of BR investment schemes:

Investment Backed

These are managed portfolios of qualifying AIM shares. The AIM is the alternative investment market, part of the London Stock Exchange. It is a stock market for small companies. They are not all start-ups or fledgling companies and include established business such as clothing company ASOS, Fevertree Drinks and Youngs & Co’s Brewery. Domino Pizzas was AIM listed before moving to the main market as was Tottenham Hotspur football club before it went private. Not all AIM stocks qualify for BR, notably property and finance companies.

A number of my clients have managed portfolios of AIM companies which have delivered outstanding if volatile returns in the medium term. Since 2013 AIM shares can be held within an ISA which means dividends are not taxed.

Asset Backed

These are investments in one or more unquoted trading companies set up by the provider. The company invests in assets such as renewable energy, notably solar and wind, battery storage, property lending, anaerobic digestion, infrastructure and smart meter leasing. They benefit from physical assets, government subsidies and long term contracts with sustainable cash flows.

Asset backed BR schemes typically have an objective of steady capital growth and preservation and usually have a target return, for example 3.5% p.a. net of all ongoing management charges and costs. Many providers do not take their management fee unless investors receive the target return. They are especially suitable for cautious risk clients, ethical investors and people looking to deploy excess cash for a potentially higher return than bank interest but without taking undue risk.

A principle downside of BR investments are charges tend to be relatively high. Initial charges which have all but disappeared from mainstream investments such as unit trusts and OEICs (open ended investment companies) are levied by BR providers. These are typically 2% or 2.5% although IFAs may be able to negotiate discounts. Ongoing costs are also higher than unit trusts and OEICs. The other main disadvantage of BR investments are they are not covered by the Financial Services Compensation Scheme (FSCS) in the event of failure. This is no different to investors in any other direct shareholding.

Conclusion

The use of BR is an excellent way to mitigate against IHT, quickly, simply and without a loss of control of capital. An investment of £50,000 will result in an inheritance tax saving of £20,000 after just two years if retained until death. On death there will be no capital gains tax either. The underlying investments themselves will typically complement mainstream portfolios and add diversity. A number of providers offer accelerated tax relief with an option to add life assurance to cover the tax on death within two years. As a group life arrangement there will be no medical underwriting and acceptance is guaranteed unless you have been diagnosed with a terminal illness. That is the only question investors are likely to be asked. An additional charge is levied if the life cover option is selected.

There is a natural reluctance for people not undertake IHT planning. The reasons are varied but include loss of control, complexity and inertia. However someone once said inheritance tax is a voluntary tax paid by people who love their children more than the taxman, and inaction may be costly. In reality some of the barriers are easily overcome.

Finally BR is also available to Enterprise Investment Scheme (EIS) investors. These are the super heroes of tax efficient investments with a variety of other tax benefits including 30% income tax relief. More on EIS another time.

*Relevant business property. This includes a business or interest in a business, qualifying AIM shares, unquoted securities or land, buildings, plant or machinery for the purposes of a business. Relief for the latter is 50%. For a technical description see:

https://www.rossmartin.co.uk/private-client-a-estate-planning/inheritance-tax-probate/619-business-property-relief-iht

The content of this blog is based on my own understanding of Business Relief and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest in AIM shares or other BR schemes. You should seek individual advice based on your own financial circumstances before making investment decisions.