It is the wealthy saver’s idea of nirvana – an investment that can make you
money but escapes the taxman’s clutches when you die.
With soaring house prices pushing many more people’s total wealth above the
£300,000 threshold where inheritance tax (IHT) starts to bite, the hunt is
on for assets that fall outside its wide ranging scope.
There are two types of investment that could fit the bill, but both are
complicated and high risk. The first consists of shares in certain companies
quoted on the Alternative Investment Market (AIM). If held for more than two
years these shares qualify for business property relief, which means that if
you hold them when you die they will be excluded from your estate for IHT
purposes. There is an added bonus that if you sell your shares before you
die they will benefit from accelerated taper relief on any capital gains tax
(CGT) due, reducing the effective tax rate from a potential 40 per cent to
10 per cent.
The shares must be held directly, not as part of a shared pool of investments,
which means that investors either have to build up their own portfolio of
shares or pay a manager to do the job for them.
One of the dangers of selecting a portfolio of AIM stocks is that they are
riskier than mainstream stocks and the spread betweeen the buying and
selling price is usually much bigger than for blue chips. Performance has
been patchy, too. The FTSE AIM index has lurched from a high of 1,274 points
in May last year to 977 last October before rising to 1,236 in July and
plunging again to 1,064 last month. Another drawback is charges, which tend
to be fairly steep. For example, the Close Inheritance Tax Service makes an
initial charge of 6 per cent plus VAT, with a further annual charge of 1.75
per cent.
Another way to avoid IHT is to make use of the Enterprise Investment Scheme
(EIS), through which you invest in a small company and enjoy generous tax
breaks in return. As with qualifying AIM shares, the EIS investment will not
be liable for IHT on your death if you have held it for at least two years.
There is no CGT to pay either if you stick to the EIS annual limit. In
addition, you can obtain upfront tax relief of 20 per cent if you hold the
investment for at least three years.
However, there are potential pitfalls. David Knight, of BDO Stoy Hayward, the
accountant, says: “In many cases there is not much information about EIS
companies, so you are relying on the promoters of the company. All
companies, especially small ones, can suffer problems and there are few
safety nets, so you could lose all your money.”
Many EIS promoters do their best to minimise the inherent risks by opting to
back entrepreneurs with a good track record and who are operating in a tried
and trusted sector, such as pubs.
As with AIM portfolios, charges can be steep. Noble & Co, an EIS promoter,
is preparing to launch a fund – the Noble Pub Company – that will invest in
several EIS pub companies and enjoy the full range of tax breaks. In
addition to Noble’s 5 per cent initial charge and 1 per cent annual charge,
the pub operators will be entitled to a performance fee of 25 per cent of
any profits. If the share price of any of the pub companies rises by more
than 15 per cent between launch and a stock market flotation the operators
will receive 20 per cent of any surplus.
Investors now also face additional constraints imposed by the Government.
Before April last year they could invest in schemes raising up to £15
million. Now an EIS company cannot raise more than £2 million in any
12-month period and cannot have more than 50 full-time equivalent employees
when it raises the money.
On the plus side if the investment goes wrong, you can set 80 per cent of any
loss against your tax bill.
CASE STUDY BUILDING A TAX-FREE NEST EGG
Glyn Simpson is a firm believer in taking advantage of any available tax
breaks. Mr Simpson, 57, who lives with his wife, Patricia, in York and is a
training consultant for West Yorkshire Police, says : “The Government is not
exactly generous with its tax concessions so I think people should grasp
whatever is on offer.”
Mr Simpson is keen to build a nest egg through his Isa allowance. He says: “I
am putting in as much as I can each year to a stocks and shares Isa because
it offers the prospect of better long-term returns than a deposit account,
and any profit rolls up free of capital gains tax. As a higher-rate taxpayer
I also suffer less tax on dividend income. I have about £8,000 in the M&G
Recovery fund, half through an Isa and half in an old-style personal equity
plan (Pep). I have also put £1,500 into the M&G Property fund.”
Ten ways for families to cut their tax liabilities
1 In households where one spouse is in a higher tax bracket than the other the
higher earner should pass assets, such as savings, to the lower earner to
minimise the amount of tax payable on the interest.
2 Make substantial pension contributions. You will enjoy the twin benefit of
knowing that you are saving for your old age as well as obtaining tax relief
at your highest marginal rate on the money invested.
3 Use the umbrella of an individual savings account (Isa) to shelter a large
chunk of your savings and investments from tax. Those saving in a cash Isa
will not be taxed on any interest earned, while those putting money in a
stocks and shares Isa will suffer no capital gains tax (CGT) on any profits.
Higher-rate taxpayers will also pay a reduced rate of income tax on their
equity dividends.
4 Families with children and household income up to £50,000 should claim the
full basic family element of the child tax credit, worth £545 this financial
year.
5 Chas Roy-Chowdhury, of the Association of Chartered Certified Accountants,
says that employees should take advantage of the save-as-you-earn share
schemes that many companies offer. He says: “This allows you to build a
tax-free lump sum through regular saving over three, five or seven years,
with the option of investing in the company’s shares at a discount to the
share price prevailing when the savings contract was started.”
6 If you own assets that have built up substantial capital gains, make sure
that you take advantage of your annual CGT allowance, currently £9,200. Also
consider splitting ownership of any assets between spouses, thus enabling
you to enjoy gains of up to £18,400 a year without paying CGT.
7 Make use of the various gift exemptions available for those wishing to
reduce their potential inheritance tax (IHT) bill. You are permitted to give
away, free of IHT, a total of £3,000 a year to one or more individuals as
well as any number of gifts of up to £250 to different people. Parents can
also give their children £5,000 as a wedding gift and £2,500 to their
grandchildren.
8 For more substantial sums there is the possibility of making a potentially
exempt transfer of any amount to another person. There will be no IHT to pay
on these transfers, provided that the donor survives for seven years after
making the gift.
9 Look at your spending habits. John Whiting, of PricewaterhouseCoopers, the
accountant, says: “Cigarettes and alcohol carry heavy amounts of excise duty
and VAT, so going without fags and booze you will actually reduce your
overall tax bill.”
10 If you are moving house, pay careful attention to the stamp duty band in
which your new house falls. Buying a property for £250,000 rather than
£251,000 would save you more than £5,000 in stamp duty.
Have you nothing original to say on the subject of IHT? None of the schemes you mention should be touched with a bargepole.
It is perfectly straightforward for any UK taxpayer to arrange their affairs to avoid any IHT liability whatsoever, this can be achieved whilst living thus providing certainty of outcome and incurs no cost to the taxpayer. It also works equally well where the main, or indeed sole, asset is the family home in which the parent wishes to continue residing.
If you care to forward any generic cases, which you consider to be either representative of your readers circumstances, or particuarly difficult to mitigate the IHT liability, I will be delighted to confirm whether the approach to which I refer would be effective.
I'm sure your readers would prefer some new information on the subject rather than read the repeated rehashing and promotion of unnecessary, and questionably effective, financial products as a "solution" to their perceived problems.
J Johnson, Inverness,