BR November

09

BR: the relief that takes a licking and keeps on ticking

“Are tax reliefs good value for money?” MPs want to know

For a number of years, critics have looked askance at Business Relief (BR). The relief is relatively costly (In 2019, it was estimated to cost the Exchequer approximately £1 billion per year. This, however, was just a quarter of the cost of transfers between spouses and civil partners).

However, the Office of Tax Simplification (OTS) has used HMRC data to demonstrate that the extra tax raised by abolishing BR would not be enough to fund a significant cut in the rate of inheritance tax (IHT).

Nonetheless, concerns that the OTS might recommend the outright abolition of BR have persisted. But all indications are that the OTS’ focus is on options for reform. It acknowledges that some aspects of the BR regime are distortive, overly complex and, at times, inconsistent with other parts of the UK tax code.

The agency’s second report on simplifying IHT, published in July 2019, recognised the ‘important role’ that BR plays in ensuring that businesses can pass from one generation to another.

In light of this primordial function of the Scheme, the question has been raised as to whether it is within the policy intent of BR to extend the relief to AIM-quoted shares, in particular where they are no longer held by the family or individuals originally owning the business.

Ultimately, BR has proved irreplaceable in its role of rescuer of family businesses upon the death of the founder. Under the current rules, BR generally allows owners of family companies and other private businesses to pass on their shares to the next generation without an IHT charge.

This helps to prevent the break-up of businesses on the death of a founder, the original intention of the relief.

Particularly reluctant to blow their own trumpet, family businesses are surprisingly key contributors to the UK economy and also have a significant overlap with SMEs which are also very significant.

The Treasury Select Committee is now considering submissions to its recent inquiry into tax reliefs. Their specific aim is to find out whether the system ofreliefs as a whole achieves benefits for the UK economy that justify their cost.

In February, the Treasury’s inheritance tax revenues increased by £700m since last April – making it a record high.

The investigation will look at the many tax reliefs available to businesses as well as those available to individuals on their personal tax liabilities.

Jessica Franks, Head of Retail Investment Products, Octopus Investments

Do the tax reliefs impact employment, investment and growth in the UK? Are the reliefs being used in the way they were intended? Do they cause problems to the tax system, such as through tax evasion or avoidance?

What potential reforms could make tax reliefs more supportive of businesses and invetment? What reliefs can be added or removed? How effective is the current
administration framework and means testing?

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Most people would be surprised to know that family businesses account for more than half of all private sector jobs in the UK as well as around 44% of private sector turnover.

BR is a win/win, for both clients and the UK economy.

Dominique Butters - Blackfinch Executive Business Development Manager

In times of heightened market risk and volatility, understanding history can help to maintain perspective.

08

BR lending in a volatile market

In February, the Treasury’s inheritance tax revenues increased by £700m since last April – making it a record high.

While high inflation, rising interest rates, and now a looming recession, have impacted the loans market negatively, BR managers who are engaged in lending activities as part of the underlying BR trade of the companies that their investors buy into are able to use a variety of strategies to face up to the resulting volatility.

Jessica Franks, Head of Retail Investment Products, Octopus Investments

More than 80% of the unlisted BR offers that are currently open (30 in total) have some sort of lending trade. The remaining offers (only 5) do not have a lending strategy.

As the Bank of England forecast that the economy will begin to shrink in the last quarter of the year, and continue contracting until the end of 2023, BR managers are bolstering their defences against the gathering market storm.

As economic growth slows, credit risk is expected to increase further.

As noted in a recent release from the Association of Investment Companies (AIC), floating rate bonds and loans could be a good investment in the current inflationary environment.

This is because the income from these instruments is linked to benchmarks that move in line with central bank interest rates, which the market expects to rise over the next twelve months.
These loans may also offer a complexity or illiquidity premium, which means they can provide higher income than traditional government and corporate bonds with equivalent credit ratings. This helps further to offset the effects of inflation on returns.

There’s however a distinct difference between loans and bonds which makes the former more advantageous for investors in periods of rising interest rates. Floating-rate loans (which have a variable interest rate) offer a payment that moves in tandem with the interest rates of central banks, unlike bonds which have a fixed rate on issuance.

In an environment, where it is hard to predict when interest rate rises will stop. BR managers can offer floating loans as their trading activity, which offers the benefit of being less affected by inflation than fixed-rate loans. These variable-rate loans
are also preferrable from the BR manager’s perspective, as they tend to have higher interest rates than fixed-rate loans.

BR managers use these and other tools to hedge against inflation.

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ANNUAL GROWTH OF LENDING TO SMES AND LARGE BUSINESSES

%changes on a year earlier

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Large businesses

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Source: Bank of England

Investing to make an impact

BR deductions for liabilities

Environmental, social and governance (ESG) investing has increased in popularity due to the positive financial performance of ESG investments, the non-financial impact they have on our world, and a significant ongoing  wealth transfer to a younger and more socially conscious generation.

BR strategies often focus on loans to specific sectors like renewable energy, forestry and house builders that generate specific ESG benefits in addition to financial gains.

One investment strategy that can offer compelling returns for BR investors is secured lending to the real estate sector. Through investing in portfolio companies that provide senior, asset-backed loans to developers on a project-by-project basis, investors have achieved steady returns with low volatility in a challenging investment environment.

The real estate sector is not often considered to hold any ESG credentials, because of the perceived environmental impact of construction. However, in parts of the market, a focused investment strategy, construction reforms, and government initiatives can make for a more socially conscious investment opportunity than may present itself at first.

There is a longstanding, structural shortage of affordable housing in the UK, leaving huge pent-up demand in communities across the country. Without alternative lenders funding development projects across a diverse range of locations, this is set to worsen and could push affordability further out of the average household’s reach.

The supply deficit has been recognised by the governments for several years. In response, various policies have been enacted—for instance, Help to Buy—that has enabled many, often first-time buyers onto the property ladder at a more affordable level than would ordinarily be possible.

Combining the social impact of the contribution towards building affordable housing and the environmental impact of driving more sustainable practices within the construction industry, loan finance for real estate development projects can not only be an effective investment to grow wealth while mitigating IHT, but is an increasingly valid option for ESG-conscious investors.

Loans to Private Sector in the United Kingdom increased to 2698489 GBP Million in the fourth quarter of 2021 from 2663478 GBP Million in the third quarter of 2021.

Inheritance tax (IHT) anti-avoidance measures were announced at Budget 2013 and introduced in Finance Act 2013, affecting IHT deductions for liabilities. Following the changes, investors can no longer obtain IHT relief on loans used to buy shares that have been secured on their home or perhaps investment properties.

Before FA 2013, such arrangements would carry an IHT benefit because of the general rule that an encumbrance on a property reduces the value of that property for IHT purposes. Thus, if the investor died, the shares would attract BR and typically the chargeable value of the home would be reduced by the mortgage.

However, this potential benefit has now been countered by the FA 2013, which provides that any borrowing used to finance the purchase of BR eligible shares (and other qualifying BR assets) must be deducted against the value of those shares for BR purposes.

Consider a scenario where a property developer company takes a loan to build houses. The shares in the company are BR qualifying (property development is a qualifying trade). If a shareholder in the company dies, then BR is available on the value of the assets less the value of the outstanding loan.

This means that BR would now only be given against the ‘net value’ of the shares after deducting the debt. If the value of the shares at the time of the death of the investor exceeds the original loan amount (i.e., if the shares have increased in value), then any value in excess of the loan amount is BR-qualifying.

In other words, while the outstanding loan amount doesn’t qualify for IHT relief, the added value does qualify—making borrowing to buy BR qualifying assets still potentially profitable.

Needless to say, the company receiving the loan to purchase new equipment, expand its existing business, or pursue a new business opportunity is also expected to make a profit.

In light of the current cost of living crisis, Inheritance Tax has never been more topical.

Simon Housden - Sales and Marketing Director, TIME Investments

In times of heightened market risk and volatility, understanding history can help to maintain perspective.

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UK: LOANS TO PRIVATE SECTOR

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Source: Bank of England

Due diligence: a necessary precaution

Lending is an inherently risky business. It relies on trust in another entity to return the advanced amount in the agreed manner, at the agreed time, with the agreed interest.

With increased fraudulent activities and money laundering, assessing a borrower’s background before lending any money has become critical. The level or riskiness of the loan will determine the level of thoroughness of the due diligence.

Asset backing is obviously a good way to mitigate the risk of lending, but BR managers must be sure to verify all the assets backing their loans. Collateral due diligence, meaning all collateral appraisals, should involve field examinations, physical inventories, and searches for any other tax liabilities and liens.

Lenders need to know the purpose of the loan and the ventures they are willing to enter.

Failure of due diligence: the Arena Television “fraud” case

More than 50 high street banks and specialist lenders are left holding the bag, after relying on non-existent collateral of almost £300 million to give out ‘secured’ loans to Arena Television, administrators have revealed.

It appears that no more than nine of the 55 lenders to the broadcasting company bothered to thoroughly verify the assets supposedly backing their loans, according to an official filing by insolvency practitioners at Kroll.

The lenders issued more than £90 million loans to the group on the basis of assets pledged as collateral, but the group “does not hold the vast majority of assets”, according to a filing.

Now facing a shortfall of several thousand assets, forty-six lenders, owed a combined £182 million, “do not have recourse to any assets” underlying their lending, administrators said.

07

Business Relief stands strong amid the political storm

It’s been a turbulent few weeks in UK politics, during which multiple changes in prime minister and chancellor left little clarity on the policy direction of the UK’s leadership. It has lurched from growth to warnings of huge cuts and tax hikes, with yet another budget event - the Medium Term Fiscal Plan - due to take place shortly from the time of publication.

In the midst of all this, there has been no specific mention of Business Relief. In Mr Kwarteng’s initial Mini-Budget 2022 on 23 September. His Growth Plan, looking for turbo-charged economic growth, did make reference to changes to three other well-established tax-advantaged government schemes - the Seed Enterprise Investment Scheme, Enterprise Investment Scheme and Venture Capital Trusts. All of these are intended to encourage investment into UK start-ups and young SMEs as a way to fund home-grown businesses.

BR can play an influential part in this agenda and has proved a particularly useful mechanism for developing renewable energy solutions with the incentive of IHT tax relief. But its originally envisaged purpose of providing protection to family businesses endangered by large IHT bills on the death of founders remains hugely important, given that they account for more than half of all private sector jobs as well as around 44% of private sector turnover.

This summer, Institute of Family Business Chief Executive Neil Davy described the ongoing relevance of this sector, saying, “You genuinely put people first; you take risks and innovate, but you also take a long-term view.” He went on, “Family-owned companies should be recognised as an example of responsible, sustainable business – and now, more than ever, there is the opportunity and need for the voice and the model of family businesses to take centre stage.”

The move of the Rishi Sunak government towards consolidation and more traditional economic policies perhaps signals an environment in which a scheme such as BR is valued even more greatly; it combines protection of an important sector of UK companies with support for non-family business companies through both private investment and the AIM market. That support can both drive growth and bolster more established firms in the UK.

When it comes to BR, any changes that impact companies are of interest. Any help or hindrance to them may well be reflected

in the levels of success or failure of BR investee companies. Among those that still appear to be on the cards are help with energy costs, a currently soaring expense to many firms and the cut to National Insurance. The latter will also make it cheaper for businesses to employ more staff being worth an average of £9,600 for over 900,000 businesses, according to the Treasury.

In fact, Boris Johnson’s National Insurance tax hike of 1.25% introduced to help fund the NHS and social care has already been scrapped (effective 6 November 2022.) The reversal of the Health and Social Care Levy leaves potential changes to the current care system in doubt. According to the government, the NIC raise, along with increased dividend tax was expected to raise approximately £13 billion a year to fund health and social care.

With no details on alternative funding and what this will mean for changes to the care system, such as capping the care costs of individuals, the value of BR as an estate planning method that allows investors to retain access to their funds continues to be attractive. With no certainty about what financial assets individuals may need to have in place to pay for their later life health needs, BR remains a useful option to the right clients.

Another measure that has survived the multiple Autumn budget events of 2022 is the cut in stamp duty. From 23 September 2022, the threshold above which Stamp Duty Land Tax (SDLT) must be paid on the purchase of residential properties in England and Northern Ireland increased from £125,000 to £250,000.

Property is the most valuable asset in most people’s estates and the value assigned to it can have a great impact on their net worth calculation. At the same time, average UK house prices hit a record £296,000 in August 2022, £36,000 higher than the same month a year earlier, according to figures from the Office for National Statistics (ONS).The ONS said house prices grew by 13.6% over the year to August, down from a peak of 16% a month earlier and UK home sellers boosted the prices they’re asking for their properties at the strongest pace in four months, the property listing website Rightmove said in September.

On the other side of the coin, there is growing evidence that rapidly rising mortgage rates, driven by Bank of England base rate increases aimed at dampening inflation, could put the brakes on the property market. Nevertheless, question marks remain over how high mortgage lenders interest rates will climb and an ongoing shortage of stock has historically helped to keep asking prices up.

Houses being the largest assets in most estates, their soaring prices have fuelled inheritance tax in recent years, underscoring the importance of BR as a powerful inheritance tax (IHT) relief. What’s more, the nil rate band, below which no inheritance tax is paid, has been £325,000 since 2009, and isn’t due to be reviewed until 2026 at the earliest.

At the time of publication, predictions for the Medium Term Fiscal Plan, due to take place on 17 November, included the extension of the frozen nil rate bands generating a stealth rise in IHT receipts and all sorts of other possibilities for tax rises. Mr Sunak and Mr Hunt were full of warnings about the necessity of filling the treasury’s big, black, fiscal hole. In that context, it seems only sensible that advisers are fully cognisant of all the legitimate tax planning tools at their disposal, with Business Relief ticking many boxes for the right clients.

"Family-owned companies should be recognised as an example of responsible, sustainable business"