Readers will recognise that IHT liabilities are increasingly prevalent in the UK, but the conventional estate planning strategy of gifting money can be problematic. What other options are out there for advisers
There is a growing market of investments that qualify for business relief (BR). Formerly known as business property relief, BR was introduced in 1976 to enable owners of small and medium-sized enterprises to pass them on intact to their beneficiaries. However, over the past decade, many fund managers who invest in small and unquoted companies have developed services that utilise BR, providing their clients with 100 per cent IHT mitigation after two years.
Aim investments
These services fall broadly into three categories: those investing in the Alternative Investment Market (Aim); those that invest in unquoted trading companies; and those that fund infrastructure projects.
Aim IHT portfolios have several benefits. First and foremost, Aim shares have been investable in Isas since 2013. This means that it is possible to have IHT relief within an Isa wrapper. For clients who have built up extensive Isa portfolios and who are now starting to think about estate planning, transferring some of those Isa holdings to BR-qualifying shares could make sense.
Other benefits of Aim IHT portfolios are increased levels of transparency and liquidity and lower (or no) performance fees compared to other IHT services. They have greater levels of diversification, too.
On the downside, returns are more volatile than those of their unquoted counterparts, and they usually have higher AMCs (typically between 1 per cent and 2.5 per cent).
According to the online research and due-diligence provider MICAP, at the time of writing, there are 19 Aim IHT portfolios in the market, with a range of mandates including growth, income and capital preservation.
Unquoted trading companies
IHT services investing in unquoted trading companies target returns ranging from 2 per cent to 5 per cent a year. They are often engaged in lending or leasing activities and therefore have secure and predictable revenue streams from long-term contracts with clients such as central government, local authorities and large utilities. The trade-off is that these services are less diversified than Aim portfolios. Typically, they have lower charges, but they are more likely to take a performance fee on exit.
There were 14 open offers in this category, at the time of writing, and these services all target capital preservation, although some of them also target growth as part of their investment mandate.
Infrastructure investing
Finally, project-based IHT services focus on infrastructure investments – often renewable energy installations. These tend to have predictable returns from long-term contracts, and the investment providers usually put the money in only at a late stage, which minimises any development risk. The installation itself is also a tangible asset that provides additional security for the investment capital, although once more the trade-off is lower levels of diversification.
Project-based services have the highest levels of targeted return in the sector, with annual returns ranging from 3 per cent to 7 per cent. Their fees are comparable to those of the other services, but investors in this segment are more likely to face an annual performance fee. There are 10 such offers open to investment at the moment, with a range of investment mandates.
Although the non‑Aim services have more predictable returns, the lower levels of diversification mean that if HMRC found that the investment did not qualify for BR (the relief is only granted upon application), the entire investment could be affected by the decision, as opposed to one stock in an Aim portfolio.
If investors are choosing the BR route to retain access to their funds, liquidity is important. Aim portfolios promise more liquidity, but this will be subject to market conditions. Trading companies and project-based services promise a range of liquidity, from fewer than 30 days to redeem an investment to more than 60.
Minimum subscriptions range from £10,000 to £250,000; most services are around £45,000. As a rule, Aim portfolios have the lowest minimum subscriptions, while project-based services have the highest.
Charges and timescales
Advisers should look out for other charges, such as dealing fees, administration charges and the use of gearing to boost returns, which is not always made clear in the marketing literature.
Finally, advisers must be wary of how long managers take to deploy clients’ funds. The two-year qualifying period for BR does not start when the funds are transferred to the manager – it starts only once they are invested. This can be an issue if a BR strategy has been chosen because the client is in poor health and the short timeframe to qualify for the relief is the attraction. Aim portfolios and services investing in unquoted companies usually deploy funds in one to four weeks, but some project-based services take much longer.
Anyone with an estate that exceeds the nil-rate band who wants to retain access to their wealth and still see some growth could find a solution in BR-qualifying investments.
There are some other instances where BR might be the best option. When a lasting power of attorney is in place, gifting money is difficult. However, an attorney can implement a BR strategy as an investment.
It is also worth considering BR in the context of the taper threshold for the new residence nil-rate band (RNRB). The RNRB will be tapered away by £1 for every £2 the net value of the estate is above a threshold of £2m.
For example, if the estate comprises a residence worth £1.7m and £650,000 of other assets, there will be no benefit from the RNRB. However, if £350,000 of those other assets were invested in a BR-qualifying investment and then gifted to the beneficiaries after two years, the entire RNRB would come back in again. As a gift, the BR-qualifying investment would be outside the estate for IHT purposes, even if it was a failed potentially exempt transfer because the client did not survive for seven years.
HMRC collected a record £4.6bn in inheritance tax in the more recent tax year, and this is expected to increase to £5.6bn in five years’ time, so there has never been a greater need for estate planning. Advisers should be considering all available options, including BR-qualifying investments.
Daniel Kiernan is the research director at Intelligent Partnership
Key points
• Investments that qualify for business relief (BR) can be used to mitigate IHT.
• Project-based IHT services focus on infrastructure investments.
• It is also worth considering BR in the context of the taper threshold for the new residence nil‑rate band.
