Alternative Investment Market shares

Reducing an Inheritance Tax liability on an estate

Investing in Alternative Investment Market (AIM) shares is one way of reducing an Inheritance Tax liability on an estate. Qualifying AIM shares offer more Inheritance Tax relief than some other assets and qualify as ‘business property investments.’ If property is held as AIM shares in certain trading companies, for a period of at least 2 years, it becomes eligible for Inheritance Tax Business Property Relief at 100 per cent and will fall out of the estate for Inheritance Tax purposes. This relief is a relief by value, the shares are treated as having no value for Inheritance Tax purposes.

Not all AIM companies are eligible for Business Property Relief however. To qualify, a company must be a trading company carrying out the majority of its business in the UK. Businesses trading in land or securities, or receiving a substantial amount of income from letting property or land, are excluded. Also, it must not be listed on another recognised stock exchange. If a company qualified for Inheritance Tax relief when the shares were bought, but was subsequently disqualified under these criteria, investors must reinvest their holdings into new qualifying shares within 6 months to retain the Business Property Relief exemption.

Investing in the AIM will suit financially secure people with other liquid capital who can invest widely enough to bear the risks involved. AIM shares can be unpredictable and invest in smaller, less established companies with fewer investors than other stock markets, so share prices can be volatile, rising or falling rapidly. You should always receive professional advice before considering this option to mitigate a potential Inheritance Tax liability.

Investmen tsolutions

Do you currently have the most suitable method of holding and structuring your investments to achieve an efficient mix of risk and return that is specific to your particular objectives? And are you fully utilising the income, capital gains and inheritance tax advantages of these investments, particularly as the taxation regime governing them may be subject to change in the future? We have provided a selection of tax-efficient solutions you may wish to discuss with us.

The over-50s were able to shelter more of their money from the taxman on 6 October last year when Individual Savings Account (ISA) limits rose by £3,000 to £10,200, or £20,400 for a couple. Everyone aged 18 and over will be given the new limit from 6 April 2010.

Venture Capital Trusts (VCTs) enable individuals to invest in unquoted and AIM-listed firms, and give tax-free capital gains as well as income (usually taxed at 32.5 per cent for 40 per cent taxpayers). They also attract initial tax relief at 30 per cent, which is an income tax relief that is given as a tax reducer, as long as they are held for five years. The maximum investment is £200,000 a year. This type of investment does come with a high degree of risk.

Enterprise Investment Schemes (EISs) invest in firms typically involved in a particular sector or project, and give income tax relief of 20 per cent on up to £500,000 a year, if held for three years. Gains are tax-free, but not income, and investments fall outside your estate for inheritance tax purposes after two years. This type of investment does come with a high degree of risk.

EISs also allow you to defer Capital Gains Tax (CGT) incurred in the previous three years or the subsequent 12 months, which is attractive if you paid at the old rate of 40 per cent (in force until 6 April 2008). While you still have to pay CGT on EIS shares bought with tax-deferred funds, you could save 22 per cent on past gains.

Onshore investment bonds are taxed internally at the 20 per cent basic rate. However, up to 5 per cent a year of the original investment (a minimum of £5,000, but no maximum) can be withdrawn for 20 years without any immediate tax liability. And you can ‘roll up’, taking 3 per cent income in one year and 7 per cent the next. If you become a basic rate or non-taxpayer when the bond matures, there is no further tax to pay.

Gifting income-producing assets to your spouse, where he or she is a lower rate or non-taxpayer, could save high earners a considerable sum. Say you had a portfolio of investment properties worth £500,000, which produced an income of 5 per cent or £25,000 a year. If you were a high earner and held the investments in your own name, you would be liable for tax on the income of £12,500 from the 2010/11 tax year. However, if you gifted the assets to a spouse who had no other income, the first £6,475 would be tax-free and the remainder taxed at 20 per cent, so just £3,705, which equates to a £8,795 tax saving. This example is based on the original owner having total taxable income above £150,000 (hence the liability on the £25,000 rental income would be 50 per cent rather than 40 per cent).

Venture Capital Trusts and Enterprise Investment Schemes are specialised, complex investments and are not suitable for everyone. They should only be considered as part of a balanced portfolio and advice should be sought prior to investing. These could be high risk investments. The value of investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.

Investing at a time of low interes trates

If you are an income-seeking saver in search of good returns from your savings in this low interest rate environment, we can provide you with the professional advice you need to enable you to consider all the options available. In addition, we can help you determine what levels of income you may need and work with you to review this as your requirements change. Another major consideration is your attitude towards risk for return and availability. This will help to determine which asset classes you are comfortable investing in.

Cash, especially in the current climate, is an important element for any income investor. One option you may wish to discuss with us is cash funds, dubbed ‘money market’ portfolios. These use the pooled savings of many investors to benefit from higher rates not available to individuals. They can invest in the most liquid, high-quality cash deposits and ‘near-cash’ instruments such as bonds. But, unlike a normal deposit account, the value of a cash fund can fall as well as rise, although in theory, at least, it should not experience volatile swings.

Bonds are a form of debt, an ‘IOU’ issued by either governments or firms looking to raise capital. As an investor, when you purchase a bond you are essentially lending the money to the government or company for a set period of time, which varies according to the issuer. In return you will receive interest, typically paid twice a year, and when the bond reaches maturity you usually get back your initial investment. But you don’t have to keep a bond until maturity. You can, if you wish, sell it on.

Much of the government’s debt, including the additional money being used to aid the economy and refinance the banks, is in the form of bonds it issues. Gilts are bonds issued by the British government. The advantage of gilts is that the government is unlikely to fail to pay interest or repay its debt, so they are generally the safest investments. Government bonds pay a known and regular income (called the coupon) and a lump sum at maturity (called the par). They typically perform well as the economy slows and inflation falls.

Corporate bonds operate under the same principle as gilts, in other words companies issue debt (bonds) to fund their activities. High-quality, well-established companies that generate lots of cash are the safest corporate bond issuers and their bonds are known as ‘investment grade’.

High-yield bonds are issued by companies that are judged more likely to default. To attract investors, higher interest is offered. These are known as ‘sub-investment grade’ bonds.

The risks related to investing in bonds can be reduced if you invest through a bond fund. The fund manager selects a range of bonds, so you are less reliant on the performance of one company or government. The ‘distribution yield’ gives a simple indication of what returns are likely to be over the next 12 months. The ‘underlying yield’ gives an indication of returns after expenses if all bonds in the fund are held to maturity.

An alternative route to generating income is by investing in stocks that pay a dividend. If a firm is making good profits it can decide to share this with investors rather than reinvest it in the business, so essentially dividends are the investors’ share of company profits. Share prices of companies that regularly pay dividends tend to be less volatile than other companies, but remember that company shares can fall in value. In addition, dividends can be cut if a company finds itself in need of extra cash.

Another way to invest in equities for the purpose of obtaining a better income is via an equity income fund. The fund manager running the portfolio selects a wide range of equities, so you are less reliant on the performance of any one particular company, and will try to select companies that pay regular dividends.

These investments do not include the same security of capital which is afforded with a deposit account. The value of investments and the income from them can go down as well as up and you may not get back your original investment. Past performance is not an indication of future performance. Tax benefits may vary as a result of statutory change and their value will depend on individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.