Monthly Archives: June 2014

IHT – The voluntary tax

Ever since 1694 the UK government has considered death as a sensible time to put its hand in our pockets by taxing the estate left behind. By the time the modern system was introduced in 1894, the number of duties and taxes had multiplied to 5: a legacy duty, a succession duty, a probate duty, the accounts duty (an anti-avoidance tax on gifts) and a Temporary Estate duty. From that time the basic principles of a progressive tax triggered by death have been unchanged. Ever since tax advisers have tried to help keep your hard-earned wealth away from the Chancellor.                                                                       

The most obvious way of avoiding the burden is to emigrate! The next most obvious way is to give away what you can. Children and charities are often mentioned in this context and as long as you stay alive long enough or do it in affordable dollops (out of ordinary income) you can give away everything you own. There are possible drawbacks, ask King Lear. The same effect can, of course, be achieved in terms of tax minimisation by spending the money on fast cars, fast living and slow horses. If you manage to spend it all you do not need a will, but for most people drawing up a will and considering what their spouse and other dependants will inherit is a first and extremely important step.  Even if you plan to leave the country or give it all away you should have a will as the grim reaper may call before you have done either.                                                                                       

Trusts can own various assets, and again this approach has been employed for generations. Unfortunately the Chancellor now takes a large share regularly and the net effect of much of the tax planning of recent decades has just been to give him easily taxable assets. But trusts may still have a place in planning, particularly for the care of the disabled.

Business assets include farms and forests and many businesses ( not financial, investment or property) attract relief if in a private company. A portfolio of stocks listed on the Alternative Investment Market (AIM) counts as a business asset with 100% relief.

Consider giving away what you can easily afford at an early stage; only when you have done this should you think about other ways of minimising taxes. The traditional period for gifts to become wholly exempt is 7 years but among other ideas for taxing gifts the possibility of taxing accumulated lifetime gifts in the hands of the recipient has waxed and waned so make any gifts at the earliest possible date. But keep enough for a nursing home in your declining years; you and your heirs will both feel better if you can look after yourself. If you have an income which exceeds your expenditure then giving away the surplus is simple and lies outside the lifetime gifts regime.

Exile may be effective but having seen many of those who move to sunnier climes return because they did not want to die abroad, missed grandchildren or wanted to have the NHS around them be certain that you really want to leave permanently. The outstanding bargains in the tax saving arena are the business property reliefs. Think about how you can maximise the amounts in such ventures.

Finally there are two very important points which are as true now as they were when the first estate duties were designed. The first is that it is a very easy tax to collect because death is difficult for the most avid tax avoider to hide. Secondly, it is the most painless tax to collect because the victims are not in a position to object, or really care too much. So death duties will not go away.

Inheritance Tax is charged on certain lifetime gifts, on the value of an estate at death and on certain transfers into and out of trusts.

No tax is payable until cumulative transfers over a seven year period, whether lifetime or on death, exceed £325,000 for individuals or £650,000 for married couples or civil partners (effective up to and including 2014/2015 tax year). The rate is 40% on death and 20% for chargeable lifetime transfers, payable immediately if the value of such transfers is above the Nil Rate Band. There are certain transfers, which are not chargeable.  Broadly these are:

  • Transfers to a UK domiciled spouse.
  • Transfers up to £55,000 in total to a non-domiciled spouse.
  • Transfers to charities.
  • Transfers to political parties.
  • Lifetime transfers to an individual, or an absolute trust after which the transferor lives for at least seven years and contain no reservation of benefit by the donor, these are known as “Potentially Exempt Transfers”.
  • Lifetime transfers out of income which do not reduce capital i.e. one does not have to resort to capital to supplement diminished income.
  • The first £3,000 of a lifetime transfer in any tax year is exempt. This exemption can be carried forward for one tax year if unused.
  • Lifetime gifts to any person that do not exceed £250 in a tax year.
  • Lifetime gifts in consideration of marriage. The exempt amounts are:

£5,000 from parents,

£2,500 from grandparents, and

£1,000 from others.

In addition, Business Property Relief and Agricultural Property Relief may allow business owners and farmers to make IHT-free gifts of some of their business interests.

Graham Clark
Certified Financial Planner
01603 692750


Stocks in Focus: Fidelity Special Values

This week I have looked at Fidelity Special Values (FSV), a £500m investment trust that has been managed by Alex Wright since September 2012.

FSV aims to achieve long-term capital growth for investors from an actively managed portfolio of predominantly UK-listed special situations (companies of any size that are undergoing a turnaround or some other change that the market has failed to properly value. Since Mr Wright’s appointment as manager, FSV’s share price has risen by an impressive 71% compared with 21% from the FTSE All Share Index. However, some investors have expressed concern that he has recently taken on too much; indeed, having taken over the £2.9bn Special Situations open-ended fund from Sanjeev Shah in January this year, Mr Wright is now responsible for about £4bn of assets at Fidelity. Responding to these concerns at a recent investor meeting, Mr Wright reassured that Fidelity is providing him with the resources and support that he needs to continue to manage his funds effectively, including a reduction in the number of hours he spends marketing them.

At the time of writing, FSV is trading at a small discount to the value of its net assets and, with markets close to all-time-highs, it will be interesting to where Mr Wright sees pockets of value going forward given his contrarian style.

Points of View: Rising Interest Rates

While I usually highlight a particular company in these articles, this week I have taken a look at a macroeconomic issue.  Mark Carney has announced that interest rates could rise ‘sooner than expected’.  He made the announcement on Thursday but stressed that by raising interest rates he was keen not to damage the economic recovery.  The theory is that earlier and more gradual increases to interest rates would make the process of adjustment easier.  This goes against earlier guidance, as last year Mr Carney suggested that rates would remain at 0.5% until 2016.  Following this announcement it is widely thought that Mr Carney will increase interest rates in November to 0.75%.

Since the initial increase in interest rates is likely to be 25bps or less, most companies are expected to be able to cope without undue strain. However there is concern that it could affect them indirectly at a consumer level.  Household income would suffer, as two thirds of all mortgage payments are linked to interest rates.  Since mortgage payments are such a large part of most people’s outgoings, even a small increase in interest rates could affect their ability to meet their liabilities, particularly those households with high loan to income mortgages.

Mr Carney has indicated that any increase in interest rates will be made cautiously and clearly recognises the potential dangers of excessively rapid tightening to both companies and consumers.

Stocks in Focus: Tesco

Tesco last week announced falling sales in the first quarter. The retailer’s woes are well known in the market and the company certainly has some sizeable challenges to overcome.  With difficulties in some overseas markets (notably South Korea and the failed assault on the US), the competitive squeeze from Waitrose and M&S at one end and the hard discounters (Aldi and Lidl) at the other, fears of a price war putting pressure on Tesco’s high margins and the threat of online competition have all combined in a perfect storm.

The company’s strengths lie in its massive UK footprint, underpinned by land assets, its potential of leveraging of the customer base by offering additional services (such as  Tesco Bank) and – until the last couple of years – a good record of shareholder returns. The past history of strong performance with high margins offers investors some hope that the company can return to its winning ways, although many feel that a management shake-up would be required for this to occur.

For contrarian investors, a potential turnaround story such as this can be attractive, particularly when sentiment surrounding the stock is as negative as it is today. Of course, it is not without risk.  The unknown factor with Tesco is the degree to which the market has priced in ongoing bad news, which may continue for a little while yet.  If company sales and market share  continue to fall, the share price will too.  One could argue that with a 5% dividend yield, investors are now being paid to tolerate the volatility that will inevitably accompany the share price in the coming months.  As part of a well-diversified portfolio, Tesco could offer the chance of superior returns but one must always keep an careful  eye on these investments as the investment case can change very quickly.

Reduced Rate IHT for Charitable Giving

If your estate is worth over £325,000 when you die Inheritance Tax may be due. From 6 April 2012, if you leave 10 per cent of your estate to charity the tax due may be paid at a reduced rate of 36 per cent instead of 40 per cent.

Any gifts you make to a ‘qualifying’ charity – during your lifetime or in your will – will be exempt from Inheritance Tax.

In order to qualify for the reduced rate you must leave at least 10 per cent of the net value of your estate to a qualifying charity.

The net value of your estate is the sum of all the assets after deducting any debts, liabilities, reliefs, exemptions and the nil-rate band.

A qualifying charity is an organisation that’s recognised as a charity for tax purposes by HM Revenue & Customs (HMRC).

There are different ways that you can own assets such as money, land or buildings and the way that you own the assets and with who, affects the way they’re treated when deciding whether the reduced rate of tax can apply.

To see how much you need to leave to charity to qualify or whether your estate can pay a reduced rate of Inheritance Tax because of a charitable donation left in a will, you have to work out the value of each of the separate parts of an estate. These are known as ‘components’. It’s possible that one part of your estate may pay Inheritance Tax at 36 per cent and another pay tax at the full rate of 40 per cent.

To work out whether the reduced rate applies, your estate and your assets are broken down into three components as follows:

  • assets that you own jointly with someone else that pass by ‘survivorship’
  • assets in trust
  • assets that you own outright or as tenants in common with someone else

A simple example with one estate component is outlined below.

Robert died on 17 June 2012 leaving an estate valued at £750,000 after the deduction of liabilities. He leaves £50,000 to the National Trust in his will.

  • Step 1 – deduct the £50,000 National Trust donation from £750,000 (the net estate). This leaves a figure of £700,000.
  • Step 2 – deduct £325,000 (Inheritance Tax nil rate band) from £700,000. This leaves a figure of £375,000.
  • Step 3 – add £50,000 (the value of the National Trust donation) back to £375,000. This gives a figure of £425,000 – the ‘baseline amount’.

10 per cent of the estate of £425,000 is £42,500. This estate qualifies for the reduced rate of Inheritance Tax because the charitable donation of £50,000 is more than 10 per cent of the ‘baseline amount’.

The Inheritance Tax payable will be £135,000 compared to £150,000 if Inheritance Tax was paid at the full rate.

Stocks in Focus: Fundsmith

This week, I am focusing on fund management boutique Fundsmith and the launch of their new investment trust, Fundsmith Emerging Equities Trust (FEET), at the end of this month.

Fundsmith was established by Terry Smith in 2010 with the aim of delivering superior investment performance in a straightforward, uncomplicated manner and to achieve this at an attractive cost. Terry takes a long-term view to investment, focusing on high-quality, consumer-orientated global stocks held within a concentrated portfolio. His successful strategy – already employed in his £2bn Fundsmith Equity Fund – will also be applied to FEET, for which Fundsmith is attempting to raise between £100m and £250m.

To date, Terry has refrained from acquiring shares in companies based in emerging markets in his Equity Fund – despite impressive capital growth over the longer-term – due to concerns over their liquidity. While the Equity Fund and FEET are both funds that invest in portfolios of securities, there is one key difference: their “share capital”.

Should an investor of the “open-ended” Equity Fund wish to sell their stake, the manager would have to liquidate assets within the portfolio, potentially doing so at unattractive prices if these assets are particularly illiquid. Conversely, as shares of “closed-ended” investment trusts such as FEET can simply be sold into the market, there is no such pressure on the manager to liquidate. Hence, Fundsmith has chosen the investment trust structure in the expectation that this will prove more beneficial to investors.  Time will tell if this strategy will be effective in addressing the liquidity concerns.