For all their tax “goodness” – tax-free dividends and interest, and CGT-free gains – Isas cannot be assigned and so cannot be used in estate planning. Of course, if the Isa holder leaves the proceeds of the Isa to a surviving spouse on death, there will be no IHT payable. The surviving spouse can then, if appropriate, consider IHT planning with those proceeds.
The extent to which planning can be carried out with those Isa proceeds will substantially depend on the potential donor’s need for access to, and control over, the available funds. Even after the passing into law of the general anti-abuse rule, the opportunities to tax-effectively estate-plan with cash and investments remain strong. The discounted gift trust was even mentioned as being GAAR-proof in the GAAR guidance notes.
Subject to this possibility, the Isa proceeds will be added to the investor’s and/or the inheritor’s taxable estate. This fact has even led some to question the “holistic tax benefit” of the Isa for older investors for whom IHT/estate planning is an important factor. “Does the IHT inefficiency outweigh the income tax and CGT efficiency?” some may ask.
Despite the IHT inefficiency of ordinary cash and stocks and shares Isas, one would still have to think pretty carefully before deciding to disinvest or invest free funds in something else other than an Isa through which IHT planning could be carried out. For those prepared to accept an additional level of investment and liquidity risk with their Isa, IHT efficiency is now possible.
From 5 August 2013, the list of qualifying investments for stocks and shares Isas (which for this purpose includes Junior Isas) and child trust funds was expanded to include shares traded on small and medium-sized enterprises equity markets. This was achieved by including within the list of qualifying investments company shares admitted to trading on a recognised stock exchange in the European economic area.
One impact of this change is to permit shares traded on the Alternative investment market to be held in Isas. This means such shares can benefit from 100 per cent business property relief for IHT purposes, if they satisfy the relevant IHT conditions, and the usual freedom from income and capital gains tax on an Isa.
Before the change described above, shares traded on Aim were not eligible for inclusion in an Isa. In seeking to take advantage of the potential for IHT BPR it is not possible to transfer shares in specie to an Isa by way of subscription. There is a limited facility to do this but only with shares issued in connection with certain employee share schemes. So, for shares traded on the Aim, to include an existing holding in an Isa will mean that the investor would need to sell the shares and the Isa manager would need to purchase a replacement holding.
Isa Bulletin 55 points out the potential drawbacks of such an operation as follows:-
(a) The disposal of EIS shares traded on the Aim could result in the clawback of income tax relief and capital gains tax (CGT) implications if the disposal occurs within three years of acquisition.
(b) The holding will qualify for upfront EIS income tax relief and CGT reinvestment relief only if it is new shares in a qualifying company.
(c) For Aim shares to be eligible for IHT BPR they must have been owned by the transferor for at least two years before the transfer. If a sale of Aim shares is followed by the purchase of a replacement holding, the two-year ownership rule will be satisfied if the transferor owned the sold shares and the replacement shares (via the Isa) for a combined period of two years during the five-year period before the transfer for which BPR is claimed.
Some took the view that the prohibition on holding Aim shares in an Isa never made much sense anyway because there was no restriction on holding them in a self-invested personal pension. Given that an investor would probably only want a relatively small proportion of the overall portfolio in Aim shares, an investor could secure further tax advantage for their Aim shares by putting them in their registered pension scheme. Their Isa could then be used for “main market” holdings.
It is likely, though, that the investment risks associated with Aim investments may have been one reason the Government kept Aim stocks out of Isas until now.
Official determination to increase available funds for SMEs appears to have overridden this concern. If you accept the additional investment risk, Aim shares held in an Isa represent one of the most tax-advantaged of all investments. And, from next year, investors will not have to pay stamp duty on Aim stocks either.
So what is the market like for Aim/Isas? Well, there are more than 24 million Isa savers in the UK and over 5.6 million of these are age 65 or over. How attractive and popular will “Aim Isas” be?
It may be that the undoubted greater element of risk may be able to be accommodated as part of a bigger diversified portfolio for older investors for whom the IHT benefit is attractive.
Advice will be essential and it will be important that potential investors are made aware of the investment and liquidity risks and resist getting carried away with the IHT freedom to complement income tax and CGT freedom that Aim stocks in – or out of – an Isa can deliver.
Tony Wickenden is joint managing director of Technical Connection
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