You are a 70-year-old with £5m of investments which you want your children to inherit. But you’d like to avoid the £2m of inheritance tax.
You ask your tax adviser for advice on how to avoid the tax, and are expecting a long complicated memo, proposing a tax avoidance scheme involving seventeen companies, three tax havens, two trusts, and large fees.
What you actually get is written on a postcard:
- Step 1: Sell your existing investments1Won’t there be CGT on the sale? Probably not much. £1m of the investments are in an ISA. As for the rest, like any tax-obsessed investor, you’ve been managing CGT as you go, crystallising gains to use your annual allowance, and using your wife’s annual allowance (i.e. total gain sheltered = £25k * years invested). You’ll have a bit of gain, but it’s a price worth paying. and replace them with shares listed on the Alternative Investment Market. Either assembling a diversified selection yourself, or paying someone else to do it.
- Step 2: Make sure to live at least two years.
- Step 3: Drop dead, happy in the knowledge you’ve avoided inheritance tax.
- There is no Step 4.
Why does this work?
Most AIM shares qualify for complete exemption from inheritance tax after two years.
Given AIM companies are small/mid-cap, the obvious downside is that your portfolio suddenly becomes more volatile (although not as much as you might think). But many people would see that as a small price to pay for avoiding a 40% tax hit.
Why is it so stupidly easy to avoid IHT?
The road to tax hell is paved with good intentions (and also flapjack).
Inheritance tax can be unfair for small family businesses. Imagine a small shop, making a profit of £50,000/year. That business is plausibly worth £500k. So when the owners die, their children – who expect to inherit the business – have a £200k bill. A larger business could deal with this by borrowing, or bringing in outside investors – but for a small business that’s much more difficult.
So most countries with inheritance/estate taxes have exemptions for private businesses.
The UK does that with business property relief. But BPR goes much further than it needs to:
- First, the exemption has no limit. What makes sense for the cornershop doesn’t really make sense for a £1bn business – but the exemption covers it just the same.
- Second, the exemption doesn’t apply to shares in listed/quoted companies, for the very good reason that you can easily fund the tax by selling the shares in the market. But shares in alternative markets like AIM aren’t considered “quoted” for this purpose, even though you can easily fund the tax in precisely the same way.
How to fix it
That’s easy. Exemptions and reliefs should do what they’re supposed to do, and no more. If we are trying to protect small private businesses then business property relief should only cover small private businesses. Cap the relief at a generous but sensible level (£1m?). Exclude all forms of listed security2probably with the £1m capped relief still available to the original owner of the business, before it was listed, if they continue to hold the listed shares. Job done.
Given the high cost of BPR, this could raise a serious amount of money, and could fund a reduction in what is (by international standards) quite a high tax rate3We can ballpark this: HMRC stats show the exemption costs £1bn, and on average it’s applying to £780k of property. So we’d save c£500m if the exemption was capped at £1m. That would fund a 2% cut in the rate. And that’s just the start..
None of this is legal advice. Anyone stupid enough to plan their tax affairs on this basis deserves everything they get. Anyone wanting impartial and clear advice on how to avoid inheritance tax should go to this well respected independent adviser.