Michael Fryer, wealth management consultant, Mattioli Woods, examines the tax and risk implications of using a business relief strategy in IHT planning.
They do say that there are three things that are certain in life: death, taxes and change.
You can’t avoid change, although the debate is still open regarding progress, and while life can perhaps be extended by eating ‘5 a day’ and keeping fit and healthy, the grim reaper will eventually come to collect us all as the last grain of sand passes through his hourglass.
That leaves us with taxes and, as a continuance of the cheery theme, the tax applied upon death. Inheritance Tax (IHT) is a tax charged on the value of an assessable estate when an individual dies, with an estate being everything the individual owns, including their home, any other properties, cars, investments, bank deposits as well as personal effects such as antiques and jewellery.And anything they have given away in the previous seven years, over and above certain exemptions.
In simple terms, IHT is charged at a rate of 40% on the value of everything owned above the nil rate band threshold. The nil rate band, which is frozen at £325,000 until 2021, is the portion of the estate that is currently not chargeable to IHT. In April 2017 an additional allowance, known as the residence nil rate band (RNRB), was introduced that now removes £150,000 of the value of a person’s home from IHT if it is left to a direct descendant, typically children. For married couples, these nil rate bands can effectively be doubled resulting in a potential IHT threshold of £950,000 being available on second death in the 2019/20 tax year.
As IHT is charged on the value of an estate that is more than the NRB, the simplest way to avoid it is to reduce the value of an individual’s assets so that at the time of death they are less than the prevailing allowance. In theory, this sounds simple. In practice, however, it can be difficult to achieve. Assets such as a home often increase in value over time, meaning that even if other assets such as cash are given away, placed in trust or simply spent, the overall value of an estate can still increase. Many of our clients find themselves with this quandary.
There are strategies that can be used to mitigate IHT, and indeed a combination of several methods is usually used to provide an overall solution. Each has its own merits and drawbacks, and the right combination of each should allow IHT to be mitigated while allowing assets to be retained as needed and passed onto your family as per your wishes. A key element to any IHT plan is to ensure that you secure enough to live on comfortably in later years.
An overall strategy often includes one or more of the following:
- Writing a will
- Utilising the NRB and RNRB
- Giving cash gifts to family and using exemptions
- Willing gifts to charity and/or political parties
- Making Potentially Exempt Transfers (PETs)
- Placing assets into trust
- Using life assurance policies in trust
- Owning assets that are not subject to IHT
No doubt you will be familiar with most of these methods, so I would like to focus on what could be described as the most obvious, but perhaps the least used – simply owning assets that are not subject to IHT.
Owning an asset which qualifies for Business Relief (BR) can form part of a strategy that allows for the sum allocated to such qualifying assets to be exempt from IHT, as long as they have been held for at least two years prior to death. While some such assets benefit from relief from IHT at a rate of only 50%, others, which can broadly be summarised as ownership of a business or the ownership of shares in a business, can qualify for relief at a rate of 100%. Specifically, these are:
- A business or an interest in a business
- Unquoted shares that give control of a company
- Alternative Investment Market (AIM) shares
For the owners of an existing business, BR is extremely beneficial when granted, but of course is subject to the business being genuinely trading. A business that generates only investment income, such as one that is active in shares, property or land dealing, would not qualify for BR.
I understand that one cannot easily establish or buy into a business at any time, let alone in later life when IHT concerns are more relevant. However, BR can still be gained by purchasing shares in AIM listed companies, and this should be considered when forming an effective IHT mitigation strategy.
Investing in AIM
AIM was established in 1995 and was traditionally viewed as a home for small, young, fast-growing companies. Consequently, mainstream investors could be put off from participating in this market due to the perceived high-risk nature of this asset class. The market has since matured and provides a home for a varied and diverse mix of companies. Consequently, for those individuals who are looking to use BR as part of their IHT mitigation strategy, AIM investment can be beneficial.
An investment in AIM either via the purchase of individual shares or, as is more likely, via an AIM fund operated by an investment house, will qualify for BR after it has been held for two years. On death, this investment will then not be included in the value of an estate for IHT purposes.
We have seen that the value of an estate is made up of a home, any other properties, cars, investments, bank deposits as well as personal effects such as antiques and jewellery. By transferring investments such as cash, unit trusts/OEICs and ISAs to AIM, after the two-year qualifying period has passed, the estate will be reduced by the value of the AIM investments.
Furthermore, since 2013, AIM shares can be held within an ISA, which means that the associated income and capital gains tax advantages are retained. To benefit from BR, the AIM investment would have to be held at the time of death; however, the right of access is still available, if the AIM shares are readily tradeable. This investment flexibility can overcome one of the main drawbacks of IHT mitigation, that is the loss of access to funds that is inherent with alternative strategies such as gifting assets.
I should make clear that AIM investment can and does pose a greater level of risk and volatility in the value of the asset than investing in the principal markets – it is not for everyone. In a worst-case scenario, companies could be delisted from AIM making their shares difficult to deal in. Consequently, such an investment should be part of an overall portfolio and of course should be made in accordance with attitude for and tolerance of risk.