BR Q1 2021

WHAT'S ON THE HORIZON / UPCOMING IHT CHANGES

31

UPCOMING IHT CHANGES?

S E C O N D R E P O R T R E C O M M E N D A T I O N S

Although BR was originally designed as a way to prevent family businesses needing to be broken up or sold off in order to pay IHT, it has since also developed into a key channel in funneling funds into unlisted businesses and the AIM market.

The OTS acknowledged that BR plays an important role in promoting AIM as one of the world's premier growth markets.

The changes it suggested are quite technical in nature. For example, in relation to what proportion of trading versus investment activity a BR qualifying company should have. In order to remove inconsistencies across the tax landscape, the second report recommends changing the proportion of qualifying trades a company undertakes before BR qualfication (and IHT relief) is available to match the proportion required for Gift Holdover relief and Business Asset Disposal Relief (both providing CGT relief). More than 50% of a company’s trading activity must currently be in BR-qualifying trades, with investment activities included among those that are non-qualifying. But CGT relief by way of gift holdover relief or Business Asset Disposal Relief, requires an 80:20 split of trading vs investment.

This could see the government lifting the qualifying trading requirement for BR up to 80% to bring the reliefs in line. This would result in a number of companies that currently qualify for BR becoming potentially excluded, limiting their access to investor capital, but also reducing the number of options for BR investors.

The OTS also suggested reviewing the treatment of indirect non-controlling holdings in trading companies which is different for BR purposes than it is for income tax and CGT. If the BR treatment were aligned with income tax and CGT, it would broaden the opportunity for limited liability companies (LLPs), for example, to qualify for BR.

Another recommendation was that the government should consider whether to align IHT treatment of furnished holiday lets with that of income tax and CGT, where they are treated as trading providing that certain conditions are met.

If the latter of these moves was to allow furnished holiday lets to qualify for BR without the current legal grey areas, this would be extremely positive. Holiday lets can provide relatively safe, seasonal returns over the long term, making them potentially attractive to BR investors. In addition, multiple other land-based activities and their Business Relief qualification could benefit.

If any of these changes were to be made, current BR rules allow BR investors and managers to sell assets that would no longer qualify, and buy into companies that did, without the need to reset the BR two year minimum holding qualification clock, providing the reinvestment was made within three years of the disposal.

W

           ith IHT firmly back on the government’s agenda following Tax Day, it’s worth considering what other changes the government might look to introduce in the near future.

In their Tax Day response to the Office For Tax Simplification’s (OTS) 2018 review first report, the government  already mentioned they were considering the OTS recommendation to introduce an entirely digital journey to probate.

In his response,  MP Jesse Norman also stated the government plans to respond to the OTS’s second IHT Report from July 2019 ‘in due course’.

Whereas the first report focussed on easing the administrative costs and complexities around settling estates, the second report focussed on three areas: the interactions of IHT with capital gains tax (CGT), Agricultural relief (AR) and BR, and lifetime gifts.

WITH THE UK GOVERNMENT LIKELY TO SEEK TO MAXIMISE TAX REVENUE IN THE COMING YEARS TO FUND THE COST OF COVID-19, OPTIMISING THE EFFICIENCY OF PERSONAL TAX AFFAIRS WILL BECOME AN EVER MORE PRESSING MATTER. INHERITANCE TAX IS JUST ONE SUCH TAX WHERE ADVISERS CAN SEEK TO REDUCE THEIR CLIENTS’ POTENTIAL TAX LIABILITY UPON DEATH VIA AN INVESTMENT IN A BR RELATED INHERITANCE TAX SERVICE – MANY OF WHICH HAVE NOW DEVELOPED INTO TRIED AND TESTED SOLUTIONS WITH ATTRACTIVE PERFORMANCE RECORDS.

- CEO RICHARD MANLEY, SENECA PARTNERS

REFRESHER:CURRENT GIFTING RULES

OTS IHT 2ND REPORT - CGT

G I F T S

I N T E R A C T I O N W I T H C A P I T A L G A I N S T A X

In contrast to BR and AR, the OTS made some more dramatic recommendations for gifting. The OTS found that for many people the current raft of gifting exemptions is too complex, while the 7 year wait until gifts become IHT free is too long.

Executors said it can be difficult to obtain records going back up to 7 years, and the OTS noted that older gifts did not generate very much tax - just £1 million IHT in 2015-16 was paid from gifts made 6-7 years prior. This was out of a total £4.38 billion IHT paid that year.

The taper added another layer of complexity on top of this, and the OTS found many did not fully understand it.

It added that some of the exemptions had not kept pace with inflation. For example, if the £3,000 annual exemption had kept pace with inflation since it’s introduction, it would now be worth approximately £11,900. As a result, these exemptions allow for estates to pass on relatively small amounts of money, with a trade off being increased confusion and difficulty understanding what will and will not incur IHT.

The OTS made the following recommendations, among others:

Currently, a client is able to gift up to £3,000 each year tax free. Anything above that will incur IHT if the estate is large enough, and the client dies within seven years of making the gift. If the client dies sooner and there is IHT to pay on this gift, a taper applies after 3 years. So between 3 and 4 years after the gift, a 32% IHT tax rate applies, then 24%, 16%, 8% and then, after 7 years, 0%.

There are a number of exemptions to this - for example for wedding gifts up to a certain size, gifts to charities or political parties or gifts under £250 do not incur IHT. For more information on gifting, see our Estate Planning Guide

Although IHT and CGT typically target different areas, the fact CGT is erased at death means inheritors can benefit from what is known as the ‘capital gains uplift.’ This can cause confusion, and create situations where assets are transferred in death rather than life, simply to benefit from the CGT uplift.

For example, Mo buys £100,000 worth of BR-qualifying shares. 10 years later, those shares are worth £150,000. If Mo sold those shares, it would crystalise the £50,000 gain and a CGT liability would be due on that gain. However, if Mo retained the shares and passed them on death, the beneficiary would pay no CGT or IHT on the £150,000 as the uplift in the value of the legacy is not liable to CGT when inherited. So, when the inheritor disposes of the shares, only amounts above the value of the shares when he interited them (£150,000) are assessed for CGT. However, if these shares had been handed over in life, CGT would have applied to the £50,000 gain.

The OTS questioned if it was fair in these circumstances for the benefactors to in effect pay 0% tax on these assets.

Therefore, the OTS suggests where an exemption from IHT applies, the CGT uplift be removed, and instead provide that the recipient is treated as acquiring the assets at the historic base cost - often known as a ‘no gain, no loss’ transfer (In our example above where the shares are passed on on death this would have been the £100,000 at which the shares were originally bought, rather than the £150,000 value at which they were inherited by the beneficiary). CGT would then be payable when the assets are disposed of by the inheritor.

Since the IHT report, the OTS has doubled down on the ‘no gain, no loss’ concept, and in November 2020 released a set of recommendations surrounding CGT. While the CGT review again called for the introduction of ‘no gain, no loss’ to cases where a relief or exemption from IHT applies, it added additional recommendations:

1) Reduce the 7 year period required until gifts become IHT free to 5 years, but abolish the taper
2) The government should, as a package:
- Replace the annual gift exemption and the exemption for gifts in consideration of marriage or civil partnership with an overall personal gifts allowance
- Consider the level of this allowance and reconsider the level of the small gifts exemption
- Reform the exemption for normal expenditure out of income or replace it with a higher personal gift allowance

Given the fact that since this report came out the government has frozen the Nil rate band (as well as numerous other tax thresholds), it seems unlikely the government will look to dramatically increase the amount that can be passed onto the next generation tax free via gifting, however the idea of a simplified gifting structure may find more success.

1) The government should consider removing the capital gains uplift on death more widely, and instead provide that the person inheriting the asset is treated as acquiring the assets at the historic base cost of the person who has died.

2) If the government does remove the capital gains uplift on death more widely, it should consider a rebasing of all assets, perhaps to the year 2000

Certainly, the idea of the government suddenly acquiring new taxable items could be appealing for a chancellor looking to raise new revenue, but the benefits within the current drive to simplify and clarify taxes in an effort to aid correct reporting and payment and to close the tax gap, may be questionable. Then there is a risk that the very family businesses BR was set up to protect, will simply fall victim to large CGT rather than IHT bills, particularly if the deceased was a major shareholder for a long period, even if a rebasing of assets took place.

Another factor to consider is that estate planners may be left to choose between IHT and CGT mitigation, taking into account the estate value and asset types. Where the decision is to leave an IHT liability rather than a CGT bill for beneficiaries, SMEs and AIM companies could find themselves missing out on BR investment - a particularly unwelcome result right now.

30

6. What's on the Horizon?

UPCOMING IHT CHANGES?MOVING ON FROM COVID-19: WHAT'S NEXTWHAT THE MANAGERS SAY

MANAGERS IN FOCUS / BR COMPARISON TABLE

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MANAGER NAME

DESCRIPTION OF OFFER

PROVIDER YEAR FOUNDED

PROVIDER ASSETS UNDER MANAGEMENT

PRODUCT ASSETS UNDER MANAGEMENT

SECTOR

LAUNCH DATE
(OF SERVICE)

NUMBER OF INVESTEE COMPANIES

ANNUAL RETURN SINCE INCEPTION

TARGET ANNUAL RETURN AND/OR TARGET YIELD (WHERE STATED)

MINIMUM INVESTMENT

INCOME AVAILABLE?

NUMBER OF DIRECTORS

LEGAL STRUCTURE

INITIAL FEE

AMC

PERFORMANCE FEE

PERFORMANCE HURDLE

TARGET LIQUIDITY

Beringea LLP

The ProVen Estate Planning Service is a Discretionary Management Service that aims to achieve capital growth of 4-5% over the medium term, providing full IHT relief to investors  focusing on two distinct sectors:

1. Lending businesses via Proven Legacy PLC
(SME Lending) and Secured Lending Limited (Energy/Infrastructure and Property lending)

2. Solar Energy generation businesses via Solar Growth Limited (mostly Large-Scale Ground Mounted) and Solar Income and Growth Limited (mostly Roof top Solar)

Investors have the flexibility to select if they want 100% lending, 100% solar or a mixture of both within their application. There is a clear and straight forward investment strategy into established trading sectors with predictable revenue streams; this includes a level of government backed income streams. The UK Solar trading companies focus purely on well-established solar technologies rather than pursuing less established renewable energy trades; being UK based, there is no volatility foreign assets.

1988

US$740m

£90m

Lending and Solar

ProVen Legacy established in 2016
Secured Lending 2014
Solar Growth  2013
Solar Income & Growth  2013

4 (SPVs of 25)

Please see updated fact sheets.  All companies are performing well.  In particular, Solar Income & Growth has a 5 year actual return per £100 invested 1st January 2016 and exited 31st December 2020 of £121.00

4-5%

£25,000

Yes

3/4 per trading co

Discretionary Management Service

2%

1.50%

No performance fees

NA

Monthly

Blackfinch Investments Ltd

The Adapt IHT Portfolios are our flagship Inheritance Tax (IHT) solution and are well established. It offers return potential and competitive charges alongside a route to IHT relief. Our four model portfolios cater to the need for diverse, ESG focused IHT offerings. Blackfinch only takes its annual management fee of 0.5% plus VAT after achieving a minimum target return of 3% p.a., 4% p.a., 4.5% or 5%+ p.a., depending on which of the four model portfolios an investor has selected.

1992

£540m

£201m

Asset-backed lending, property development finance and renewable energy generation

Dec-13

3 underlying companies

Refer to factsheet for latest annual performance. Since Inception*:
Ethical - 3.06%
Balanced - 4.02%
Balanced Growth - 4.48%
Growth - 4.92%
*Historic performance has been calculated based on the performance of the underlying companies.

Ethical 3%
Balanced 4%
Balanced Growth 4.5%
Growth 5%+
All targets are net of fees"

£25,000

We do not have an income portfolio but withdrawals are available

We have two directors and three independent directors involved in this product: an Independent director for each of the three investee companies"

Discretionary Portfolio Service

2%

0.5% + VAT deferred until exit and only if target return has been achieved

No performance fees

N/A

2-4 weeks

Downing LLP

The Downing Estate Planning Service (DEPS) looks to provides full IHT relief to investors after two years by investing in IHT-qualifying businesses in two sectors: asset-backed and energy & infrastructure. The target return to investors is 3%-4.5% p.a. over the medium term.
The Service offers standard Downside Protection which will cover for any loss in value of up to 20% of net initial investment on death (only if under 90 years of age). This comes at no extra cost to investors.
The Service also offers optional life cover, which is dependent on meeting medical conditions.

1986

£1.4bn

Over £535m

The two different investment strategies are:
- Energy and infrastructure: focusing on renewable energy generation businesses, as well as energy infrastructure assets.
- Asset-backed: Revenue generating businesses with tangible assets. Examples may include care homes, secured lending and property development.

Feb-13

77

3.09% p.a. if an investor had a 50:50 split across the two strategies (net of fees)

3%-4.5%p.a. (net of fees)

£25,000

Yes, investors can opt to sell their shares to receive regular distributions on a monthly, quarterly, half-yearly or annual basis.

4 on Bagnall (3 are independent), 3 on Pulford (2 are independent)

The Service is a discretionary managed portfolio of trading companies. Each investor will become a direct shareholder in the underlying company(s). The Service is not an unregulated collective investment scheme

2%

Up to 0.5% +VAT p.a. of net assets. Subject to a minimum investor return of 3%. If investor returns are between 3% and 4% p.a., the charge will apply on a sliding scale – up to a maximum of 0.5% p.a

No performance fee

N/A

The Service will provide exit opportunities on a twice-monthly basis, subject to 10 days’ notice, liquidity and Downing’s discretion.