I was recently invited to present at an event in Liverpool, focused on investment into businesses operating in and around the North-West. The event was well attended by both investment professionals as well as numerous financial advisors. The topic of my presentation was focused on an "Overview of the Tax-Advantaged Space" and, accordingly, I outlined the core themes and developments which the tax-advantaged investment team have noticed in recent months, as we undertake our research. Following the interesting conversation spurred by the presentation, I thought it fitting to discuss the points raised here.
The presentation was divided into two broad categories, the first was an examination of Business Relief ("BR") and the second takes an examination into the effects which the Patient Capital Review ("PCR") has had on the EIS and VCT market, and more pertinently the implications which this has had on the due diligence process in this space.
Over the course of two editions of View From the Bridge I will address these two topics. In this edition, I will address the recent review of Inheritance Tax ("IHT") undertaken by the Office for Tax Simplification ("OTS"), and the potential implications, if any, which this could have on qualifying trades. Secondly I will take a brief look at the impact which the recent AIM sell-off may have on sentiment around AIM IHT products.
1. Office for Tax Simplification review of Inheritance Tax Relief Business Relief
When thinking about Inheritance Tax, one is reminded of Benjamin Franklin's statement that, 'In this world nothing can be said to be certain, except death and taxes". Although an emotive topic, IHT remains a certainty. However as increases in the nil rate band fail to match the rise in housing prices, the recent review of regime, undertaken by the OTS, has ruffled many feathers. Firstly due to the increased use of tax planning to minimise their exposure to IHT, and secondly due to the possibility of the review ushering in a change to a BR market that is increasingly popular as an IHT planning tool. In particular, concerns that many of the trades traditionally invested into by BR investments, may no longer qualify for tax relief.
The first of two reports, in response to the review, was published in November last year, and was titled "Overview of the Tax, and Dealing with Administration"1 and addressed the practical complexities of IHT. There is a second report, which is to be published in the Spring. It appears to have much wider scope for review, and potentially (although unlikely) some discussion on qualifying trades.
One cannot rule out the possibility of some amendments to the current regime, however, it is equally important to consider the OTS' review within the political context in which we find ourselves. IHT is unpopular, but it generates significant tax receipts for the government. In fact the government received a record £5.2 billion in the 2018 financial year. As a result a private sector solution (i.e. Business Relief), enabling mitigation of IHT without having to reduce it, will likely to appeal to political leaders. My colleague and Senior Analyst Simon Radford recently took part in a panel on the topic, reiterating this point. He made the observation that the Conservative Party first overtook Labour in the polls during Gordon Brown's premiership due to promises to cut IHT. While we live in a more populist moment than back then, Phillip Hammond is unlikely to risk making IHT more burdensome.
From our perspective, it would appear therefore that government are seeking to demystify inheritance tax and the complexities which it can create from a financial planning perspective. We feel that there are no intentions for a major review of the current IHT regime or the qualifying trades. However, the team at MJ Hudson Allenbridge remain in contact with HMRC and we continue to keep our ear to the ground for any significant developments. It is important to remember, that unlike VCT and EIS tax reliefs, IHT relief is retrospective, and so it is important to be aware of any significant changes, should these come about.
2. Performance of the AIM through Q4 2018
AIM IHT services have been a popular option for many in recent years. Exposure to BR-qualifying companies listed on the AIM has generated positive and significant returns for a number of years. At the same time it benefits from a good level of liquidity with beneficiaries of the estate able to receive their money much faster than other BR services.
For the five-year period to 31 December 2017, AIM gained a healthy 58%. Although the universe of companies listed on the AIM which potentially qualify for BR relief is much narrower, these levels of return are still reflective of the gains investors in AIM IHT products might have enjoyed. That being said, the recent sell-off on AIM through Q4 has shaken many within the market, and many portfolios have lost significant value. In sight of this, an examination of the AIM's performance in recent years paints an interesting picture, as noted in the table below.
| Period | Return |
| 5yr to 31 December 2017 | 58% |
| 5yr to 31 December 2018 | 8% |
| 1yr to 31 December 2018 | -17% |
| Q4 2018 | -22% |
| 5yr CAGR to 31 December 2018 | 2% |
| Source: Bloomberg |
Following the sell-off on AIM through Q4 2018, during which the index lost over 20%, many of the gains seen in recent years were eroded. It is particularly noteworthy that over the five-year period to 31 December 2018, the AIM index generated a CAGR of just 2%. This is far lower than many of even the most conservative BR products on offer, and highlights the volatility which investments into AIM can present; although of course the Index return does not take into account manager skill, the fees levied by the product, or factor in tax relief to the return. However, the timing of a withdrawal for IHT relief can never be predicted, and those estates seeking redemption in most recent months would have realised this more acutely than most.
For most the goal for Business Relief is capital preservation, and investments into unquoted businesses, have historically provided more stable returns, albeit over some periods much lower returns, with limited liquidity. However, for those who are more return-minded, can live with the volatility of investing in AIM and the market risk it poses, or who might need to access funds by using the liquidity of AIM to access funds for care costs or other incidental expenses, AIM might be a better option.
It is therefore important that advisors and their clients are comfortable with the trade-off between liquidity and the elevated risk of capital loss which AIM BR products potentially provide. If investors are interested in investing in AIM for IHT mitigation, it is important that they are happy with the level of volatility, that they can give investment managers enough time to demonstrate value over business cycles, and that the "alpha" that an investment manager can provide is greater than the fees incurred by accessing the scheme. This is where we come in as independent reviewers of the sector and many such IHT products active on AIM. While we can't judge individual client suitability, we can assess the strength and experience of the team, the strategy employed, the fees charged, and the Manager's performance when compared to the market as a whole. This way we hope to shed some light on this part of the BR market and the variety of different products vying for a piece of the increasing amount of money flowing into BR products as a whole.
Footnote
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
