The business of IHT

As I noted in a previous column, inheritance tax (IHT) seems to be one of the most disliked of all taxes. There are many approaches to reducing IHT exposure, but the answer is that fundamentally, they all boil down to just two options.

The first way is simply not to have significant assets on death, either by having spent it all, or having given it away beforehand. Of course this isn't really 'simple' at all, since we never know when our own personal 'deadline' is. The seven year clock also means it can't be left to the last minute. As a result there is often a risk of leaving oneself short.

The second way is to have wealth in assets that are exempt from the tax. The main exemptions are for farming land and assets connected to one's own business, both of which are useful if your circumstances already lie that way, but are blind alleys for many clients. However an extension of the business exemption (properly called Business Property Relief) is that certain company shares are also exempt from the tax.

They don't have to be in the holders' own business at all, so long as they are 'unquoted' shares. Confusingly, 'unquoted' includes shares that are quoted on the AIM index, which lists fledgling companies too small to be included on the main stock exchanges. There are some restrictions (they must be genuine trading companies and certain business types are excluded).

There are some caveats. First, the shares are not exempt straightaway. They have to be held for two years before the exemption kicks in. Second, and perhaps most importantly, these are by definition smaller and less well established companies, so normally higher risk from an investment point of view.

It is quite possible, for example, for investment losses to wipe out the 40 per cent inheritance tax saving. In a worst case scenario, a client could even be hit with a double whammy; big investment losses followed by an inheritance tax charge if they didn't live for the required two years (or if they withdrew).

There are many managers and stockbrokers who will create and maintain a portfolio of suitable shares.

Some managers emphasise the possibility of strong investment returns. However it's important to remember that the volatility accompanying all share investments can be amplified with smaller companies. These portfolios may see spectacular gains but may also see spectacular losses.

Other managers, in choosing companies to invest in, emphasise an aim to keep the investment risk as low as they can, reasoning that their clients (typically in their later years and concerned about passing on their wealth) would prefer a slow and steady approach to a high-wire act.

In recent years, a third option has developed.
Money is invested into the shares of a specific unquoted company which the specialist managers themselves create, oversee and manage. This allows
the manager to ensure the company operates in
as low-risk a way as possible. But with lower risks come lower returns. These schemes are intended to keep up with inflation and maintain the real value of the money, but not much more. This makes such schemes more suitable for the very cautious, or those whose expected timescales would make 'real' investment unwise.

The key benefits in this type of planning are, first, the two year period to achieve exemption compared to the seven years most other arrangements entail. Second, the money is never given away but remains in the ownership of the client, and they can choose to take the money out again at any time.

Although these advantages are exceptionally beneficial ones, the caveats are also particularly important. As ever therefore, planning in this area always involves a careful balancing of the competing points. n

Scott Gallacher is a director at Rowley Turton

He writes the regular IFA comment in Private Client Adviser

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