Investments  

IHT comes under the HMRC cosh

Recent sharp house price rises and an equally buoyant equity market mean that an increasing number of people could find their estate becoming unexpectedly liable for inheritance tax.

The most recent figures from HMRC show that the level of tax taken in the form of inheritance tax is at its highest level since before the recession. And the sum, at £3.4bn, is more than 15 per cent higher than two years previously.

As it released the figures, HMRC said the sum had been affected by government freezing of the band at which people start to pay tax: £325,000. So with house prices rising more than 10 per cent in the past year alone, it is easy to see that HMRC looks set to get even more of a windfall.

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Crackdown

Aware that inheritance tax is something of a cash cow, HMRC has recently said that it is planning a crackdown on inheritance tax avoidance schemes. One of its arguments is that there is a risk that IHT attracts those who wish to abuse the tax system by engaging in tax avoidance activity; IHT is subject to relatively few disclosure rules. HMRC is consulting on a new regime that will mean a lot more tax schemes will have to be disclosed to HMRC before they can be deployed. The new rules look set to catch tax schemes entered into during a person’s lifetime and designed to reduce their estate’s value. However, HMRC guidance is very clear: it does not want to inadvertently affect reliefs and exemptions that “are used legitimately in many arrangements by most people”.

A way of legitimately shielding money from IHT rules is to invest through the Enterprise Investment Scheme, a tax-efficient plan aimed at encouraging investment in small UK firms. EISes were introduced in the 1990s to provide small unlisted UK firms with access to a new form of financing.

In exchange for providing support for these firms, investors get very good tax incentives, and one of the key ones is that investments are, under current legislation, free of IHT if held for more than two years. The idea behind the EIS was to promote growth and employment, which will raise the overall tax raised by the UK economy in the long term.

For investors, the short two-year qualifying period for IHT exemption provides an immediate and significant advantage over gifting and trust-based estate planning options. EIS investments receive 30 per cent income tax relief, which means the government is effectively funding almost one-third of an individual’s entire investment.

The maximum an individual can invest in an EIS and claim income tax relief is £1m for each tax year, creating a potential annual income tax reduction of up to £300,000. This is provided a person has an income tax liability equal to or greater than that sum. Clearly, some investors commit less than a £1m, but the saving is nonetheless very high.