KAIKAI

A senior married couple in their 70s study inheritance tax documents sitting down in their living room at home.

Investing in certain businesses can be a canny way to cut an inheritance tax (IHT) bill.

Back in 1976, business property relief was introduced to help business owners pass shares on to family members when they die. The idea was it would spare the younger generation a tax bill that would effectively force them to sell or break up the family business.

Roll on 50 years and BPR – or business relief (BR) as it’s now known – has evolved, and investors in any qualifying business can pass on their shares IHT-free, so long as they have held them for two years.

To bring the benefits of BR to a wider number of people, numerous business relief funds have sprung up in the past 10 to 15 years, offering investors direct access to a portfolio of qualifying businesses, to help them mitigate an IHT bill.

But while these funds have proved popular, they’re also risky, as highlighted by recent problems with the Octopus Inheritance Tax Service, which was forced to suspend withdrawals in July.

We’ve spoken to financial advisers and tax experts to explain how business relief works and whether these funds can still be relied upon as an effective estate-planning tool.

What is business relief?

Business relief effectively reduces the value of a business or its assets when inheritance tax is being calculated, and it applies to owners and shareholders.

After two years, qualifying holdings worth up to £2.5m per person are eligible for 100pc relief, reducing to 50pc on any remainder.

But not every business is eligible. “To qualify for business relief, a business must meet certain criteria, including being a trading business rather than an investment company,” explained Hayden Fisher, a financial adviser at Shackleton Advisers.

“Typically, these are smaller, non-listed businesses. An investor could not simply buy shares in a large listed company such as HSBC and expect to qualify for the relief... Certain AIM-listed companies can qualify, albeit they only receive 50pc relief since April 6.”

How do BR funds work?

Business relief funds offer investors access to a portfolio of qualifying shares, with a target return of between 2pc and 4pc.

Ian Dyall, the head of estate planning at Evelyn Partners, said: “The sectors selected typically prioritise asset-backing and predictable revenue streams over investment gains, so they tend to provide less potential for growth but also less volatility.

“That said, you are still investing in smaller unlisted companies and any investment in small, illiquid companies carries increased risk.”

Typical sectors are likely to include: renewable energy, infrastructure, property and housing – including retirement living – finance for property development, fibre broadband, and lending and leasing in the public and private sector.

Adam Vanstone, a chartered financial planner at Chester Rose, said: “For example, Octopus’s BR business invests through Fern Trading, whose activities include renewable energy, fibre infrastructure and property lending and house building. Downing’s unquoted strategies invest in activities including property development, public sector financing, renewable energy and infrastructure.”

Mr Fisher added: “Some companies purchase assets such as medical equipment or ambulances and lease them back to organisations including the NHS. These businesses tend to offer lower yields but can benefit from lower counterparty risk because they are dealing with government-backed organisations.”

What happened at Octopus Investments?

Octopus Investments is one of the most well-known providers of BR funds.

But back in July, the Octopus Inheritance Tax Service informed its 18,000 investors that the fund had been frozen and that withdrawals were blocked while it worked on a deal to acquire Platform X, the wholesale arm of TalkTalk.

The deal has since fallen through, but the fund is being restructured so that investors will be able to access their money, although Octopus has warned that “withdrawals cannot be guaranteed”.

Mr Fisher said it was this exposure to fibre broadband infrastructure that was causing much of its problems.

“Business relief strategies generally aim to deliver relatively steady positive returns through diversified portfolios of trading businesses. While many competitors have generated returns of around 3pc to 4pc annually over long periods, Octopus has experienced three consecutive negative years, which is unusual for this part of the market.

“One of the distinguishing features of the Octopus strategy is the scale of its exposure to fibre broadband. Around 38pc of the portfolio is invested in fibre broadband businesses, alongside renewable energy assets and lending-related activities.”

But while the broadband issue seems to be unique to Octopus, Mr Dyall said there are other challenges that are affecting the market as a whole.

“There has been pressure on the housebuilders in recent years with higher interest rates, higher build costs and higher national insurance bills. This is one of the key areas that many BR companies focus on, including Octopus.

“Renewable energy, another significant area of investment, has also had its challenges with volatility in the energy markets and a change in government subsidies.”

Do investors in Octopus need to worry?

It’s a worrying time for investors in Octopus – who can do little now but sit and wait.

Mr Fisher said: “Investors should understand that the recent losses largely reflect the reassessment of the fibre broadband investments.

“The key concern now is liquidity. If large numbers of investors seek to redeem once withdrawals reopen, the company may need to find ways to meet those requests.”

Many funds will be able to manage investor withdrawals with incoming deposits, cash reserves and loan repayments. This should mean they don’t need to dispose of the funds’ assets.

He added: “The concern arises if significant redemptions require the sale of long-term assets such as infrastructure projects, particularly in circumstances where the market knows those assets may need to be sold.

“What providers generally want to avoid is being forced to sell infrastructure assets quickly, as that can affect valuations and potentially result in assets being sold below what might otherwise be considered fair value.”

As such, investors will need to talk to their financial planners and decide whether to remain invested, or join the redemption queue.

However, it’s important to note that if you do sell up, you’ll lose the tax benefits, unless you reinvest the proceeds in another qualifying investment within the required timeframe.

What about investors in other BR funds?

Investors in other BR funds may understandably have concerns too.

However, Mr Fisher thinks the challenges Octopus Investments is facing are not representative of the wider market.

He said the concerns stemmed from concentrated exposure to a single asset, leverage and the cost of rolling out the required infrastructure.

“Many competing providers either have broader diversification across multiple asset classes or no fibre broadband exposure at all, with some focusing predominantly on lending-based strategies. Others include exposure to areas such as renewable energy, forestry and other asset-backed activities.”

He added: “Importantly, other providers are not necessarily negative on fibre broadband as an asset class. Some continue to see the long-term outlook as positive but are reducing future exposure because of investor sentiment rather than concerns about the underlying sector.”

Is a BR fund still a worthwhile strategy?

In the right circumstances, our experts are agreed that BR funds can be an effective estate-planning tool.

In particular, Mr Vanstone said business relief offers two distinct advantages:

Holdings only take two years to become IHT-free.
Individuals can maintain ownership and control over their investment.

“This can offer an alternative to simply giving assets away,” he explained. “These have to be outright, with no ownership retained by the donor, and any inheritance tax benefit will usually only apply after seven years, with taper relief applying sooner for larger gifts.

“The two years can be especially powerful for older clients or those in ill health, who may not survive for seven years. Or even for those who have lost mental capacity where there is a property and financial lasting power of attorney in place, with the attorneys able to consider using BR solutions.”

However, he also stressed this should always be done with a solicitor and adviser, to ensure the rules are followed and any investments are appropriate.

These funds can be particularly helpful if you’ve sold a business too, said Mr Dyall. “For business owners who have sold their business, BR investments can be really valuable. If they reinvest the proceeds of the business sale into BR investments within three years, they can use replacement relief, which means the investment will immediately benefit from 100pc relief on the first £2.5m and 50pc relief on the remainder.

“The shares can then be given either to an individual or to a trust, and provided the recipient holds the shares for seven years before selling, the value remains outside the business owner’s estate for inheritance tax. Even if the investment reduces in value slightly, the 40pc IHT saving will more than compensate for the loss.”

The risk of investing in BR funds can also be managed, to a degree, by investing in multiple BR funds and ensuring you have sufficient assets elsewhere so that you don’t need to make a withdrawal at the wrong time.

And while there will always be the risk that legislation could change, the process for claiming BR is reliable.

Mr Fisher said: “Business relief investments also have a long-established track record in practice. Thousands of business relief claims have progressed through the HMRC probate process without challenge, giving advisers confidence in the relief where qualifying conditions have been met.”

But despite the benefits, wealthy retirees shouldn’t hang their hats on BR funds: they are not a mass-market solution to inheritance tax woes.

Mr Dyall said you should always explore other options first, such as giving gifts, spending and maximising the nil-rate band with well-written wills, before you even consider higher-risk strategies such as investing in illiquid assets.

“It is easy to get fixated on the potential tax savings available and overlook the fact that you are investing in smaller, unlisted companies,” he warned.

“BR investments should be used as part of a broader overall plan to mitigate tax. Many people are forced to consider higher-risk solutions, such as BR investments, because they leave the planning to the last minute, or are not keen on losing access to their money by making gifts.”