Inheritance tax has always been one of the least popular government duties. People understandably resent the state taking money away from their children when it is passed on through an inheritance.
There are a number of ways to mitigate inheritance tax. The most common are giving the money away in the form of a lifetime gift or putting it in trust. The problem with these strategies, however, is that anyone transferring money, shares or other assets will need to survive for seven years before the gift is fully exempt from inheritance tax. Trusts are also complex and costly to set up. In addition, access to the capital is lost a high price to pay for most people, who may need the money in later years to pay for nursing care or unexpected events. An alternative and more flexible way of mitigating IHT and maintaining access to capital is by using business property relief.
BPR applies principally to sole trad-ers and partnerships but also includes unquoted shares in a company. By a legislative quirk, shares traded on the Alternative Investment Market but not the LSE are considered unquoted for tax purposes.
HM Revenue and Customs rules restrict investments qualifying for BPR to be made in companies that do not derive a material amount of their income from investments so no property companies or investment firms. Still, even with that caveat, we estimate that of the 1500 companies on Aim, 60-65 per cent potentially will qualify.
What are the advantages of BPR? First, it offers 100 per cent relief from inheritance tax on qualifying shares. Second, the shares only need to be held for two years before death as opposed to seven with a lifetime gift before qualifying. And third, a portfolio of Aim-listed shares is a relatively straightforward investment, which means holders are free to unwind them or cash in part of their portfolio at any time.
A further wrinkle of an Aim tax port-folio is that you don’t need to be invested in the same shares for the entire two years, just the Aim market itself. It is therefore perfectly possible to sell qualified shares at any time and replace them with other qualified shares, without interrupting the two-year BPR period, which can be very useful if the investment climate changes. The meter, as it were, starts ticking when you first invest in Aim, not when you buy specific qualifying shares.
It is unfortunately unclear how long you can keep your investment in cash between selling one batch of shares and buying another. There has never been a test case. We urge our clients to remain fully ’The meter, as it were, starts ticking when you first invest in Aim, not when you buy specific qualifying shares’
invested and to reinvest the proceeds of anything they’ve sold within a few days.
There is, of course, risk involved in setting up a BPR portfolio. The first is obviously tax risk. Nothing is guaranteed and the rules could change at any time. However, having said that, the regulations governing BPR have not been amended since 1995 and there is little to suppose they will be in the near future.
Finally, while the Inland Revenue, as mentioned above, will not guarantee relief in advance, preferring to pass judgement on a company’s suitability for relief after the fact, I have been dealing with the process for 15 years and never had any problems yet.
The second risk is investment risk. Aim has a reputation for being riskier than the LSE, say, and it’s true that the smaller start-up companies that dominate the alternative market are more volatile than the well-established blue-chips of the LSE. The Aim is also less regulated than the LSE and because companies on Aim are often young, they will have a shorter trading history, which makes analysing their track record more difficult. However, it is perfectly possible to put together a good portfolio that is akin to the FTSE 100 index in terms of volatility.
Although we would categorise all Aim-listed companies as high-risk investments, we look for opportunities in companies with lower risk profiles. These companies typically have a market capitalisation of more than £100m and, by definition, will be more liquid and more mature. We look for companies that have grown organically, not by acquisition. More importantly, we look for companies that pay dividends. And we want to invest in companies that have grown their business, have taken market share and have never issued profit warnings. That still leaves us with a reasonable number of Aim companies to look at. Our estimate is that there is a universe of some 200 Aim-listed com-panies that we would look to invest in.
So who should invest in an inheritance tax portfolio? Obviously, people approaching retirement age who have a substantial amount of assets that they would like to pass on to their children would benefit enormously. It should be noted, however, that the value of the benefits of an IHT portfolio will depend on individual circumstances. In general, these portfolios do not target high returns although we would always expect some investment growth.
It best suits those who have excess equities, who can take some money out of an Isa or equity portfolio and switch it into an Aim portfolio.