InvestmentsDec 9 2013

Inheritance tax problems and solutions

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Case study 1: Elderly couple with significant invested capital

The problem:

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

• £28,000 capital gains tax saving

• £30,000 income tax relief

• Retained control over investments

Case study 2: The power of attorney

The problem:

A Power of Attorney (POA) can enable a person (the donor) to give powers to another person (the attorney) to act on their behalf. These powers can apply if the donor loses mental capacity providing the POA is registered. Attorneys can be granted many powers, but specific restrictions apply to making gifts away from the donor, which can cause difficulties when it comes to estate and IHT planning.

The solution:

While they are not allowed to make gifts away from the donor, attorneys can make investments into solutions that invest in companies that qualify for Business Property Relief (BPR). BPR is a tax relief provided by the UK government as an incentive for investing in specific types of trading companies. Investments in BPR-qualifying businesses are exempt from IHT as long as the owner has held them for at least two years at the time of death. BPR-qualifying solutions can have different approaches. Some focus on targeting growth, while others are designed to be more predictable and target capital preservation – something which might be more appropriate for an attorney looking after the affairs of an elderly person..

The case study:

James has acting Power of Attorney over his mother’s affairs, following her deteriorating health. His mother had previously consolidated her assets and converted them to cash as she was going into a care home at the age of 84.

James is concerned about the amount of inheritance tax that would be levied on his mother’s estate and has contacted a solicitor to discuss the various options available. After allowing for her (and her late husband’s) nil rate bands, his mother’s estate has an excess of £200,000 that would be liable to inheritance tax. This would result in a tax charge of £80,000.

As James is responsible for his mother’s affairs and because of the Power of Attorney that’s in place, gifts from his mother’s estate are restricted. What’s more, any gifts made over and above annual exemptions would take seven years to fall outside of his mother’s estate.

James is one of three beneficiaries and does not want to take any high risks with his mother’s capital. He also wants to ensure that his mother is not financially disadvantaged in any way.

James could invest £200,000 on behalf of his mother into a BPR-qualifying solution. As well as providing an investment return, after two years, these investments will be exempt from inheritance tax.

Because these investments can be sold, James now has the peace of mind that he can access the capital if required, should his mother need further funds, while also knowing that the investment will be IHT-free in two years’ time.

Benefits of this solution:

• £200,000 is exempt from IHT in just two years, providing it is still held in a BPR-qualifying solution at the time of death, a saving of £80,000 in inheritance tax

• Full access to capital and regular withdrawals

• Retained control over investments