BPR and AIM portfolios in IHT mitigation
David Thurlow, director, Mattioli Woods look at the advantages of Business property Relief and, in consequence, an AIM share portfolio in mitigating inheritance tax
Inheritance tax was famously described in 1986 as “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. Currently, an individual’s estate worth more than £325,000 (the nil-rate band) is subject to 40% inheritance tax (IHT), payable by beneficiaries on death. The nil-rate band will be frozen until at least 2020, albeit with an increased allowance worth up to £175,000 in respect of the family home. The family home allowance will give respite for some, but the trend is for more and more people to be affected by IHT.
Much has changed since 1986 and the extension of Business Property Relief (BPR) has made it easier for investors to retain control of their assets without suffering IHT. Since 1996, BPR has been available on up to 100% of the value of unquoted shares held in qualifying business assets.
Where unquoted shares are concerned, BPR reduces the value of the business by up to 100% when assessing IHT, provided shares have been held for at least two years. If the proceeds of the sale of qualifying assets are reinvested within three years, the holding period of the sold assets is included. Therefore, it is possible to sell unquoted shares and reinvest the proceeds in another unquoted share, without having to wait the two years for the IHT benefits.
What lies outside BPR?
It is important to note that many unquoted shares will not qualify in full for BPR, or may not qualify at all. Care needs to be taken if investing in unquoted shares for the IHT advantages. Furthermore, because qualification for BPR is backward looking, it is possible to buy qualifying shares that subsequently cease to qualify.
Investment companies do not qualify, nor does money held within the company that is not used for trading or company related investment purposes. The most common example would be where a company is holding more cash than it could sensibly need for trading purposes, as HMRC could disallow the proportion of the overall value held in surplus cash. Similarly, if a company sells a property that it owns and makes a profit, the cash raised could be disallowed.
The restriction on investment companies also applies to OEICs and means that investment trusts and OEICs investing solely in unquoted companies do not qualify for BPR, even where the underlying holdings would if held individually. Therefore, Venture Capital Trusts, which have many other tax advantages for encouraging investment in smaller, unquoted companies, do not benefit from BPR.
Using AIM portfolios
The Alternative Investment Market of the London Stock Exchange (AIM) came into being in June 2005 and was developed as a more lightly regulated stockmarket designed for smaller companies. AIM shares are regarded by HMRC as unquoted shares, but they have a significant advantage over most other unquoted shares – liquidity. This has led to growth in AIM portfolios, where discretionary managers manage a portfolio of direct investments in AIM quoted shares, in order to access the IHT advantages of BPR. Since June 2013 AIM has the added and unique advantage of qualifying for BPR and being eligible for inclusion in ISAs.
Of course, there is nothing in theory to stop individuals from creating their own AIM BPR portfolios, but good discretionary managers have critical advantages. Clearly, investment performance is important – AIM had its own annus horribilis in 2008 when the index lost 60% of its value and there is no point investing to save 40% IHT and suffering a greater loss on the value of the investments. AIM is a much more mature market today, but still predominantly consists of smaller companies and still attracts the latest investment fads seeking a listing.
As well as identifying good investment opportunities, it is imperative to ensure that these are and remain BPR qualifying. Of over 1,200 companies that are quoted on AIM, less than 60% are believed to meet BPR criteria. Even within that more restricted universe, there are companies that, at any given point in time, will not qualify for 100% relief. The better discretionary managers are alert to this and will ensure that the investments fully qualify for BPR, as far as is reasonably possible. There is also the need to ensure that cash is reinvested quickly. As mentioned above, a reinvestment within three years means that BPR qualification is maintained, however if cash is held at the time of the investor’s death, this will not qualify for BPR.
Using AIM portfolios to mitigate IHT can be a highly effective strategy, allowing investors to benefit from the IHT advantages of BPR whilst retaining ownership and control of their assets. However, there are many traps for the unwary and given the investment risks involved, it should only ever form part of an estate planning solution, and never be the solution.
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