Inheritance tax planning gets new lease of life

Inheritance tax (IHT) is levied on the value of a person’s estate at the time of their death. Often considered to be a tax on the very wealthiest in our society, the statistics suggest an alternative truth.

According to HMRC, the tax raised £4.7bn from 26,000 estates in 2015/16. A similar return is expected when the final figures for 2016/17 are known.

To put that into context, during 2015/16 HMRC’s High Net Worth Unit was monitoring 6,500 individuals living in the UK with a net worth in excess of £20m. Between May 2014 and April 2016, HMRC identified 161 inheritance tax records relating to high net worth individuals’ estates, with £183m generated from those same estates.

Arguably these numbers go some way towards dispelling the myth IHT targets the super-rich hardest. The reality is far different, with many more families caught by the tax who would perhaps consider themselves asset rich but cash poor.

As a consequence awareness of IHT is on the rise as people attempt to plan and structure their wealth according.

IHT is charged at 40% above the tax-free threshold, which is £325,000 for 2017/18. When discussing IHT with clients they are often astonished to hear that the tax is payable on a slab rate system, in that once the threshold has been exceeded tax is payable at a flat rate of 40% of the estate, rather than the tax being progressive. An additional nil-rate band was introduced in April earlier this year and applies to transfers on death of a main residence to a direct descendant. A direct descendant includes a child, step-child, adopted child or foster child of the deceased and their lineal descendants. The additional nil-rate band is set at £100,000 for 2017/18.

Undoubtedly the introduction of the additional nil-rate band will be beneficial to families who fit the fairly stringent criteria for the relief, but many will still be left exposed to a significant bill on death.

The desire to consider inheritance tax planning often wanes when the issue of gifting large sums of capital is raised, as that is often perceived as unaffordable when clients are potentially faced with a significant bill for long term residential care. There is a huge amount of uncertainty over how much anyone will need to pay for care, and the current uncertainty leading up to the General Election is just adding to this.

Increasingly therefore clients look to adopting IHT planning which will give them some degree of access to capital should it be needed in future to provide for care.

A number of strategies have been heavily marketed by the Financial Services sector over recent years, including:
Discounted gift trusts;
Loan trusts; and
Wealth preservation trusts.

The first and last of these involve a gift into trust which will require the donor to survive for seven years to be completely effective. Depending on the age and health of the individual the discounted gift trust will provide an immediate IHT saving related to the discount on the value of the gift which is deferred, as far as the recipient is concerned, until the death of the donor. A loan trust has no immediate IHT saving and is targeted at clients who do not have the nil-rate band available or who wish to retain full access to the capital being loaned to the trust, and the IHT saving is therefore limited to any growth in the value of the funds invested. The wealth preservation trust allows the donor access to some of the capital on an annual basis should it be required, but ad-hoc payments cannot be taken.

There are therefore considerable restrictions on either the access to capital in these structures or the IHT benefits they offer. On the plus side, relatively modest sums can be invested.

Anyone advising on IHT will tell you that clients often leave it until far too late in the day to consider IHT planning, and the prospect of surviving for seven years seems unlikely.  Although there can be some IHT saved if potentially exempt transfers are made which exceed the nil-rate band and taper relief is then available on those gifts, that is often still seen as unacceptable to clients, especially if such gifts would trigger a Capital Gains Tax (CGT) charge.  It may well be better to retain the CGT uplift on death rather than risking incurring a charge to both taxes if the client failed to survive for seven years.

Business Property Relief
Business Property Relief (BPR) could provide a solution for those clients with a limited life expectancy and a desire to retain access to capital to pay for care if necessary. The relief is available at a rate of 100% provided certain conditions are met, namely:
The investment in the business has been held for two years on death;
There is no binding contract for the sale of the business on death; and
The underlying business is not a disqualifying activity, i.e. a business which is mainly one of the holding or making of investments, which would exclude property investment businesses.

Although BPR, on the face of it, is there to provide relief for shareholders of qualifying companies and unincorporated businesses, so that those businesses can continue without the impact of a large inheritance tax bill on a death, the relief is also available in respect of investments in qualifying investments quoted on the Alternative Investment Market (AIM), irrespective of whether or not the shareholder is actively involved in the operation of the business.

Numerous stockbrokers have offered AIM portfolios for their clients for many years, but the entry level for such investments has often been considered too high for a client with a modestly valued but still taxable estate. Those clients are also unlikely to be experienced investors willing to take the level of risk involved, as the purpose of the AIM market is for growth companies to attract investment. Investments quoted on the AIM exchange are often perceived as being much higher risk and notwithstanding the fact that the investment may save 40% inheritance tax, the thought of an investment falling in value or not being quickly realisable is too challenging for an inexperienced investor.

The attraction of 100% BPR with only a two year window prior to death for the relief to apply, coupled with the fact that no gift or complex trust structure is required, has undoubtedly led to the development of more productised solutions with a much lower entry level. This is further enhanced by the fact that AIM investments can also now be held within an ISA. There are now numerous providers in the market offering BPR investments which meet the criteria required for 100% relief on death, which often carry a lower level of risk than was previously the case. Some even include a degree of life assurance for the initial two year period.

Enterprise Investment Scheme
As well as investments quoted on AIM, BPR is also available on Enterprise Investment Scheme investments, which are aimed at business start-ups and consequently have additional tax benefits as well as BPR after two years. Furthermore UK companies which are not quoted on any stock exchange will qualify for relief if they are carrying out a qualifying activity. It is in this latter market where there has perhaps been the most growth in investment, as IHT planning providers have sought to establish companies which satisfy all the required conditions and they have marketed investment in those companies purely as an IHT shelter. What they have sought to do is establish businesses which are within the rules but which aim to carry a lower level of risk and also return. Achieving the IHT relief is sold as part of the “return” on the investment, which is otherwise unlikely to grow significantly in value. The risk is often managed with a commitment that the promoting company will only take out their fees if a certain level of return has been achieved.

These investments are undoubtedly attractive to the client who has a fairly modest IHT liability, who does not want to make gifts, or who is unlikely to survive the seven years required for gifts to be exempt, but who does not want to take on a high level of risk and wishes to have access to funds for care costs if necessary.

It is no wonder that comparatively safe investments with lower entry levels are seeing a surge in their attraction particularly where those investments carry the added attraction of two years of life cover in some circumstances.

For further information on IHT friendly investments and help with estate planning and Will writing please contact the TaxDesk on 0845 4900 509 and ask for Carol Wells.