HMRC plays the ageism card on IHT planning

The value of a gift for Inheritance Tax purposes is calculated not by reference to the value of what you have given away but by reference to the diminution of your estate as a result of making the gift.  This subtlety avoids evasion by making small gifts which dramatically reduce the value of one’s estate – for instance by gifting away a minor 5% shareholding which removes voting control from the donor!

 In the case of a traditional discounted gift trust the value of the gift into trust is discounted by the value of benefits retained by the donor.  So if a taxpayer gives away a £200,000 investment (normally an investment bond but in some cases unit trusts) but ‘carves out’ and retains an annual reversion of 5% or £10,000 per annum, then the value of the gift is £200,000 less the value of the retained ‘income’ rights.  The value of those rights at the point of making the gift obviously depends on how long the donor is likely to live and on assumptions about interest and inflation rates.  If the donor is likely to live 20 years (and will therefore likely receive a return of £200,000 over that period) then the discount will be very large.  The older the donor is at the time of making the gift the lower the discount will be.

 This process and valuation model is totally logical and actually reflects the accepted means of calculating the discount on such mitigation schemes.  In spite of this generally practical approach to discount valuation the technical definition is somewhat different and is enshrined in Section 160 of the Inheritance Act 1984, which puts an ‘open market value’ on any rights carved out and retained by a donor in such schemes.  Since an open market value is largely a theoretical concept – donors never actually wish to sell their ‘income’ rights – HMRC are happy to rely on the actuarial model described above.  So happy are they that they have spelt out, in guidance notes, precisely how the calculations should be made and what mortality tables should be used.

 The problem with the elderly has arisen over the last 5 years or so since when the HMRC has imposed its own interpretation of what constitutes an open market value.  They have been claiming that no discount is applicable to elderly donors because no potential open market purchaser would be able to ‘insure’ against the failure or potential loss resulting from their purchase, by taking life cover on the donor’s life (due to lack of demand there are very few opportunities to insure the lives of those aged 90 and over).  They suggest that an inability to insure means that the rights would have a nil open market value – they would be unsaleable.

 Last year a case went before the Special Commissioner because HMRC had once again disallowed an actuarial discount to a lady of 90 who had invested in just such a scheme and died several months later.  The challenge to HMRC had been sponsored by AXA Isle of Man whose scheme was involved.  There was a collective, albeit premature, sigh of relief in February following publication of a ruling by the Special Commissioner granting a compromise discount to the donor.

 On 7th February 2008 Special Commissioner, Howard Nowlan, ruled that the derisory £250 nominal discount offered by HMRC to an elderly DGT client was unreasonable. The case, the evidence presented and the ruling were all extremely important for those of us working within Inheritance Tax mitigation. 

For me the crunch here is that the legislation talks of ‘open market value’ but makes no reference to insurability.  The HMRC have been relying on standard practice of specialists like Foster & Cranfield who deal with the valuation and sale of second hand annuities and insurance policies.  Commissioner Nowlan, I am pleased to say, approached the whole issue from a more common sense perspective and noted that regardless of her potential insurability, or otherwise, there would be plenty of theoretical investors who would be prepared to take a ‘punt’ on her life at the right price – including himself!  To suggest that the lady’s retained lifetime ‘income’ stream could be valued at the final and derisory HMRC offer of £250 when that ‘income’ stream yielded a net return of £304.16 per month was nonsense.  She would only have to live for a month for the purchaser to be left in profit and whilst she was certainly of impaired health she could reasonably have been expected to live at least one month!  He did comment that a 90 year old in normal health would be expected to have a substantial life expectancy and a much larger discount would therefore be appropriate.

 It has now been reported that HMRC is still not content to accept the Special Commissioner’s compromise discount value and plans to appeal.  This is disappointing but not necessarily a surprise.  Mr Nowlan actually came up with a somewhat ‘Heath Robinson’ approach to valuing the discount which involved taking two thirds of the calculated actuarial discount and then deducting likely expenses of £1,000!  I think all of us would have preferred a straightforward acceptance of the practical and traditional approach used for those under the age of 90 and which was generally accepted until a few years ago.  Anything else amounts to ageism in its meanest form.  The graph shows a typical level of discount applicable at different ages and indicates that whilst discounts will gradually reduce with age there is no justification whatsoever for them to ‘fall off a cliff’ to nil at age 90 just because HMRC wish to arbitrarily hit those least able to defend themselves.  How can income or withdrawal rights be very valuable one week before attaining the age of 90 and have no value one week later!

 We await the appeal process with interest and hope that reason will prevail.

 In the meantime it was usefully stated in the judgement from Mr Nowlan that “it was accepted by HMRC that the 5% annual withdrawals under the policy, these being the sole entitlement of Mrs. Bower under the Trust, would be tax free and would occasion no liability for higher rate tax as “chargeable events” under the Income Tax provisions relating to insurance policies. It was also accepted that as Mrs. Bower’s rights were clearly defined, there would be no question of her being treated as having made a gift with reservation of benefit for Inheritance Tax purposes such that the whole gift would be disregarded. It was also accepted that she was not to be treated as having a life interest in the whole of the settlement and treated as owning all the settled property for Inheritance Tax purposes”.  Pre-owned asset tax would therefore also not apply. 

 In essence we have been delivered a watertight judgement about the general efficacy of Discounted Gift Schemes even if we temporarily remain in disputed territory for older clients entering such schemes.

Mark Benson,
Technical Manager, WAY Group.

Posted on 20th April, 2008 |
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Multi-manager a.k.a. unitised portfolio funds

The concept of collective investment has been around for almost a century.  Unit trust companies like M&G and Save & Prosper were pooling investor funds and investing with the benefits of economies of scale from the 1930s onwards.  The principle of collecting together investors’ moneys and then appointing a specialist stockpicker to run a large and effective fund of invested shares became very popular with the more sophisticated investing public.  Instead of having an individual portfolio which needed regular attention, large amounts of administration, including the completion of annual tax returns, and the potential for regular tax liabilities every time profits were taken, investors could suddenly buy and enjoy owning a collective fund.  The benefits were not limited simply to convenience or to putting off any tax liabilities.  The primary benefits were the ability to achieve much greater diversification than would be possible with one’s own limited portfolio and the opportunity to share in the rewards of employing a top class manager and his or her 24/7 team rather than simply your tired local stockbroker.

 In those early days investment tended to be limited to the UK market where many international companies were, in any case, listed.  As exchange controls disappeared (as late as 1979 in the UK when Margaret Thatcher opened up the markets) it then became more conventional to have some exposure to overseas companies within your mainly-UK portfolio.  It was in the ensuing decade, the 1980s, when overseas unit trusts really took off.  Specialist funds based on various markets around the world, both large and small, managed by specialist managers who were often based in those geographical areas, flourished during this time.  I recall funds investing specifically in Hong Kong, or Singapore and Malaysia becoming very popular.  During this phase your local friendly stockbroker would have progressed to setting up client portfolios, mainly comprising a range of UK blue chip shares, supplemented by two or three holdings in specialist overseas unit trusts.

 In my own case as a Licensed Dealer in Securities, back in the dim and distant early eighties, I became manager of a range of third party insurance funds.  In my view funds like these were in the vanguard of the Multi-Manager movement.  Regulation then was not even a twinkle in the Government’s eye and yet most of us were highly professional both in our motives for establishing such funds and in the way they were managed.  It was an opportunity to set up a pooled fund of investors’ money and then to invest and manage it across the world, utilising the combined skills of all the top specialist managers and funds available.  Many of those early funds (subsequently dubbed ‘broker bond funds’) were pretty effective for their unitholders.  In those early days the life companies tended to be scrupulous in their vetting of the competencies of anyone wishing to set themselves up as managers of such funds. Generally anyone appointed was extremely talented and professional.

 Unfortunately the success of such funds was their undoing.  They had generally turned in competitive performances during those early years and were attracting increasing amounts of money.  Not only that they gave advisers the opportunity to collect their clients’ assets into a more easily managed format – one which offered not only a greater sense of corporate ownership but a regular management income deducted at source and paid over by the life company.  Soon a number of commercially successful advisers, but with far less adequate skills and experience, were set up with these broker bond funds.  To compensate for their lack of skill certain insurance companies invented ways for such managers to ‘milk’ the system by indulging in historically priced switching – betting on certainties.  Of course any such benefits were always at the expense of the other unitholders in those underlying funds who suffered the cost of such historic dealing.  By this time the new Financial Services Act was in force and it was not long before broker bond funds were under the microscope.

 As one door closes another one generally opens.  Whilst the broker bond saga was brewing the more purist investment industry, comprising the unit trust companies, was developing funds which were not invested in shares but instead across a range of other specialist unit trusts – the fund of funds unit trust was born.  Initially such funds were only permitted to buy underlying funds on a charge-free basis in an attempt to avoid double-charging.  Fortunately it was not long before rule changes were introduced into the administration of such trusts whereby fund of funds unit trusts were permitted to buy underlying funds at ‘best’ rather than at cost.  This was October 1991.  Being the unit trust industry this development was seen as offering a more comprehensive means of accessing specialised markets rather than as a potential panacea for portfolio investors.

 For us portfolio-style managers, however, it offered an even more effective means of delivering collective portfolio management than was available from the old broker bond funds.  The costs were lower and the potential tax savings were even greater.  Firms like Old Mutual and what subsequently became Capita, started offering their unit trust administration structures to third parties who wished to manage their various clients portfolios on a more efficient, contemporary and effective basis.  Firms like WAY have come in later offering even more specialised services whereby third party managers can access sophisticated financial planning structures underpinned with their own funds and/or fund management.

 Recent bear markets and the associated volatility within funds and markets have continued to highlight the benefits of Multi-Manager style investment in the hands of competent and independent managers.  More recent changes in fund rules permitting greater mixing of asset classes has improved the scene even more, allowing the professional Multi-Manager to utilise all the important funds, managers, assets, asset classes and financial instruments to generate competitive returns with low volatility.  We must not allow this success to be the undoing of the new breed of third party MultiManagers just as we did with broker bond funds.

 In reality TCF dictates that we all manage our clients’ assets in the most effective and fair manner possible.  So long as MultiManager funds are established with very clear investment mandates and are managed appropriately by fully-qualified and top-class managers they will go from strength to strength.  Long live the MultiManager Fund!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Note: WAY Fund Managers has recently launched a new Multi-Manager fund, the WAY MA Growth Portfolio, managed by T. Bailey Asset Management.  WAY Fund Managers also acts as host ACD to several third party unit trusts under the Elite banner.

Posted on 1st April, 2008 |
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