We recently completed a job for a company called Blackfinch that stimulated some thought.
The investment that prompted this reaction is a seed EIS discretionary managed portfolio of music companies. Sounds sexy but may be a bit racy.
If you listened to mainstream opinion, you could be excused for thinking, why would anyone ever expose someone to that kind of risk? But looking after wealthy people usually means having more tools in your box than can be fixed with a cashflow.
I have written before about the more esoteric parts of the investment world, with the consideration that they are only to be used in the right circumstances but, equally, that outlawing them entirely is a step too far.
Fortunately, VCTs and EISs were not part of the outlawing by escaping classification as a Ucis, so investments like this can be regulated.
EISs and probably to a greater degree SEISs are a genuine opportunity for mutual benefit. The clients, who are providing the money, get valuable tax planning opportunities while in return, the companies get access to money to help drive their business forward. Ultimately, the country benefits through increased employment and economic growth.
In the middle are individuals with huge responsibilities: first, people who recognise the opportunities and can package managed solutions that are attractive to clients and, second, advisers who know their clients really well and can identify the right people to expose to these opportunities.
As long as everyone plays a straight bat, the outcome should be great. Advisers and planners need to be doing a very thorough job beforehand and should not casually introduce concepts like these without creating important standards.
Before going that deep, here is a quick catch-up. In simple terms, SEISs offer:
- 50 per cent tax relief, irrespective of the rate of tax at which you pay
- 50 per cent capital gains tax relief on gains in 2013/14 (was 100 per cent in 2012/13)
- A carry-back facility for 2012/13 on both income tax and CGT
- After two years, the investment is outside your estate utilising business property relief
- The CGT gain is not deferred
- No age restriction
- Maximum £100,000 investment in any single tax year.
SEISs can be useful for people facing the double problem of unresolved large capital gains, on either properties or equity portfolios, and inheritance tax.
Think of more mature people who were part of the first dynamic house-buying boom in the UK in the late 1950s and 1960s. This was the start of the surge in homeownership that most people today take for granted. These people will have bought a house for a few thousand pounds that could now be very valuable.
As they became more successful in their careers, these same people maybe went on to buy second homes and holiday homes in the 1960s and 1970s and dabbled with investments or received shares as part of their remuneration.
Finally, some of these people will have been professionals and now, in retirement, are the lucky recipients of significant final salary pension schemes. They typically make little or no attempt to utilise any allowances to reduce their income tax bill.
Their problems, should circumstances prompt any, are CGT liabilities and, for their beneficiaries, large liabilities to inheritance tax.
Of course, not every well-off person with a high property value, large equity portfolio and good final salary scheme faces problems. But for those who do and who are forced to disturb their comfortable circumstances, it is important for their financial adviser to be well prepared.
IHT is currently levied by the Government at 40 per cent and is already a huge drain on estates in the UK, standing at around £3bn per annum. HMRC predicts that this figure will rise by as much as 100 per cent in only two years.
Two factors contribute to this prediction:
- The IHT threshold is currently frozen whereas property prices have recovered and are increasing again, and
- There is a significant demographic bulge in the population whereby elderly property owners are now passing away, fuelling the growth in taxable estates.
With individual allowances to CGT at 0 per cent on only the first £10,900 of gains, it is not hard to see how the Treasury will be able to claim £12.5bn per annum.
A potential solution
The truth is, when advisers are chasing high-net-worth clients, a lot of these people want to see some dynamic planning for taxes.
Clever tax avoidance schemes will, at some point, come unstuck. An adviser’s job is not about avoiding tax, it is about managing when it is paid, giving clients the opportunity to plan based on their needs.
So when considering the people who may need help – typically well-off, older people – the usual methods of IHT planning could be supplemented and complemented by the judicious use of SEISs as part of the overall strategy.
At first glance this seems counter-intuitive because SEISs have, in many people’s eyes, been regarded merely as a way of helping thrusting Dragon’s Den investor types seeking to avoid the payment of higher-rate income tax.
However, a more considered scrutiny of what SEISs have to offer throws up some benefits that can be very useful for elderly clients looking to plan for IHT with the right set of circumstances.
If we apply these attributes to an IHT case, the results are quite surprising. Take as an example a retired couple, both aged 80, with taxable income of £90,000 each and a pregnant capital gain after allowances of £100,000 for the 2013/14 tax year. Jointly, their income tax bill would be £51,644 (£25,822 x 2). If they invested £100,000 into an SEIS, they would receive tax relief of £50,000, thus reducing their joint tax bill to £1,644 (£822 each).
In addition, they would be subject to CGT on the £100,000 at 28 per cent, giving a CGT bill of £28,000. Investing the £100,000 into an SEIS would provide 50 per cent capital gain reinvestment relief, thus reducing the tax by 50 per cent to £14,000.
When we combine the income tax and CGT savings, by factoring in the tax relief this is a net investment of £36,000.
If we then consider business property relief after two years, the £100,000 investment (assuming no growth) will save another £40,000 in potential IHT charges.
Overlooking the obvious
Our paraplanners see a number of IHT cases that are difficult to deal with because the first thing to be addressed is a capital gain that advisers and clients are generally reluctant to realise.
By utilising a significant income tax and CGT saving, SEISs are a way of solving this conundrum. But they can be overlooked because of the perceived risk of what has often been deemed an esoteric investment.
Assuming that advisers carry out the necessary suitability and risk assessments, SEISs can provide the solution when the right product is matched to the right individual.
It should be remembered that the reliefs offered by SEISs are HMRC-approved reliefs. Should you wish to take advantage of this product prior to the end of the tax year, I suggest sourcing an SEIS from an FCA-regulated promoter which has HMRC Advanced Assurance already in place with a specific proposition rather than an investment concept.
Furthermore, in the run-up to 5 April, the number of SEIS opportunities will be limited due to the maximum raise allowed of £150,000 per company. If you are considering utilising this vehicle, you probably need to act quickly.
Finally, it is important to take extreme care when choosing a firm to entrust with your client’s affairs.
I advise assessment on two levels:
- Research – what is the product, what does it do and how does it do it?
Without wishing to scare you, the best way to answer these questions is to visualise yourself in court defending the product. If it offers a guarantee, how is that possible? If it talks about low volatility, how does that correlate with asset valuations? Why do they have a collar on the fee?
If you can satisfy yourself that the product manages the tax, management and investment risks appropriately, move to the next stage.
- Due diligence – who manages the company, what is its track record and what controls does it have in place?
Visualise the trust you have built up with your client as the inflation of a balloon. It is pretty hard work but once it is full, it is easy to keep inflated.
If you introduce your clients to anyone who could burst that balloon, there will be little that you can do to fix it. But careful due diligence will ensure that only people trusted by you as unlikely to burst that balloon will ever come near your clients.
Damian Davies is director of The Timebank