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Tony Wickenden: Offsetting IHT using Isa investments

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It’s a “given” that, for most individuals saving outside of a registered pension arrangement, the Isa is a “tax no brainer”.

Income tax and capital gains tax freedom, with access to a wide range of investments, make it so. But “no brainer” status is not the phrase you would use to describe its IHT effectiveness.

Its non-assignability status makes it impossible to give – outright or into trust.

Of course, and some older investors may consider this, it could be wholly or partially encashed and IHT planning (with retained investor access and control through the use of an appropriate trust structure) could be carried out.

This year, though, there’s another way to achieve IHT free status with Isa investments – through investment of the Isa funds into AIM securities qualifying for IHT business property relief.

From 5 August 2013, the list of qualifying investments for stocks and shares Isas (which for this purpose includes Jisas) 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 BPR for IHT purposes, if they satisfy the relevant IHT conditions, as well as the usual freedom from income tax and capital gains tax afforded to an Isa.

Before the change described above, shares traded on the 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, issued by HMRC, 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 CGT implications if the disposal occurs within three years of acquisition.

(b) The new holding will qualify for upfront EIS income tax 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 IHT BPR is claimed.

Bulletin 55 also makes reference to VCT shares, although they cannot be traded on the AIM because to qualify as a VCT the shares must be quoted on the full listed stockmarket. It is pointed out that the disposal of VCT shares for replacement in an Isa could result in the clawback of income tax relief if the disposal occurs within five years of acquisition. In addition, Bulletin 55 carries the reminder that the replacement holding will qualify only for dividend relief and CGT exemptions under the VCT rules but not income tax relief on the investment – see next paragraph.

If an Isa manager invests in new shares in a VCT, income tax relief on the amount invested will not be available. This is because the VCT legislation stipulates that VCT income tax relief is available if a VCT issues eligible shares to an individual and the individual subscribes for the shares on his own behalf. This wording would rule out the prospect of a nominee being involved, both because of the requirement that the individual subscribes on his own behalf, and because the VCT has to issue the shares to the individual. Because the ISA manager actually subscribes for the shares and has them issued to him rather than to the investor, the individual won’t therefore qualify for the 30 per cent upfront income tax relief. 

It is difficult to see the merit of holding VCT shares in an ISA because such shares are free of income tax and CGT outside an ISA except to the extent they were not acquired within the permitted maximum for the income tax relief for a particular tax year. The maximum is £200,000 for 2013/14. In addition, because VCT shares must be quoted, shares in a VCT only qualify for 50 per cent BPR and, then, only if the holding is a ‘controlling shareholding’. A controlling shareholding is basically one which enables a shareholder to control the majority of the voting powers which generally means holding over 50% of the shares.

With an EIS, the ISA benefit would be to shelter dividends from income tax and provide exemption from CGT from day one. In addition, an investment in new shares could qualify for income tax relief.

The two-year ownership rule (where replacement shares are involved) is a beneficial rule but a disposal could lead to the loss of IHT BPR if, for example, it occurs within, say, one-and-a-half years of ownership and the replacement shares are not bought for a further four years. Also, if a disposal takes place within two years of acquisition with no reacquisition of property also qualifying for IHT BPR then BPR would be lost.

Tony Wickenden is joint managing director of Technical Connection

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