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TaxationWeb by Bob Fraser MBA MA FSFA

Bob Fraser, MBA, MA, FSFA, Associate Investment Director, Rensburg Investment Management Limited, examines the ‘pre-owned assets tax’ (POAT) regime from 6 April 2005, and considers two potential IHT planning approaches.This article is intended to do exactly what the title says – to look at 2 IHT planning approaches post-POAT. These are not the only 2 potential solutions, nor are they suitable for all individuals. As always in financial planning, individuals should take professional, independent and well qualified advice to develop solutions appropriate to their own circumstances. I have also made the assumption that the obvious first steps (writing wills and using the nil rate band on first death) have been carried out.

Introduction

Although initially intended as a tax on the very wealthy, inheritance tax (IHT) is increasingly catching families with comparatively modest disposable wealth but whose house has grown considerably in value. Over the years, IHT thresholds have, in real terms, stealthily fallen. During the past five years alone, house price inflation has hit 60 per cent, while the Nil Rate Band (the threshold above which IHT applies) has only increased by 14 per cent.

A consequence of this is that whilst the very rich can take steps to reduce the IHT liability by gifting assets away, many individuals need to retain access to their wealth for their future financial security in old age. The tax can thus bite hardest at those who are not the main targets.

We have therefore seen a growth in the number of increasingly sophisticated tax avoidance schemes, normally based around the family home. Despite Inland Revenue legal challenges, many of these were successful. Some were outlawed by new legislation, but the government has now decided to get tough. Speaking to the House of Commons Standing Committee on the Finance Bill on 18 May 2004, the Paymaster General, Dawn Primarolo, said:

'People who have used such schemes, or who contemplate others like them in future, are right to think that they will get any inheritance tax saving that their scheme is able to assure, but they are wrong to think that that protects them against any future tax charge. That is at the heart of the changes under Schedule 15'.

The tax charge to which she was referring is the Pre-Owned Assets Tax (POAT), which will be chargeable from 6th April 2005. It is also retrospective in that it will apply to assets disposed of since 17th March 1986. The Inland Revenue, in Briefing Note 40, has stated that the tax is targeted against

'People who have entered into contrived arrangements to dispose of valuable assets, while retaining the ability to use them, (where) the main purpose of arrangements subject to the charge is to avoid inheritance tax.'

A reason for the government’s impatience with clever tax planning is clear. Figures just released by the National Audit Office of the IHT taken for 2003/04 shows that 30,000 estates were taxed, yielding net receipts of £2.504 billion. Some people would argue that this is just another stealth tax.

So what steps remain for IHT tax planning? The old adage ‘if it looks too good to be true, it probably is’ should be borne in mind. More particularly, given the retrospective nature of the POAT, is the concern that the government may be similarly vindictive against other arrangements that they deem as contrived. So for the moment I would opt for arrangements which the Inland Revenue have either given the nod to, or which do not involve any form of gifting. The specific approach will depend on whether access is needed to income or capital.

Requirement for income

If income is needed, then discounted gift trusts remain an option depending on how the trust has been written (in essence income ‘carve-out’ trusts should be acceptable to the Inland Revenue but the status of each scheme’s particular trust needs to be checked). Under these trusts (generally marketed through life offices), the settlor retains the right to an income from the settlement, but gifts the capital. The cash value of his retained income is immediately outside the estate for IHT purposes, and the balance of the capital is a ‘potentially exempt transfer’. The amount of the income cannot generally be varied, nor can the lump sum be retrieved. This arrangement is therefore only suitable for individuals who are certain of their future income and capital needs, or who have other assets on which to draw.

For those determined to protect the family home, the following solution could be considered by those for whom it is appropriate:

 The owner(s) could take out a mortgage on part of the value of the home.

 The sum raised could be invested in a discounted gift trust.

 The 5% retained income from the trust could help to service the mortgage.

 As there has not been any disposal of the asset there cannot be either a ‘gift with reservation’, nor any liability to POAT.

 Equally there has been no “deprivation of assets” for assessment of long term care costs.

 If the house is sold during the owner’s lifetime there will be Principal Private Residence CGT relief on the sale of the house.

 There will be some immediate IHT relief (depending on the investor’s health, age and income retention) with the residue falling outside estate after 7 years.

Requirement for access to capital

If access to the capital is needed, then the options are constrained by the “reservation of benefit” rules and the new POAT. Although it is possible to use a ‘revert to settlor’ trust to return fixed amounts of capital to the settlor at periodic intervals (Way Fund Managers offer an innovative solution in this area), it is not certain that these schemes will not be subject to future legislation. An alternative option is to use business property relief to mitigate the IHT. Although there are a few ways to obtain BPR, this article will focus on the use of the Alternative Investment Market.

Provided a shareholder has owned shares in a qualifying unquoted trading company for at least two years, 100% business property relief (BPR) is available which reduces the inheritance tax liability on death to nil. Furthermore, business assets taper relief also applies, which means that should the investor need to dispose of some or all of the shares after 2 years, the capital gains tax on any gain is taxed at 10% (for a higher rate tax payer) versus 24% for private assets once held for 10 years.

It needs to be acknowledged that this solution is not universally suitable as it does require a more adventurous attitude to risk. This risk can, however, be managed.

Managing the Risk

The Alternative Investment Market now (Nov 04) comprises 979 companies with a capitalization of £29.6 billion. In Nov 04 there were an average of 372 million shares traded per day, with an average daily value of £95.6 million.

It is important to understand that the AIM has widely varying companies. Some have been established for many years and have excellent credentials. Others are struggling to turn a profit. 70% of the companies have a market value of under £50M, and 27% are under £5M. By contrast 14.5% are valued at more than £50M. The 9 largest companies on AIM are all worth more than £300 million, which means that they would be eligible for inclusion in the FTSE 350 if they were on the Full List.

An indication of investment interest in the AIM is that in October 04 the total value of institutional holdings stood at £9.75 billion, or 38.3per cent of the market in all. Among the most active institutional investors by number are:

Institution	Number of investments	Value of investments (£m)
Artemis	21	99.45
Fidelity International	17	84.20
Foreign & Colonial	14	58.67
Gartmore	11	28.63
Schroders	10	36.80
RAB Capital	10	28.35
Framlington	10	26.54

Institutional Investors in Aim compiled by Growth Company Investor, Oct 04

Clearly, therefore, there are investment opportunities in the AIM, but equally clearly identifying these opportunities is a specialist task. For this reason, self investing in the AIM would be highly speculative. One way to reduce risk would be to invest through a collective investment, and there are indeed unit trusts/OEICs which have a high AIM content. However, these collective investments do not qualify for BPR. The reason is that the individual shares have to be owned both legally and beneficially by the investor, which unit trusts are not.

The investment solution is, therefore, to find a specialist investment manager who markets a specific AIM IHT share portfolio, although most such managers have a minimum investment amount of £30,000+. Not only will such a manager identify suitable investment opportunities, but he will screen these for BPR compliance. Typical investment criteria would be:

 Experienced and committed management team.

 Superior services or products.

 Established financial track record with good Earnings Per Share growth.

 Sound balance sheet and dividend record.

 Demonstrable liquidity in the stock.

 At least two years on AIM and institutional following.

Clearly the portfolio has to stand on its on 2 feet in investment terms, since tax is seldom the whole justification for a course of action. By way of illustration, the Rensburg AIM IHT portfolio (‘A’ stocks) has provided return of over 40% since launch in September 2001, as well as an IHT saving of 40%.

For those individuals who have the capacity to take a more adventurous risk, this approach has a number of advantages over trust based arrangements:

• The time to qualify for 100% IHT relief is only 2 years, instead of 7 years for a potentially exempt transfer. This allows tax planning for those whose life expectancy is less than 7 years, but more than 2 years.

• As the shares remain in the individual’s ownership, they can be sold if there is ever a need to access the capital.

• It allows estate planning under enduring powers of attorney since the investment is not a gift. The powers of attorney are statutorily limited in permitting the holder only to make gifts to provide for needs, or to make gifts of a seasonal or charitable nature. Using the power for general estate planning purposes (eg to make PETs) will therefore be wholly ineffective (see the case of Brown Shipley v Holland 2004 in which the gift was voided, bringing £962,000 back into the estate for IHT purposes). Although a solution would be to apply to the Court of Protection for consent to the gift, there may be valid reasons why this approach is not appropriate.

Suitability

I always stress that investment into the AIM is for individuals with financial security independent of the investment made into the AIM.

For those determined to protect the family home, the discounted gift trust (see above) is generally more appropriate as it provides an income, and access to lower risk funds. However, if age or ill health make that option unsuitable, then substituting the AIM for the discounted gift trust may be a course of last resort rather than submit to the tax.

Generally, however, the AIM approach suits individuals who:

 Have excess cash on deposit.

 Have equity PEPs/ISAs from which an income is not being drawn, and from which capital is unlikely to be needed in the short term. PEPs/ISAs have CGT advantages but are fully assessable for IHT. Moving these into the AIM maintains their capital availability, retains some CGT advantages, but builds in 100% IHT relief after 2 years ownership.

 Have large share or collective holdings which they wish to transfer within CGT limits into a more IHT friendly environment.

March 2005

Bob Fraser, MBA, MA, FSFA
Associate Investment Director
Rensburg Investment Management Limited
Contact bob Fraser

Bob Fraser is an associate investment director and has achieved the highest level of professional advisory qualifications in the financial services industry. He is a Fellow by examination of Personal Finance Society, which is a specialist faculty of the Chartered Insurance Institute. He also holds a Masters of Business Administration degree.

Rensburg Investment Management is the largest company in the Rensburg group and a subsidiary of Rensburg plc, a public company whose shares are quoted on the London Stock Exchange. Its core business is investment management and it currently looks after around £3.0bn of funds for private investors, trustees, charities and pension funds. It provides independent financial planning advice and investment management services to both individuals and businesses in order to meet their financial objectives. Financial planning is the process by which resources and risks are firstly identified and then used or provided for in a way which best achieves financial goals and lifestyle. It provides detailed advice to clients across the whole range of financial planning issues from the provision of straightforward life assurance, to savings and retirement planning, to complex inheritance tax planning arrangements.

Rensburg is authorised and regulated by the Financial Services Authority (FSA) whose function is to provide investor protection through the regulation of financial product providers in securities and derivatives business.

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