Category Archives: Risk

Inheritance tax & houses – common errors

General election time tends to cause a spike in views being expressed on IHT and houses. By a combination of lack of awareness, the complex tax system, and sometimes political intent, common errors arise.

Some examples from the December 2019 election campaign are:

  • Not realising that only around 5% of death estates suffer IHT each year – see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/832126/IHT_Commentary.pdf
  • Not being aware that the residence nil rate band can increase the normal £325 nil rate band by £150k – see https://www.gov.uk/guidance/inheritance-tax-residence-nil-rate-band
  • Thinking IHT is double tax, rather than often being partly or mainly the result of otherwise tax free growth (or not much worse “double tax” than VAT)
  • Hoping that giving away all or part of the house saves IHT – in many cases it makes things worse, due to reservation of benefit, pre-owned asset tax and loss of capital gains tax free uplift
  • Forgetting the instalment option – see https://www.gov.uk/paying-inheritance-tax/yearly-instalments
  • Worrying, when young and healthy enough that life cover can cheaply cover the IHT risk
  • Forgetting the transferable nil rate band – see https://www.gov.uk/guidance/inheritance-tax-transfer-of-threshold
  • Focusing on “40%”, rather than what actual blended tax rate might apply – eg the estate of a married couple (or widow/widower) with £1.2m house might suffer 8.3% IHT on that asset
  • Not realising that a reduction in the IHT rate, or its abolishment, might be balanced by the removal of the tax free uplift on death or private residence relief
  • In hoping for IHT to be replaced with something else, that an annual wealth tax might cause more hardship than IHT on an elderly low income and valuable house owning taxpayer
  • Worrying about IHT but not taking advice

If any others are spotted, I am happy to add to the above list.

HMRC guidance on trust record keeping

In July 2018, HMRC updated its guidance on trust record keeping. This is a mix of tax and anti-money laundering requirements.

Dormant trusts may not have to complete a tax return or trusts register but there are still record keeping obligations, such as under para 44 and 45 of the The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

I recommend that all trusts have an annual trust meeting, asset review and simple accounts (even if just one page). Whenever I am asked to advise on a historic trust problems (eg missed IHT charge) a common theme is lack of annual meetings and accounts.

Here is the HMRC website link https://www.gov.uk/guidance/trust-record-keeping-for-tax-purposes

And a PDF version safari-30-jul-2018-at-1021.pdf

How much investment risk would you take to save inheritance tax?

The behavioural impact of tax on both advisers and taxpayers continues to fascinate me. Let’s say you have the certainty of being taxed at 40% – what percentage risk would you take to reduce that to nil?

An article in the FT (subscription required) suggests that those with inheritance tax (“IHT”) exposure as low as £15,000 are being sold business property relief (“BPR”) investments to reduce tax. As a tax adviser, the tax issues are relatively simple: invest in alternative investment market (“AIM”) shares that qualify* for BPR and survive for for two years. (*not all AIM shares qualify)

But, what about risk? It’s not too much of a tax risk but surely a significant investment risk. That’s outside my area of expertise but there is a general point here: driven by tax, why introduce the danger of overweight exposure in high risk investments to the elderly? I hear alarm bells.

Questions for the investment adviser:

  • How high risk are AIM shares?
  • Without the tax break, what proportion should an elderly person hold in such investments?
  • What is the percentage chance of the investments falling by more than the hoped for 40% tax saving?
  • Is there an AIM market bubble, caused in part by tax driven investments?
  • How active do the share/portfolio changes need to be to reduce risk (and perhaps rely on the replacement property BPR provisions)?
  • If the AIM market collapses, how many will suffer and will liquidity be an issue?
  • Is there a less risky way to save IHT?

I recall that insurance against AIM market falls used to be available with such investments. This option seems to have disappeared. If an insurer won’t take the risk, should an elderly client?

I have seen such BPR portfolios work, eg for those who were very wealthy, appreciated the risk, where BPR formed only a small part of their estate, they lived the two years and died soon afterwards and before any major fall in the investments – were their beneficiaries fortunate?

One to look back on in a few years’ time?

 

Buy to let – using a company may not be the answer

One of those situations where the question asked appears to contain the answer:

“I need a company for my buy to let portfolio – can you help me do that?”

It’s a common question at the moment.

Why a company? The restrictions to interest relief for individuals is the main driver, especially where the change pushes a basic rate taxpayer into higher or additional rate tax. Many with high rents covered by high debt don’t appreciate the impact this will have on their tax position.

Capital gains tax problems? Where properties stand at a gain, transferring these to a company may trigger tax. Although incorporation relief is available, property rental may not qualify. A taxpayer won on this issue (see this case) but on specific facts that will not apply to many landlords. If the properties are not standing at a gain, or just a small gain, this problem goes away.

Banking? some promote the idea of a beneficial trust company, in an attempt to use a company without telling the bank (see this article) but that would be foolish. An early discussion with the bank to get them onside with holding debt in a company is essential – it increases their risk and they may say “no” or increase their charges and interest.

What about SDLT? a transfer to a company usually will trigger Stamp Duty Land Tax. There is a relief for partnerships but two problems arise: have you really got a partnership (rather than just joint ownership) and have you put a partnership in place to avoid SDLT (in which case anti-avoidance rules probably catch it)?

Future how will you extract profits? Is there a double layer of tax on sales? What future changes to tax or company law could put you in a worse position? Will buy to let companies be targeted by anti-avoidance legislation? Will collapsing (liquidating) the company if things change cause additional taxes?

Overall there is a strong hint that the Treasury and Bank of England wish to discourage smaller buy to let landlords, to protect against a property crash, so any planning may be targeted by future legislative changes.

An outline plan

  1. work out your tax impact of the interest relief changes;
  2. consider if you need to adjust your debt, even if that means selling some property;
  3. speak to a financial adviser on commercial property (which tends to have a better tax treatment), indirect property investment, asset diversification, ISAs and pensions (ie generally, what exposure should you have in a balanced porfolio to debt funded residential property?);
  4. if an adviser says that you should qualify for incorporation or SDLT reliefs, do they mean will qualify? Are they or you taking that tax risk if HMRC challenge and win? (Beware the “we have Counsel’s opinion” line – to me that indicates they see risk, not safety.);
  5. Don’t pretend to be more actively involved than you are in reality in order to get incorporation relief and don’t set up a partnership just to avoid SDLT;
  6. Consider a company for new acquisitions;
  7. Consider a transfer of the existing property and debt to a company, if you are satisfied that it can be done with low or no tax and the bank are happy to do so;
  8. Work out the costs and administration of having a company;
  9. Expect future attacks on buy to let property.

 

QNUPS – for pension or tax purposes?

Having posted a slightly negative view of FICs in the last blog, it is a natural step to also do something similar for another fairly common structure with apparent tax savings, QNUPS.

Tax objective or pension?

QNUPS are Qualifying Non-UK Pension Schemes. The main selling point is the possibility of IHT exemption and a tax deferral of income and gains. These benefits feel vulnerable to HMRC attack or legislative change.

If the desire is wholly or mainly to have a top up pension scheme (in addition to a fully funded normal UK pension), the concept may work. But, the more that tax is the driver, the risk of unexpected tax charges increase.

Legislation

The rules are rather thin, being mainly one paragraph of IHT legislation and a Statutory Instrument. These were introduced to amend a tax anomaly with another type of offshore pension (QROPS). The idea of a QNUPS is to piggy back on another country’s pension rules applying to its residents, subject to certain qualifying criteria.

As complex structures, advisers and offshore companies like them, as they generate relatively high or recurring fees.

What could go wrong?

  • The income and gains of a QNUPS may be taxable on the person funding it, under the UK anti-avoidance rules, although these rules have been relaxed recently, to be more proportionate in line with EU law
  • HMRC may argue that the IHT breaks do not apply
  • The press may see it, rightly or wrongly, as the next tax scam
  • Targeted legislation may be introduced to negate the tax advantages, possibly with retroactive effect
  • QNUPS may be difficult to unwind, if attacked by the tax system, as they are long term pension-like structures
  • The structure might not fully meet the requirements to be a valid pension in the other country (some countries have adapted their rules to make QNUPS attractive to UK residents – but is that enough?)
  • Even if it works, you may face the costs and uncertainty of defending it from HMRC attack

Safeguards

To safeguard against these, you should involve a pensions adviser as well as a tax adviser and I suggest taking a specific opinion from Tax Counsel, based on your own circumstances, to fully explore the risk areas.

A general opinion from Counsel may not be enough – that will be addressed to the those selling the idea to you (check that you also read the instructions to see what was asked). It may not cover downsides or specifics (eg it may say “if entered into as a pension scheme” but that doesn’t mean that you are entering into it as a pension scheme). Ensure that you ask for a review of possible downsides.

Also assume that a tax challenge will take place – does all the evidence genuinely point in the right direction? Who is responsible if ultimately tax is charged? An “audit” of the live paperwork by a tax investigation specialist may be useful to stress test the structure, advice, file notes and email trail in anticipation of a HMRC enquiry.

HMRC consultation

There is an impression that HMRC and the Treasury do not like QNUPS. There was a hint that a consultation would take place, with draft tax changes, but nothing has appeared. It would have to fit within EU law, which may limit what could be done, although a possible Brexit impacts on that, of course.

Overall, tread carefully when considering QNUPS, if the reason is any wider than “I wish to have an additional pension fund”.

 

Family Investment Companies to save income tax and inheritance tax – problems ahead?

Family investment companies (“FIC”) are popular for three reasons. For clients, (i) they can reduce or defer taxes on income from 45% to 19% or less and (ii) give away wealth for IHT purposes but retain some element of control. For advisers, (iii) there are large fees, as such structures are complex and require detailed advice.

Advantage (i) is as a result of the continued fall in corporation tax rates, compared to higher income tax rates. Advantage (ii) is a response to the restriction on the use of trusts via the tax system in 2006. Advantage (iii) may tempt some to “sell” as many FICs as possible to clients, rather than it being part of an adviser’s toolkit, suitable in only some circumstances.

What could go wrong?

The challenges FICs face are:

  1. complexity – in many cases there is a more simple and cheaper solution than a FIC
  2. future tax rates change (companies were a very bad idea for private assets several years ago and may be again in the future)
  3. company law changes
  4. targeted legislation (see-through legislation taxing the income / apportionment rules?)
  5. existing settlement anti-avoidance legislation (if there is an element of bounty eg uncommercial loans) or transactions in securities (there are rumours of HMRC attack in this area)
  6. costs, administration and reporting requirements can be expensive or burdensome
  7. they are difficult to unravel (more so than trusts)
  8. publicity, unless an unlimited or offshore company is used to limit that
  9. will the press see them (rightly or wrongly) as the next tax dodge, resulting in penal taxes in response?
  10. double tax charge on assets that grow in value and are extracted
  11. family/shareholder disputes (getting the bespoke company articles and shareholder agreement right first time)
  12. unknown unknowns (FICs are a very young idea compared to the tested ground of trusts)

These should all be considered in detail before putting a FIC into place, ie not just the advantages now but how future-proof are they, what stress tests and “what ifs?” should be considered?

With that, a fully informed decision can be made. FICs can be very useful in specific limited circumstances but beware having one just because it is in fashion or that somebody wants to earn a nice fee selling you one.

[This note was drafted in December 2016, updated in March 2017 and February 2018]