IHT Mitigation

The demand for Inheritance Tax (IHT) planning has increased over recent years as more Estates are becoming liable to IHT as a consequence of asset price inflation and the freezing of the IHT nil rate bands and exempt gifting allowances.

This has led to the introduction of a range of innovative Business Relief schemes (previously known as BPR, Business Property Relief), which provide an exemption from IHT after a two-year holding period (providing the assets are held on the date of death), whilst also enabling investors to retain control and flexibility to realise the assets if their financial circumstances change.

There are two type of Business Relief (BR) scheme – AIM and Generalist. We consider both schemes to be ‘high’ risk investments as they are invested in an illiquid and potentially volatile asset class. It is important to understand the risks as Generalist BR schemes are often viewed as ‘lower’ risk.

AIM BR portfolios have the advantage of being ISA eligible and offer a greater (uncapped) opportunity for capital appreciation, with investment returns linked to the wider UK equity market.

AIM portfolios also offer the potential for diversification by sector together with the ability to invest in companies listed on a regulated market, providing transparency, liquidity and pricing determined on an arms-length basis. However, on the downside, there is short-term volatility as the underlying holdings are marked-to-market on a daily basis. 

Generalist BR schemes have been promoted to overcome the short-term pricing volatility by investing in operating assets (such as social housing, care homes, solar and wind generation) and lending activities (in the form of leasing or property backed bridging loans). Whilst these activities are designed to provide stable and predictable returns, typically targeting 2-4% pa capital growth, there is the danger that clients fail to fully appreciate the risks and inherent difficulty valuing unlisted assets. 

Although the targeted returns of Generalist BR schemes are low, after a management fee of c.1% (which is often deferred and contingent upon hitting the target rate of return) and an investee monitoring fee of up to 3% (which is unconditional), a degree of leverage is required. Whilst, to date, Generalist BR schemes have largely achieved the target return this has been in a zero/low interest rate environment, which has reduced the cost of debt and supported asset values due to a low discount rate. It is also worth noting, a higher interest rate and more unstable economic environment increases the default risk associated with the lending activities. Furthermore, over recent years the UK Government has reduced the level of subsidies associated with renewable energy and wholesale electricity prices have fallen substantially from the 2022 peak. This will undoubtedly reduce the future returns. 

Generalist BR schemes also suffer from a lack of transparency and oversight, with information limited to Companies House and the provider’s fact sheet. There is also a potential conflict of interest in how the assets are valued, as typically the annual management fee is only paid if the target return is achieved. More recently, the difficulty with valuing unquoted assets, even when they are deemed low risk, has become evident with the difficulties at ThomasLloyd Energy Impact Trust (renamed Asian Energy Impact Trust), Home REIT and Gresham House Energy Storage Fund providing a timely reminder of the risks. Finally, liquidity with Generalist BR schemes is limited to the investment manager providing a matched bargain, which may become more difficult if outflows outweigh inflows.

What about the Budget Changes?

Clearly, the announcements made in the recent Budget are most unwelcome for those seeking to maximise the inheritance received by their chosen beneficiaries, especially with unused Defined Contribution pension assets falling into scope.

From April 2026 Business Asset relief at 100% will be available but only up to a combined total of £1 million (Agricultural and Business Asset relief), amounts in excess of £1 million will benefit from 50% relief.

AIM shares hold their privileged IHT tax status because they are not listed on a recognised stock exchange. They are, however, caught by the proposed legislation because they are listed on the AIM, a secondary market where they can be bought and sold.

While business relief will still be available at 100% for the first £1 million of qualifying business assets, this new combined allowance for business and agricultural relief will not apply to AIM shares.

Looking ahead, 100% relief will still be given on eligible shares held for two years where death occurs before April 2026. Subsequently, individuals will pay 20% IHT on qualifying AIM shares (above the nil rate band).

Why seven years may still be the ‘magic number’ for IHT relief

Like any good comparison designed to tell a story, there has to be some general assumptions made, which may or may not pan out in reality, but these are based on historic data (which should not be taken as prediction of future returns).

In this case study I am looking at Joe, a 77 year old widower who has surplus capital (not needed to maintain his lifestyle) of £500,000 that he feels more comfortable having access to in case of dire emergency, rather than gifting it to his grandchildren (who are likely to blow the lot) or gift to his children as it would only compound their IHT position.

The key assumptions used here are that (1) CAM’s long term AIM portfolio performance of 7% a year (net of fees) continues as a straight line annual returns (almost impossible given the volatility of the AIM market) and (2) the return on a Business Asset relief Investment is 3% per annum after costs and fees.

Ater 2 years, the relief from IHT is 50% for AIM and 100% for BR (up to £1 million).