An area of tax planning that has become increasingly popular in recent years is the use of business property relief (BPR) in the mitigation of inheritance tax (IHT) liabilities. Originally designed for entrepreneurs passing on family firms, BPR gives full relief from IHT on assets held for a minimum of two years. But of possibly greater significance is the fact that investors in assets such as portfolios of Alternative Investment Market (AIM) stocks retain access to their investments.
Investments that qualify for BPR include agricultural land, forestry and suitably qualifying companies listed on AIM and the Enterprise Investment Scheme (EIS). Specifically, AIM stocks must be ‘trading companies’ to qualify for BPR, so things like resources stocks and most property companies do not qualify.
A greater level of risk
Investments that use BPR are generally regarded by tax planners as the final stop, after the basic IHT reliefs and trust options have been used, or where the need to retain control of the assets is paramount.
Jason Walker, senior manager at adviser AWD Chase de Vere, confirms that ‘After we have used the basic forms of IHT planning, including discounted will trusts, we would then look at the various forms of investment solutions to IHT planning, since the seven-year qualifying period for potentially exempt transfers can effectively be reduced to two years with BPR. Typically, BPR investments have to be fairly high risk, but there are some capital-protected options available with things like AIM VCTs and EIS funds.’
Matt Phillips, investment director of BDO Stoy Hayward IM, describes these as ‘the more esoteric forms of planning, using BPR on AIM and EIS investments. This is really for people who are happy with taking on the risks associated with these investments, and risk is something they should think carefully about.’
Certainly, in current circumstances, the security of the investment will be an issue. Many investors will see little point in an investment in, for example, AIM shares that might rapidly decrease in value.
Guy Myles, managing director of Octopus Investments, which offers a range of AIM and EIS investments, explains, ‘Our service is designed to solve tax planning problems using BPR. The type of investor typically interested will be quite old, probably a widower or a widow, so they are looking for an investment that offers low risk with access to capital and the chance to produce income.
‘So we focus on businesses that are easily analysed and seek investments where all the underlying business risks have been removed. It means that you get a low-growth, but relatively secure, portfolio. We are committed to producing three per cent income a year, and if the portfolio falls below that, Octopus makes it up from its own balance sheet. You have access to your money on a monthly basis at net asset value.’
Meeting market demand
Myles feels that ‘This approach has been successful because that is what the market wants. You would have thought that a rapidly falling interest rate would have put these investments under pressure, but our ability to generate returns hasn’t been affected. This is because of the reason interest rates have been falling – there is a lack of capital for lending. But we have capital and are structured in such a way that we invest in companies that want to deal with us.’
The principle of an AIM portfolio is simple. As Deryck Noble-Nesbitt, manager of the Close IHT Service, explains, ‘Somebody places money with us and we buy a portfolio of around 30 qualifying investments, which we look to hold for the long term. Providing you have held them for two years, they will qualify for BPR and will be outside your estate.’
Rupert Hunter of AXA Investment Managers agrees that ‘They are not suitable for everyone. I have always felt that the main benefit of AIM portfolios in IHT planning is that you retain control of the investment. They can be extremely flexible, so that, for example, if you become ill at any stage, you can access your money and use it for, say, healthcare expenses. And we check with PricewaterhouseCoopers that the companies we invest in will qualify for BPR.’
Still finding value
However, with equity markets generally suffering, the risks of investing in AIM have increased. Deryck Noble-Nesbitt agrees that ‘The recent performance of AIM has been unattractive, but I would argue that Close Brothers has been launching one of these portfolios every quarter since early 2001, and the only one that people didn’t invest in was February 2003, although those that were in the previous quarter’s fund would have made a good return.
‘We liken it to Christmas 1974, when, as now, there were plunging stock markets, economic gloom and political unrest. The UK stock market had fallen 70 per cent prior to that but recovered over the next three years.’
He argues that ‘At the moment, you have the irrationality of AIM. A good example is Nichols, the maker of Vimto, which has been around for over 100 years. It has no significant difference in its business model from larger soft drinks manufacturers. People get confused between the operational risks and the technical market risks. Yes, with a stock like Nichols, which is infrequently traded, there is a lack of liquidity, but the underlying business is pretty sound.’
Rupert Hunter also insists that there are attractive investments to found on AIM: ‘There are still some very good companies on AIM that qualify for BPR and are on very attractive ratings. Companies we like at the moment include Advanced Medical Solutions, which specialises in wound treatments, and Hargreaves Services. Others we like that have fallen quite a way are Romag, which makes laminated glass for solar panels, and May Gurney, which should benefit from government expenditure. Then there is Wynnstay, which is an agricultural product retailer. Even something like Majestic Wine looks attractive at these levels.’
Deryck Noble-Nesbitt argues, ‘We have been emphasising that, if you are investing in equities you need patience, and the lower down the capitalisation scale you go, the more patience you need. If you are 60, with children, and have spare cash you want to put to work in the stock market, now is not a bad time to do so. To those who can only see the risks of AIM stocks, I would ask, if you had an investment in a bank, large-cap property companies or large-cap miners over the past six months, how much risk were you taking on?’
However, an alternative BPR solution that avoids the risks of AIM is to form a traded property company. Stephen Oliver of Close Traded Property Companies reports, ‘We have been running these since 1997. Initially they were focused on CGT planning but this changed to a focus on IHT with the introduction of BPR. We have around 1,600
of them currently in operation. It gives exposure to directly held property assets, as an alternative to share-based investments or trusts.’
He adds, ‘The way it works is that you establish a single shareholder property company – the investor is the only shareholder – and then invest across five strategies, two of which are capital growth focused while three provide income and capital growth. The specific capital growth strategies are for the development of residential or commercial properties. These are joint venture-led transactions, where we buy a site with planning consent, build it out and sell, to produce the capital gains.
‘The three income and growth approaches are based on owning and operating, forestry, self-storage or public houses. Where these companies differ from, for example, AIM portfolios is that the investor is owning a real asset, with a known and quantifiable value and a known cost structure. You also have a known exit date.’
A similar approach is offered by specialist property manager SPREFS. Gary Lewis of SPREFS explains, ‘We manage anything that is property based but indirect, including third-party funds, fundraising for third parties and property partnerships. It must be new-build but it doesn’t have to be commercial, although most investments are in commercial property because that offers the best value. The developer is at the base of the project. A new company is set up for each project and in most cases it is the developer who approaches SPREFS.’
He confirms that ‘The primary goal is as an IHT planning tool. It is a five-year fund, which gives certainty for investors, knowing when they can get their money back, but there is certainty for us too, in knowing how long we have got the money for. And if people want to continue, they can roll over into another fund as we set up a new one each year.’
Close’s Stephen Oliver explains, ‘We try to look to uncorrelated asset classes. So, for example, trees will still grow in forestry plantations even when the commercial and residential property markets are depressed.
‘The existing capital growth schemes have undertaken 137 developments, of which 102 have been completed, with an average return of five per cent a year. This is an alternative asset class that is not correlated with the stock market.’