Ten years on – managing the impact of periodic charges on trust investments

It is ten years since the relevant property regime was extended beyond discretionary trusts. With many clients now facing periodic charges for the first time, is it time to look at Business Property Relief investments as a potential solution?

This blog is aimed at qualified financial advisers. It should not be construed as financial advice and it should not be used as the basis for any investment decisions. Investments with Oxford Capital should only be made on the basis of our full Information Packs and application documents.

For advisers in the estate planning market, 22 March 2006 will always be remembered as the date the landscape for trust based planning changed significantly.

Prior to this date, the periodic and exit charges of the relevant property regime had been limited to discretionary trusts. Assets in a trust such as money, shares, houses or land are classed as ‘relevant property’. Most property held in trusts counts as relevant property.

In the March 2006 Budget the relevant property regime was extended to include other types of trust, including interest in possession trusts. The changes were wide reaching, with only bare trusts, together with those which conferred an immediate post death interest (IPDI) and those for certain vulnerable beneficiaries, remaining outside the relevant property regime.

The immediate impact of these changes was for clients to limit the value of transfers to within the value of the available nil rate band, to avoid an initial entry charge (typically 20% of the excess). Now, ten years on from the changes, trustees are having to consider the impact of the ten-yearly periodic charge (also referred to as the principal charge) for the first time.

Because of rising asset values, combined with a nil rate band which has been frozen since April 2009, a significant number of trusts will now hold assets with values in excess of the nil rate band and are facing an IHT charge of 6% on the excess.

Having received advice on creating the trust, many clients, and their trustees, will now be returning to their adviser seeking guidance.

Reporting requirements
Reminding trustees of their obligation to report to HMRC is vital.

On all occasions, where the value of the trust fund exceeds the value of the available nil rate band, the trustees are required to submit an account to HMRC within six months of the anniversary date using forms IHT 100 and IHT 100d. Any tax due is payable by the same date.

It is also important to note that where the trust fund comprises assets other than cash or quoted stocks and shares, there is a requirement to submit an account where the trust fund exceeds 80% of the nil rate band – even when there is no tax to be paid.

Calculating the charge.
The calculation for the 10-yearly charge is complicated. Before you can begin, you’ll need the following information:

  • the value of the relevant property in the trust on the day before the 10-year anniversary.
  • the value – at the date it entered the trust – of any trust property that has not been relevant property at any time while in the trust.
  • the value of any property in any other trust (except wholly charitable trusts) that the settlor (creator of the trust) set up on the same date as this trust.
  • the value of any transfers subject to Inheritance Tax (whether into trusts or not) that the settlor made in the 7 years before this trust was set up.
  • the value of any transfers – at the date they were transferred – of relevant property out of the trust within the last 10 years.
  • whether any of the relevant property was relevant property in the trust for less than the last 10 years.

The charge itself is based on the net value of any relevant property in the trust on the day before that anniversary. To arrive at the net value, debts and reliefs such as Business or Agricultural Property Relief should be deducted.

Mitigating steps
In order to escape the 10-yearly periodic charge, it is often thought that a timely distribution of capital, reducing the value of the fund below the available nil rate band, is all that is required. Unfortunately, unless the trust fund is distributed in full, this would not work. Any partial distribution of capital within the first ten years is taken into account in the calculation.

Where time allows, an alternative option could be to invest a proportion of the trust fund into assets that qualify for Business Property Relief (BPR). Provided they have been held for at least two years at the time of the ten year anniversary, the value of the BPR qualifying asset is reduced by either 50% or 100% (depending on the nature of the asset held).

It is also worth mentioning that, in addition to helping mitigating the impact of ten yearly periodic charges, BPR can also provide a mechanism through which to manage initial entry charges when making larger transfers into a relevant property trust.

By investing in BPR qualifying assets, once they have been held for two years, it is possible to transfer these assets into trust and benefit from the relief. Where BPR is available at 100%, it is theoretically possible to transfer an unlimited amount into a relevant property trust without incurring a 20% initial charge. Once in trust, it is possible to replace the BPR assets, however, care is needed to ensure that the impact of periodic charges, and the death of the settlor within seven years of the transfer, are fully considered.

BPR assets as a trustee investment

Introduced in 1976, BPR has become a mainstream solution for many private clients and is increasingly being used by trustees.

Prior to making any investment, it is important to establish whether the trustees have the appropriate powers. One of their primary duties is to ensure they manage the trust in accordance with powers and provisions set out in the trust deed, together with their statutory powers.

Whilst most trustees enjoy wide investment powers, it is also important to consider the statutory duty of care introduced by Trustee Act 2000. This requires trustees to exercise reasonable care and skill when considering investment matters, to ensure the trust fund is invested in a suitable manner, with appropriate diversification.

It is possible to access BPR-qualifying investments in many forms that do not require the trustees to be actively involved in running the business. By investing directly in businesses that qualify for BPR, it is possible to add further diversification to the trust fund by accessing asset classes that may not currently be represented and which are often uncorrelated.

A number of investment management firms have developed investment opportunities designed to help investors access the benefits of BPR. These investments typically fall into two categories.

  • AIM portfolios – One quirk of the BPR rules is that shares in companies listed on the Alternative Investment Market (AIM) are considered to be unlisted, with around 70% of the companies on AIM qualifying for BPR.
  • Asset-backed IHT Investment Services – These investments usually have names such as ‘Inheritance Tax service’ or ‘Estate Planning Service’ and are designed to preserve the value of your capital rather than achieve significant returns.

The companies’ activities will vary, but often they will own and operate physical assets that generate regular and preferably stable revenues. Examples could include care homes, nursery schools or renewable energy installations.

In conclusion, BPR can provide an effective way of mitigating ten-yearly periodic charges whilst also providing access to investment which may add additional diversification to the trust fund.

With periodic charges increasingly on trustee agendas, now may be a good time to reconsider how BPR can enhance your advice proposition. As a statutory relief, BPR can provide a non-contentious planning opportunity.

Estimated reading time: 2 min

 

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    1. If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
  2. You are unlikely to be protected if something goes wrong
    1. Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker here.
    2. Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
  3. You won’t get your money back quickly
    1. Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    2. The most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
    3. If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    1. Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    2. A good rule of thumb is not to invest more than 10% of your money in high-risk investments. https://www.fca.org.uk/investsmart/5-questions-ask-you-invest
  5. The value of your investment can be reduced
    1. The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    2. These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

 

If you are interested in learning more about how to protect yourself, visit the FCA’s website here.