Estate Planning Guide

The new risk to capital conditions depend on HMRC taking a ‘reasonable’ view as to whether an investment has been structured to provide a low-risk return for investors. There are two overarching principles to the risk to capital condition, and an investment must meet both parts: 1) The company in which the investment is made must have objectives to grow and develop over the long term (ostensibly already required as a result of rules changes in 2015) and 2) The investment must carry a significant risk that the investor will lose more capital than they gain as a return (including any tax relief). HMRC (draft at this stage) guidance refers to, among other things, new limitations on the use of ‘special purpose vehicles’ and subcontracting, the use of assets that could be used to secure finance, considering any ‘assured’ income streams and fragmented structures using multiple companies carrying out similar activities. Since investments will be looked at ‘in the round’, it is not yet fully clear how and under what circumstances, some risk mitigation strategies may continue to be allowed within EIS qualifying investments. It is clear, though, that the risk profile for EIS investments will be increased. The risk to capital conditions came into effect with Finance Act 2018, which was enacted on 15 March 2018. However, the principles were implemented by HMRC immediately for all EIS advance assurance applications submitted from December 2017 (‘advance assurance’ is a mechanism for having HMRC give their view, in advance of a share issue, as to whether the shares to be issued are regarded by them as meeting the requirements for EIS). The risk to capital conditions apply to SEIS, EIS and VCT investments equally. As mentioned, EIS qualifying investments will generally qualify for BR (subject to a minimum holding period and any ‘excepted assets’) because the qualifying trades for EIS purposes are very similar to those which qualify for BR. In general terms, clients seeking to mitigate IHT may be relatively cautious and therefore perhaps not natural EIS investors. In the past, EIS managers were able to limit the risk profile by investing in EIS companies that were backed by ownership of real assets or with relatively strong and predictable cashflows derived from contractual arrangements with reasonably reliable sources at some time in the future. However, the extent to which this is now possible is likely to be severely restricted by the prohibition on capital preservation EIS structures (via the new ‘risk to capital’ conditions) as referred to earlier in this section. EIS and BR are sometimes used in combination - if clients have surplus investable assets, an EIS investment may be used to maximise the IT relief, or defer tax on capital gains elsewhere, and the remainder is placed into a BR product for the IHT mitigation. Younger investors who may have used up their ISA and pensions contributions limits, who are looking for tax efficient methods to continue to grow their wealth, while starting their estate planning journey, may also find EIS with higher risk/ reward profiles of interest. But if the objective is IHT relief while retaining access to the funds, and the risk appetite is lower, then BR should be preferred over EIS (or SEIS, explained in the next section). EIS and SEIS investments are sometimes referred to as funds. While EIS and SEIS investments can be set up as Alternative Investment Funds (AIFs), many are not technically pooled investment vehicles but rather a series of investments in individual EIS qualifying companies which are collectively referred to as a ‘fund’. In effect the management team behind the fund provide a 59 58 ESTATE PLANNING OPTIONS ESTATE PLANNING OPTIONS The MICAP Fund Finder can be a useful research tool for EIS and SEIS investments. www.micap.com discretionary investment management service within the parameters of a common investment policy for all investors. SEIS Seed EIS is a tax relief for start-ups introduced by the Finance Act 2012. SEIS is a derivative of EIS and its aim is to attract seed investment in early stage companies. By their nature, these companies are generally higher risk investments and so the tax reliefs on a SEIS investment are more generous. The trade of SEIS investee companies must be less than two years old, with gross assets of £200,000 or less and no more than 25 employees. The company must not have had any investment from a Venture Capital Trust or issued any shares under EIS. In exchange for investing up to £100,000 in any tax year investors potentially benefit from: • Immediate IT relief at a rate of 50% (limited to the amount that reduces the individual’s income tax liability to nil). • For CGT relief to be available IT must have been claimed and received and must not subsequently have been withdrawn. • Reinvestment relief of 50% of the gain when a capital gain is reinvested into a SEIS qualifying company. • Loss relief against IT or CGT for losses made on disposals at any time. This can be set against the investor’s IT in the year of disposal or the previous year, or against CGT in the year of disposal or carried forward. As with EIS, the SEIS investment will qualify for IHT exemption after a holding period of two years provided the investment is held at the time of death. Forestry or Agricultural assets Commercially-managed woodland and/ or farms should qualify for 100% relief from IHT after two years. AR takes precedence over BR and applies to the agricultural value of assets although qualifying businesses could qualify for AR and BR. Any increase in the value of timber and plantations is exempt from CGT and income generated from the ownership of commercial woodlands is also generally exempt from IT, making forestry a very tax efficient option. Nonetheless, where investments receive income from interest and rents, that income would potentially be taxable. The client retains ultimate control and full beneficial ownership of the investment and is therefore able to access the full amount of capital held within the portfolio if required. However, forestry and farming can be relatively illiquid and it may not be possible to realise an investment until the underlying property is sold. Some managers may be able to offer a matched bargain basis but their ability to do so obviously depends upon demand.