Inheritance tax problems and solutions

This article is part of
Inheritance Tax Solutions - December 2013

Investment Adviser asks Octopus’s Mark Williams, business line Manager for IHT and John Thorpe, business line manager for EIS to solve some inheritance tax dilemnas.

Case study 1: Elderly couple with significant invested capital

The problem:

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When the time comes to plan for inheritance tax (IHT), one of the biggest challenges is often that an investment such as a share portfolio or a second home may have grown in value over the years. The owner is then faced with a dilemma. If the value of the second home or portfolio sits outside the nil-rate tax band, then it will be subject to 40 per cent inheritance tax when the owner dies. However, they would also have to pay capital gains tax (CGT) if they decide to sell or gift the investment.

The solution:

Using an Enterprise Investment Scheme (EIS), investors can address a number of tax liabilities through just one investment product, providing the underlying investments made by the EIS are held for at least three years. Smart investors can use an EIS to defer a capital gains tax bill, while also taking advantage of the inheritance tax exemption available through Business Property Relief (BPR). BPR is available either through an EIS or other investment solutions.

The case study:

Andrew and Sarah Morrison are 78 and 76 respectively. Their home is worth £625,000. They hold £25,000 in cash savings. They also have £250,000 worth of shares, £100,000 of which is capital gain made since investment. This means that the total value of their joint estate is £900,000. When they pass away HRMC could claim 40 per cent of the £250,000 remaining above the nil-rate band, which sits at £650,000 for a couple.

Andrew and Sarah could sell their shares, and invest the £100,000 capital gain in an EIS. This defers the CGT liability of £28,000. It is then exempt from IHT after two years, providing it is still held at the time of death, saving £40,000 for their beneficiaries. Furthermore, the deferred CGT would be eliminated on death and Andrew and Sarah could also benefit from reducing any income tax they pay since investments in EIS benefit from 30 per cent income tax relief.

They could also invest the remaining £150,000 proceeds from the share sale into an EIS and have the flexibility to invest into any BPR qualifying investment. On death, an interest in a BPR-qualifying business (for example, unquoted shares in qualifying trading companies) is exempt from IHT as long as the owner has held it for at least two years out of the past five.

One of the main advantages of an EIS or a BPR-qualifying investment, in contrast with making a gift, for example, is that investors still have access to their money should they wish to withdraw it. No one knows what the future might hold, and increasingly, investors are keen to have the flexibility to access their capital should circumstances change.

Benefits of this solution:

• The entire estate is exempt from IHT in just two years, saving £100,000