Darling incentivises the wrong investors

Margaret Coles is a fit and healthy 73 year old widow.  Her late husband used his Inheritance Tax Nil Rate Band by leaving a holiday property to his children. She remains fairly well off with a house, various investments including an ISA portfolio, a healthy sum on deposit and two pensions.  Her son, Raymond, helps his mother to manage her financial affairs and has suggested she take immediate advantage of the new ISA limit for older persons announced in Alastair Darling’s recent Budget. He thinks there will be a stockmarket recovery within the next few months and believes she should capture the maximum benefit by adding to her substantial ISA portfolio by investing her 2009/10 ISA allowance now.

The primary benefit of placing investments within an ISA ‘wrapper’ is that they are then permanently exempt from Capital Gains Tax (CGT) and from higher rate Income Tax. But how beneficial are these concessions in general and, in particular, to Mrs Coles? Anecdotal evidence from advisors indicate that a high proportion of ISA holders could easily hold and manage their investments perfectly well and effectively tax-free by utilising their existing annual CGT allowances. Most ISA investors, such as Mrs Coles, are not higher rate Income Tax payers and so will not suffer any further tax on dividends/distributions. So, are they needlessly investing in ISAs?

The only real beneficiaries of these tax-exempt investments are either:

•  (a)those taxpayers who invest in cash or fixed interest investments (not equities or mixed funds) and who benefit from exemption from standard rate Income Tax on those specific investments, or
•  (b)higher rate taxpayers who are already utilising their annual CGT allowances.

For these two groups the continuing concessions are very good news. In particular young, dynamic, higher-rate taxpayers saving on a monthly basis into high growth funds for school fees and other medium term commitments, and doing so with the added benefit of pound cost averaging, are likely to benefit most. Whilst Mrs Coles is interested in boosting her flagging income, which has fallen with interest rates over the last year or so, she is certainly not in the second group. Even in her search for income the benefits of Income Tax relief on currently miniscule yields are not great.

In reality the Treasury is actually misleading naïve investors into thinking there are substantial tax benefits in retaining ISA portfolios into one’s dotage, while simply ensuring that it can continue to collect large amounts of IHT from the unwitting and unprepared elderly investor. Arguably investors from their mid-sixties onwards who believe they will have an IHT liability should no longer be holding ISAs and certainly should not be buying more. What so many of them do not realise is that they will suffer a punitive IHT sting at death, whereby at the top end they and their families potentially lose a colossal 40% of their hard-earned savings. This loss completely dwarfs the often marginal annual tax benefits resulting from the ISA wrapper.

So what can Mrs Coles do to avoid IHT on her accumulated savings? The answer is simple, she should encash her ‘tax-free’ ISA and supplement the proceeds to a total of £325,000 by selling a portion of her stockmarket investments and then make a gift of the total sum to her chosen beneficiaries via a flexible reversionary trust. Although gifts into such trusts constitute an IHT taxable transfer there will be no tax so long as the gift is within the current Nil Rate Band for IHT – £325,000 per person.

Such gifts then fall out of account after 7 years and so there is an opportunity for each taxpayer to make gifts up to this level every 7 years. Mrs Coles has a life expectancy of some 13+ years and so should easily survive the first 7 year inter vivos period and might even survive a second. Even should she not survive to see her gift fall out of account, any growth (recovery) enjoyed by the gifted assets will occur outside her chargeable estate.

A good flexible IHT gift trust will offer Mrs Cole’s trustees extraordinary ongoing flexibility over the trust whereby she can be supported with regular or occasional ‘reversions’ to top up her conventional income. In her case she will certainly need to replace income from her surrendered ISAs (Capital Gains Tax exempt) and part of her share portfolio (which she was able to dispose of within her annual CGT allowance and without incurring Capital Gains Tax).  Since the assets will have been placed within a gift trust then it is proper that drawings or reversions from the trust should be made available to replace that sacrificed income. The trust wording is sufficiently flexible to also allow the trustees to continue to look after the needs of her children and grandchildren in exactly the same kind of way as before the gift.

Assuming she does live those 7 years then she will have dramatically reduced the potential IHT liability on her death.   Moreover her ‘income’ is maintained and, via her trustees, she retains tremendous flexibility over the future return of funds from the flexible trust.  The table shows that at current levels her family is likely to benefit from a tax saving of some £130,000 which completely dwarfs any conventional’ benefit she is likely to receive from her ISAs.

 

Paul Wilcox
Chairman & Technical Director, WAY Group.

Posted on 24th April, 2009 | Tags: Budget 2009, IHT, IHT Mitigation, Inheritance Tax Nil Rate Band, ISAs |
Comments: One Comment

Ken Clarke fails to stop Cameron and Osborne committing election suicide

In September 2008 I penned a piece about what I then thought was the likelihood of the Tories following through on their 2007 pledge to increase the personal Nil Rate Band (NRB) for Inheritance Tax (IHT) to £1 million.

The question of increasing the NRB was raised again with Ken Clarke on Sunday 22nd March 2009 by the BBC.  He responded by saying that ‘cutting inheritance tax would not be a high priority for an incoming Tory government’.  He went on to confirm that the Tories were still committed to increasing exemptions on IHT but that the current financial conditions meant that the ambition to increase the band to £1 million was now considered to be an ‘aspiration’.  In a later partial retraction he said ‘we are fully committed to raising the threshold for inheritance tax in the first parliament of a Conservative government.  This measure will appear in the manifesto and I support it.  We also agree that George Osborne cannot write his first budget until we have seen what we have inherited’.

On Monday 23rd March this view was refined again by a statement that confirmed that in future ‘only millionaires would pay Inheritance Tax’.

It is clear from these exchanges that my earlier suspicions that Osborne’s original intention of moving to a £1 million NRB were effectively scuppered by Darling’s inspired move to make the NRB transferable.  By avoiding any specifics over recent days it seems that the Tories are, quite understandably bearing in mind the deterioration in the economy and in government finances, leaving themselves wriggle room.

In the longer term I suspect that the Tories will either, (a) increase the personal NRB to £0.5 million and retain the new transferability rules to give every couple a joint allowance of the promised £1 million, or (b) increase the personal NRB to £1 million and remove transferability. 

However, in the short term I do not think that any major moves are likely because of the state of government finances.  It is more likely that any move towards either of the above scenarios will be made incrementally over a number of years.  The background environment has changed dramatically between 1st October 2007, when Osborne made the ‘commitment’, and today and I do not believe the electorate will accept moves to benefit the ‘wealthy’ during a period when all taxpayers are likely to be hit hard in an attempt to rebuild government finances.  As David Cameron pointed out only last week, the ‘wealthy’ will have to pay their ‘fair share’ during the economic downturn.

With asset values well down, inflation about to turn into deflation and unemployment forecast to hit 3 million in the coming year, the public will feel there is little justification at this moment for taking the wealthy out of any form of taxation!

Changes in Wealth and changes in Public Sentiment – 1st October 2007 to late March 2009
	Oct 2007	Latest 2009	Change
FTSE 100	6,506	3,843	-40%
Average House Price (Nationwide Index)	186,044	147,746	-20%
Inflation (ONS)	4.2%	0.1%	-4.1%
Bank Base Rate (Bank of England)	5.75%	0.5%	-91%
Unemployment levels (ONS)	5.2%	6.5%	+25%
Movement in unemployment since 1997 (ONS)	Lowest	Highest

 

 

Paul Wilcox
Chairman & Technical Director, WAY Group.

Posted on 23rd March, 2009 |
Comments: Have Your Say

Humanitarian aid is in our hands

Returning from Australia late in January we avoided travelling for 26 hours non-stop by taking a two day stopover in Dubai.  Having spent a miserable time being monsoon rained upon for days on end in the Whitsunday islands (discovered by James Cook, British navigator on Whit Sunday in 1770 – us Brits are nothing if not logical, albeit somewhat unimaginative) we were determined to have some last minute sun before returning to our cold and snowy shores.  Five o’clock in the morning approaching touchdown at Dubai’s new airport terminal the pilot announced that for the first time in several months it appeared to be raining in Dubai.  I was beginning to take things personally.

We had last been in Dubai just a year ago, en route to another sunspot, as we have tended to do.  It is a great stopover with good hotels, generally reliable weather and a relaxing environment to bridge the gap between 24/7 holiday and the realities of home.  We stayed, as per normal, at the Hilton Jumeirah Beach hotel just along from the ‘sail’ of the famous Al Burj.  Ten years ago this hotel stood in splendid isolation on Jumeirah beach, with unspoilt views in every direction.  Today its ten stories are completely dwarfed by the rows of 40-50 storey beachside apartments which line the new promenade directly across the road from the hotel.  We have watched these apartments being built over recent years and have been fascinated by the working practices employed by the local building companies.

 Allegedly because of the heat they run their building sites 24/7 bussing in hundreds of workers three times a day for each eight hour shift, day and night.  There has been a great deal of controversy about the extremely tough conditions endured by building workers in Dubai, most of whom come from places like Bangladesh or Pakistan.  This year we walked around all the new developments and there is no doubt that progress has slowed a great deal.  There are plenty of ‘immigrant’ workers but their numbers are vastly reduced from previous years.  The global credit famine is hitting Dubai hard.

 With a tiny Emirati population and a large but quickly shrinking ex-pat community one wonders who is going to buy the thousands of properties being built.  Most residents of Dubai (between 80% and 90% are ‘visitors’ working on short term visas) are male and working to support families elsewhere.  With the economy going through a tough time many are losing their jobs and leaving the country.  At the same time property investors around the world are pulling in their horns.  This leaves Dubai property companies selling off luxury villas and apartments at massive discounts.  Maybe more important, however, is the fate of the erstwhile imported labour who, whilst earning a pittance by western standards, relied on their sparse income to support their families in some of the poorest parts of the world.

 This reminds me of some research trips I took several years ago which later led to many heated dinner table debates about capitalism and exploitation of labour.  This has become a major social issue in the intervening years.  I visited a huge clothing factory in Bangkok in the 1990s which made women’s fashion clothes for companies like Top Shop and Marks and Spencer.  I remember visiting the quality control department run by ex-pats on behalf of M&S.  This factory employed young teenaged women who, allegedly, supported their families (who mainly lived in pretty awful conditions on the banks of the river).  They earned very little by western standards but were all nattily dressed in jeans and t-shirts or blouses, wore watches and jewellery and, bearing in mind the daily challenges of their lives, were of a surprisingly cheerful disposition.  Whilst there were no obvious abuses of workers in this particular workplace, the whole area of exploitation of poorly-paid workers in third world countries has become an ongoing scandal in contemporary life.  Even in the buoyant economic times pre-2007 the moral tensions between possible abuses on the one hand and offering people a means of climbing out of destitution on the other, were difficult to unravel.  How much more difficult is it now?

 The Financial Times recently reported (2nd February 2009) ‘more than 20 million rural migrant workers in China have lost their jobs and returned to their home villages or towns as a result of the global economic crisis, government figures revealed on Monday.  The job losses were a direct result of the global economic crisis and its impact on export-oriented manufacturers, said Chen Xiwen, director of the Office of Central Rural Work Leading Group.  He warned that the flood of unemployed migrants would pose challenges to social stability in the countryside’.

 It is a similar story across many of the poorer countries of the world.  Most of these ‘redundant’ workers have no state safety net, no social insurance, basically no hope.  And this is the awful thing about the current economic ‘crisis’.  We in the west are suffering from fear, and in some cases reduced incomes or even redundancy, but our very existence is not being threatened by this recession.  Around the world many thousands of people are facing starvation simply because western consumers have put a brake on their consumption.  Remember that something like 70% of world economic output relates to consumer spending.  No wonder economies around the world are suddenly in a mess.  We do not have to reduce our spending very much for the economy to come to a virtual halt and that is precisely what has happened. 

 As I wrote previously, the solution to this dilemma is in our hands.  Strangely there has still been no strong and charismatic leadership shown in this crisis.  I expected Barack Obama to galvanise the American people in his inauguration speech.  I expected Gordon Brown to attempt to hint at it in his speech to Congress when he recently visited Washington.  I have expected the right exhortations to come from the lips of some world leader somewhere in recent months!  But no.  The public will respond to an appropriate impassioned plea to take action to stamp on this recession.  It does not need VAT reductions.  It does not need tax rebates.  It does not need interest rate reductions (which takes spending power away from the grey economy where it is easiest spent).  It does not need public spending.  What it needs is a charismatic leader to explain to the public that they need to get back to leading normal fearless lives, where they resume their previous levels of sensible rational spending.  This will save the world.

 What the world needs now is a resumption of ‘business as usual’.  Otherwise the price to be paid by millions living in the world’s poorest nations does not bear thinking about.  Maybe we, as influencial people in our communities, should be spreading the word because it seems that no-one else is going to.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th March, 2009 |
Comments: Have Your Say

Once in a lifetime IHT planning opportunity

Anecdotal evidence seems to indicate that few advisers are working on Inheritance Tax mitigation at the present time and yet in reality the credit crunch has generated the most ideal environment for such planning for many years.  Whilst it is true that the transferable Nil Rate Band has taken a number of more modestly wealthy individuals out of the IHT trap, the number of taxpayers likely to pay this tax still appears to be substantial.  Of course, advisers are saying that their wealthy clients are more taken up with repairing their personal balance sheets (after the hits they have taken from the credit crunch and stock market rout) than they are with mitigating tax.  This is, however, a foolish approach since the credit crunch and its impact is temporary whilst the prospect of gifting one’s hard earned wealth to the Government is permanent.

I have been looking at house prices in London to get an idea of the temporary impact of the wealth destructive effects of the mortgage famine (which I believe is the real culprit in house price falls).  Looking at terraced houses, which represent the modest living accommodation of average Londoners, it seems that those living in suburbs like Camden, Fulham and Islington (even after recent substantial falls in values) still have properties worth in excess of a couple’s Nil Rate Band.  Meanwhile a couple living in Wandsworth have seen their terraced house fall from £620,000 down to £500,000.

 The other disincentive when considering IHT planning has been the dramatic falls in equity values.  During 2008 a massive 31% was wiped off the (FTSE 100) value of shares, a reversal not seen in any other year since the FTSE 100 was launched in 1984.

 These falls in personal asset values beg the question as to whether it is correct that taxpayers have become distracted from considering their potential IHT positions.  In my submission, whilst I understand the current concerns about rebuilding assets, there are very many reasons why taxpayers should be focusing on IHT mitigation at this very moment.  The main three, which I will cover individually are: (1) the seven year clock necessary to remove assets from one’s estate should be started as soon as possible; (2) the depressed value of personal assets at this time offers a ‘once in a lifetime’ opportunity to supercharge any such planning, and; (3) the availability of highly flexible schemes based on both unit trust portfolios and bonds means there is no reason to not put IHT mitigation in place as an additional benefit of normal portfolio planning.

The Seven Year Clock
Recent research (from WAY Group) indicates that taxpayers adopting IHT mitigation are doing so much later than they perhaps should to get best value from the seven year period it takes for asset transfers to fall out of one’s estate.  Men typically start planning at age 69 and women at age 72.  That leaves the average person with only one complete seven year period between starting IHT planning and when they are likely to die.  So the earlier one starts IHT planning the better to make sure one survives the seven year run-off period or even to enjoy more than one set of gifts (more than one seven year period).

Once in a lifetime opportunity
There is little doubt that today is a great time to be doing one’s IHT planning.  Why?  Because:

•         Proportionately one can remove far more from one’s estate today than a year ago, and probably in a year’s time, because of depressed values. Transfer now whilst prices are cheap.
•        There will inevitably be a recovery and assets will substantially increase in value.  Whilst nobody really believes the Halifax statistics for house price rises in January it does give some indication that there will soon be a bottom and then a recovery.  This is linked far more to the availability of mortgages (which disappeared for several months in 2008 and under Government pressure are now reappearing) than to sentiment.
•        We have seen the early green shoots of stockmarket recovery since the lows of last year and no-one should doubt the potential for a worthwhile recovery this year.
•        By moving assets into trust now, the resulting change in beneficial ownership will trigger a Capital Gains Tax (CGT) point, BUT at current depressed levels very few people will have to pay any CGT.
•         Any recovery in values, once assets are transferred, will conveniently occur outside the donor’s estate thereby saving substantial IHT on that extra value (IHT savings at 40% far outweigh any future CGT at only 18% on gains above the allowance).

With Government finances in a mess there are unlikely to be further cuts in IHT for the foreseeable future, regardless of which political party is in Government.  So there is an extremely strong case for those potentially liable to IHT to get the seven year clock ticking.

 No reason not to plan
Until a few years ago IHT planning involved putting on a financial straitjacket whereby putting assets beyond the reach of the tax man normally involved putting them beyond one’s own reach (other than possibly a fixed future ‘income’).  In addition, most traditional IHT arrangements were based on life assurance bonds and their often inconvenient attendant Income Tax status. 

 Those restrictive days have long gone and the IHT mitigation market has moved on very much in line with other contemporary developments in the investment management arena.  It is now possible to engage highly flexible trust arrangements in which trustees have extensive flexibility in passing benefits to the donor and/or beneficiaries as dictated by circumstances rather than simply by prescription.  In addition these arrangements can now contain the kind of managed portfolios investors would have held, in any case, had they not been planning for IHT.  It is now even possible for IHT-shielded portfolios to be managed on the most contemporary of investment platforms.

 The trust flexibility and investment options available today mean that the only argument for not placing an IHT mitigation trust around a client’s portfolio is the marginal extra cost of doing so which, even with trustee fees, normally works out at less than 1% per annum.

Advisers would be well advised to look afresh at contemporary IHT planning which is no longer a ‘magnum opus’ and simply represents a best practice ‘add-on’ for any portfolios managed on behalf of wealthy clients.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 13th February, 2009 |
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A tale of IHT mitigation

John and Frances Greening are facing a major dilemma regarding the death of Frances’ widowed mother in January 2008. Frances is the sole beneficiary of her mother’s Will and she was left a substantial inheritance which has unfortunately fallen in value very dramatically in the intervening period. John and Frances have been working their way through the probate process and suddenly realise that they are caught out by the credit crunch from settling the estate in the most effective manner. They are having difficulty raising funds to pay the Inheritance Tax in order to achieve the very probate which will allow them to sell assets to pay the tax. The assets in question have fallen so much in value that the effective rate of tax they could finish up having to pay is much higher than the 40% normally payable upon death. Frances’ father died nine years ago and utilised the whole of his Nil Rate Band.

There are three different problems here which combined are putting this couple in a very difficult position indeed. The challenges are:

• Mum lived in the suburbs of London in a house valued (at the date of death) at about £1.3 million. In addition she had other, financial, assets totalling a further £0.4 million. Based on a Nil Rate Band of £300,000 (as at January 2008) this would incur IHT of £560,000. So they have to find a lot of cash to pay the IHT in order to be able obtain probate to sell any assets.
• The value of the house has probably fallen by some 30% since her death and the value of the share portfolio (which was weighted towards banks with a generous exposure to builders and mining stocks) has fallen by nearer 50%. The theoretical values are therefore now £910,000 for the house and £200,000 for the shares. The house is unlikely to be saleable since similar properties in her area are just not moving. The IHT based on these lower values would be £324,000 – a huge £236,000 less than on the death values.
• There is an HMRC concession whereby falling asset prices can be re-based for probate purposes but only if they are sold by the executors within a specified period after death – 48 months for property and a challenging 12 months for other assets. To sell, the executors must have obtained probate. This is only achievable if the full tax is paid in advance and a re-base claim then made later when the assets are sold at lower prices.

The Greening’s have less than 2 months to sell the shares to establish a lower re-base value. If they manage to achieve this they will probably be well advised to re-invest any proceeds in Frances’ name straight away, to make sure they do not miss any subsequent recovery. But this assumes that they achieve probate and to do so they must pay any tax due. With Capital Gains Tax now at 18% it is better for any recovery to happen in Frances’ name rather than with the executors where any recovery will fix the IHT on the gain at 40%.

Fortunately, there is also the property instalments concession which they can use to avoid paying the full tax on Mum’s house immediately. They will have to pay 10% of any tax due to achieve probate and can then pay the remainder in another nine annual instalments with interest. This means that they can take their time selling the property and to claim any re-basing (if the house does not climb back above January’s value) so long as they sell by January 2012.

So what does this now all look like in terms of what they must do before January to achieve the optimum results – remembering that probate can take some time even once the application is in and the tax is paid? They will have to pay the full tax on the ‘other assets’ and the first instalment of tax on the property (plus a little bit of interest which becomes payable from 6 months after the date of death) before they can have access to the shares to sell them before the 12 months is up. They must work very fast to get the probate application in to make sure they get probate in time.

The calculation looks something like this:
Total Assets (£1.7m) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (the £560,000 mentioned above). This gives a marginal rate of IHT of 32.94%. This rate is applied to the separate assets, so they will have to pay £131,765 on the ‘other assets’ (32.94% of £0.4m) and £428,235 on the house (32.94% on the £1.3m) but need only pay 10% of this immediately. So to obtain probate they must submit the necessary forms and make a payment of tax on account of £174,588 (£131,765 plus £42,823).
They have to find this cash from somewhere and in the present climate that will not necessarily be easy because there are no assets available to charge to a bank (until after probate). Assuming they can raise this cash, obtain probate in time and sell the shares before the first anniversary of Mum’s death, then they can ask for the share valuations to be re-based onto an actual basis. They will then be able to obtain a partial refund from HMRC following a new calculation, as well as being able to repay the bridging finance from the share proceeds.

The new calculations will then look like this:
Total Assets (£1.5m now that the share values have been re-based) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (£480,000). This now gives a marginal rate of IHT of 32%. This rate is applied to the separate assets, so they should have paid £64,000 on the ‘other assets’ (32% of £0.2m) and £416,000 on the house (32% on the £1.3m) of which only 10% was payable immediately. So their initial tax bill should have been £105,600 and not the £174,588 they actually had to pay on account. So they should receive a refund of almost £69,000 at that point.

These potential calculations are repeated all over again if and when Mum’s house is sold for less than the original probate value. Again, there is some sense in pursuing this because John and Frances will receive an IHT refund at 40% on any reduction whilst only suffering CGT at 18% were they to reinvest and enjoy an increase in property prices.

This whole scenario simply underlines the benefit of removing assets from one’s chargeable estate early enough to avoid all of these probate challenges, quite apart from the general benefits of avoiding as much of this heinous tax as possible.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: IHT Mitigation |
Comments: One Comment

IHT and the Glenrothes effect

Labour’s surprise victory in the Glenrothes by-election (7th November 2008) has rekindled that party’s hopes of achieving re-election sometime in 2010. The reasons for the unexpected vote of confidence in Labour probably include Gordon Brown’s new reputation as financial crisis Superman as well as the apparent policy vacuum from Cameron and his front bench colleagues in relation to the current banking and economic chaos.

There has recently been some question about the future of Inheritance Tax (IHT) planning for Mr and Mrs Average. For a brief interlude the combination of falling house prices, falling stockmarket values and the promise of a couple’s £2 million Nil Rate Band from the Tories seemed to make IHT planning for all but the very wealthy somewhat less urgent.

This view is completely misplaced and has to be challenged because taxpayers need very little encouragement to be completely complacent about a tax which they will never suffer but which brings great difficulty to the next generation. An interesting and extremely difficult by-product of the recent fall in asset values, particularly house prices, is that many taxpayers that have died over the last year or two left taxable assets which have subsequently fallen dramatically in value before they were able to be sold to pay the tax.

Imagine someone having died early this year with a sizeable share portfolio focused on banks, builders and mining companies. They may be required to pay 40% tax on assets which have subsequently fallen in value by 90%. To put that into context the tax on an investment portfolio of, say, £300,000 might be £120,000 (at the full 40% assuming their Nil Rate Band was exhausted elsewhere) and yet the related portfolio may have fallen to only £30,000 in value after the dramatic market falls of the last few months. How can you realise £120,000 of tax from a portfolio worth only £30,000 – what a horrendous side effect of the recent market debacle.

This has been exacerbated for tax on properties where beneficiaries are faced with a market which has not only tumbled but in many cases has become completely static so that properties cannot be sold at all. In both of these cases there is an HMRC concession to re-base the value but it requires a sale of the assets in question by the executors within a set time period (12 months for shares) and only after the full tax has been paid to facilitate probate – so a major cash flow challenge especially in the current banking climate.

This whole new scenario is an added incentive to make sure that assets are transferred outside a taxpayer’s estate more than seven years before their demise to remove the relevance of pre and post death values. If the whole value is beyond the reach of the taxman then no tax will have to be found and therefore there will be no forced sale of assets.

So what chance is there that IHT is a thing of the past for most of us? Shadow Chancellor George Osborne was recently compromised into a confirmation of the impact of Alistair Darling’s moves on transferability of Nil Rate Bands between spouses and civil partners. Transferability combined with the Tories’ Autumn 2007.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: Glenrothes by-election, IHT Mitigation |
Comments: One Comment

Far too clever, cobber

We had left for Australia early on Boxing Day and in the rush had forgotten to buy any adaptors to convert from UK to Australian electrical sockets.  So our first stop on the way from Brisbane airport to our relatives’ house was at an electrical store to buy the necessary.  I was slightly taken aback at the cash desk when the young man asked me what on earth had happened in the UK to lead to the failure of such a great name as Woolworths.

 Little did I know that the electrical store I visited was owned by Woolworths and run by passionately loyal employees of Woolworths (Australia).  The following day we were taken to a large and very impressive supermarket – Woolworths – looking amazingly like one of our best Tesco stores in the UK.  Whilst Woolies in the UK has gone to the wall, the giant and very well-managed Australian version is actually the 22nd biggest retailer in the world, according to recent global research by accountants Deloitte.  The top three are Wal-Mart in the US, Carrefour in France and Tesco in the UK, but Woolies Australia, at almost half the size of Tesco in terms of turnover, is a real star bearing in mind the very much smaller market in which it operates.

I later learned that Woolworths, Australia, a major supermarket group, whilst owning a number of large speciality chains (such as electrical and wine stores) is also a leading brand in petrol stations, hotels and casinos.  What a very different story to their UK counterparts.  Unfortunately it all comes down to vision and quality of management.  Tesco had the vision 30 years ago to raise its game and play to the future whereas Woolworths UK remained in its post-war time warp.

 A few days later we were doing the obligatory river cruise through the beautiful and modern city of Brisbane when our attention was drawn to a massive and extremely artistic neon sign on the main wall of the Brisbane Gallery of Modern Art about half a mile away.  It gave out one huge message, the title of their current multi-media exhibition – OPTIMISM. 

 These sentiments were prevalent everywhere we went around Australia.  On a subsequent trip up the coast to an ocean resort at Noosa the local newspaper was full of opinions about the threat of recession.  Tex Pipke, head of the Cooroy Chamber of Commerce, suggested that “this community is opposed to the idea of recession in Australia, to the point that we might not participate.”  Speaking about local developments in trade and tourism over recent years he went on to say “Why would we be depressed?  We have a lot to celebrate, so let’s not go out there and participate in this recession.”

 Whilst I have been away on this antipodean trip I have had plenty of time to read the endless analysis both by competent and less competent journalists, business people, financiers, bankers and intellectuals, attempting to explain how the crazy explosion of inappropriate credit over the last decade led to the inevitable credit crunch which in turn is leading to a massive global recession.  All of this intellectualisation is fine but it fails to address the missing ingredient – what to do now.

 We have had massive sell-offs before, often following major financial dislocations in the market place.  These have involved various different sectoral difficulties over the years, the most recent being the bursting of the ‘tech bubble’ in 1999.  Each time we have managed to overcome the challenges and move forwards.  Unfortunately this time the credit crunch symptoms (in essence a sectoral difficulty) were immediately identified with the 1930’s depression and as a result we have ‘apparently’ moved directly from healthy economic world growth to a self-induced and completely unnecessary recession. 

Obviously the tightening (and often unavailability) of credit has had an impact on personal and corporate capital spending but, as an example, I needed to upgrade my own car in August 2008 and had no difficulty whatsoever in getting extremely inexpensive terms from a finance company owned by one of the big four banks (as was).  So why has the sale of motor cars fallen so dramatically over the last year?  Not just in the UK or the United States but virtually everywhere in the world (car production in France was down 8.1 per cent in November after October’s 22 per cent plunge according to Insee, France’s national statistics agency).  The knock-on effects of a slowdown in the car industry have affected many other connected industries.

 It appears to me that the whole world has gone mad.  Yes unemployment has risen but spending reductions have not been limited to those unfortunate to be out of work, everyone seems to have completely stopped spending.  As a result manufacturers have stopped ordering raw materials and retailers have stopped ordering finished goods.  Most capital spending has stopped or is stopping and everyone is cutting revenue spending.  Trade is falling off a cliff. 

 The strange thing is we are all accustomed to a certain standard of living.  With interest rates now on the floor, oil prices at almost a quarter of what they were early in 2008 and various other prices becoming competitive (Australia is now over the drought of recent years and is heading for a bumper harvest) the panic will surely ease.  Then we will be spending again, probably as early as later in 2009.  Many UK consumers have seen their disposable income rise by between £5,000 and £15,000 per annum net over the last year.  So, suddenly consumption will be up – relative to now – but everyone in business will be completely de-stocked!  There will then need to be a dramatic resumption of manufacturing/production.  So there will be a resumption of the classic ‘go’ part of the age-old ‘stop/go’ cycle and off we will go again!

 I believe Gordon Brown, Barack Obama, the Chinese Government and all other sensible thinking people wishing to prime-start their economies are absolutely correct, BUT without the consumer, who accounts for a huge proportion of overall global economic activity, normalising consumption, these other measures will take forever to work.  Intellectual discussion and actions by central governments are all well and good but what the world needs now is a return to normality. 

 The last time there was a widespread call for normality from the public was immediately after 9/11 when New York mayor, Guiliani, went public with a plea for New Yorkers to ‘carry on as normal’ (go shopping, go to the theatre, go to the restaurants).  His motive was more by way of a message to Osama bin Laden that the West would not be compromised, but his call was answered by the people.

 The current situation is not related to terrorism, but it is nevertheless extremely serious.  Whilst we do not want anybody to spend above their means nor to borrow money they can ill afford to borrow, it is important that we normalise our consumption patterns RIGHT NOW, if we are to avoid a short sharp and damaging recession.  If you are due to trade up your car, if you are due to take a holiday, if you are due to spend money on an habitual basis then do so, now.  If we all do this then we can avoid this imminent recession.

 So, cobber, stop intellectualising about the credit crunch and the subsequent chaos and get back to living your life as per normal – just like the Australians want to.  That way we can all survive this man-made disaster that the Press are constantly talking us into.  As Nike says ‘just do it’ and I suggest you convince all your friends and family to ‘do it’ too.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th January, 2009 |
Comments: Have Your Say

Sell, sell! Buy, buy!

We all know that markets and share prices are governed by fear and greed whereby bull markets are characterised by greed and bear markets by fear.  We also know that markets overshoot on both the upside and the downside – often within a short space of time.  Surely this is exactly what we are seeing right now.  If the banks were overvalued just a few months ago, surely they are undervalued now, similarly with builders and miners.  Most of us remain in a state of hung over trauma having seen a buoyant market and economy fall off a cliff in very short order.  Of course the falls have not been consistent across all sectors, as implied above, and the trick now is to determine what sectors should be backed if, and when, we can anticipate the pendulum swinging back into more positive mode.

 Not that the investing public is feeling any more positive yet.  Presently all news seems to be bad news, even when it is good!  Inflation falling would normally be considered good news but currently it is a harbinger of the dreaded deflation.  Interest rates falling would normally be considered good news but because up to a half of mortgage payers will not receive the full benefit then it is considered bad news.  Falling Sterling making our exports more competitive would normally be considered good news (look what it did to stimulate our economy in the early nineties) but because our imports will cost more and overseas investors will have less confidence in the UK then it is considered bad news.

 All this ‘bad’ news makes our market fall.  When interest rates fall, when inflation falls and Sterling becomes more competitive the market falls.  When Gordon Brown announces there will be substantial fiscal measures to stimulate the economy the market falls.

 This does not make any sense.  The fact that RBS spent more acquiring ABN Amro recently than the total current market capitalisation of Barclays, Lloyds TSB, HBOS, Marks & Spencer, J Sainsbury and WM Morrison defies logic.  Sure they may have paid too much but not so much that realistically they could have bought all those other major UK companies instead!  Many companies today are ‘dirt’ cheap. 

 The fact that many shares can be purchased at less than last year’s earnings defies logic.  The fact that our own natural everyday consumption habits will underpin the financial future of most major UK companies means that there are some terrific bargains out there.

 In managing a broadly based portfolio, managers will normally have an eye to combining undervalued assets (to achieve competitive performance) with a wide diversification (to harness and restrict volatility).  The current environment makes this task particularly important and exciting over the months ahead.  WAY Group is unusual in having its portfolio funds managed by a selection of external managers.  Not surprisingly its three main, but entirely independent, managers agree on the prospects for the next market phase.

 John Husselbee at North Investments, manager of the WAY MA Cautious portfolio which has recently been moving from cash back into the markets warns “There is no doubt that the past few weeks have given investors a white-knuckle ride that would test anybody’s faith in financial markets. There may be some who want to get off now, some who are concerned but will stick it out and even those fully prepared to take more. What you need to avoid being is the investor who gets off near the bottom, taking a large loss and giving up any potential for recovery and future growth.”

 Meanwhile Jason Britton of T. Bailey, running the more adventurous WAY MA Growth portfolio, is already working out a broad strategy going forwards.  He agrees “Returns may be volatile but one of the most important factors in relation to equity investment is when one invests and when one sells, and if you are investing for the long term then equities appear to be offering good value at the current time.  A lot of bad news has been priced in from recession, through to the financial crisis and the de-leveraging of hedge funds.  There may be further to go as the consequences of the financial crisis filter out and create ripples in even more unexpected places, or as the recession proves deeper than currently envisaged, but there is a real danger of looking back in a few years time and kicking oneself for not taking advantage of recent falls, even if markets may yet be cheaper next month.”

 On strategy Britton says “Currently we are weighting the equity portion of the WAY MA Growth Portfolio to the US and Japan.  The US was the first into a slowdown and is likely to emerge first too.  Outside of financials, the earnings reporting season is generally providing good news and whilst the outlook may be deteriorating corporates are coming from a position of strong cash flow and low-ish leverage.  But investing in the US also comes with a safety net for UK investors, namely a rapidly strengthening Dollar.  Whilst the extreme moves of recent months may not continue, we anticipate there being a bit further to run here.   Japan is also providing a mix of buy-signals none of which in isolation would be sufficient to get excited about, given its propensity to disappoint, but the weight of data suggests that Japan may move more quickly than other markets when things settle down globally.”

 Meanwhile Paul Kim of IMS Fundquest, who manages the WAY Global Portfolio range, reminds us of the benefits of the managed portfolio style adopted within WAY,
“I believe funds of funds provide a good spread for investors, with a variety of expert managers ‘at the coal face’ picking stocks that should weather the storm and emerge stronger. This diversification avoids having too much specific risk, in any one stock or sector. However, many very well-managed companies have been tarred with the same brush and have seen their share prices knocked disproportionately and now represent excellent long term value.  We seek to back those managers best likely to identify and run with undervalued companies and sectors.”

 The message is pretty clear.  There may be more downside yet to come in the market but attempting to finesse timing to hit any such further fall is far too dangerous.  The general market represents excellent value right now but for the talented manager there are some real gems out there where performance of hundreds of percent are on the cards over the next couple of years.  The clear message then is to be committed to the market right now and to get in while you can at these bargain basement prices.  Not only will we all make money (including recouping some of our recent losses) but we can bring much-needed confidence back into the market and into the economy – you could say it is our duty!

In any case and in spite of rumours to the contrary, the property market, which was allegedly the initial cause of this fall-out, is actually not dead.  Recent figures from the National Association of Estate Agents indicate that sales per agent are up from 5 per month in August to 6 per month in September, climbing again in October to 7 sales per agent.  Unless one is mistaken that seems to represent an increase of 40% from the bottom.  Is this good or bad news?

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 20th November, 2008 |
Comments: Have Your Say

Cash and the fourth dimension

Until recently the consensus view in the retail press and amongst many of the investing public was that cash, and only cash, constituted low risk investment.  However, following the failure of the Icelandic banks and fears about the solvency of banks generally, both here and virtually everywhere else worldwide, such an assumption suddenly seems rather shaky.

 We recently launched a cautious equity-based fund which was held largely in cash until mid-October.  Against a background of tumbling equity markets imagine our surprise that all enquiries by prospective investors and their advisers about the security of the fund focused purely on the cash holdings!  Investors seem well acquainted with the perceived risks within the equity markets (the memory of 2000-2003 is fresh in their minds) but suddenly are worried about the security of their cash holdings.  This brings me on to consider risk in the wider context where I see two distinctly different categories of risk – absolute risk and price risk. 

 Absolute risk is related to losing one’s stake in its entirety – as one generally does on the gaming tables.  In investment terms this normally only happens when the entity in which you have invested, primarily as a shareholder or sometimes as a depositor (think Icelandic banks), goes bust.  It can also happen when a company is nationalised, such as Northern Rock, when shareholders also lose everything. 

 Price risk, on the other hand, is where an investor buys an asset for which the price is determined by the market forces of supply and demand.  If you buy RBS shares today, will the price rise or fall between the point of investment and any subsequent sale?  Having fallen some 90% or so from its peak and now that its future has been underwritten, RBS should have zero absolute risk and, probably, a very low price risk (the FT website was recently quoting a prospective running dividend yield of 33% – we know this wont happen but it puts the current share price into context compared with recent profit and dividend levels).

 There is little to say about absolute risk other than to emphasise that it is sensible for investors to do adequate due diligence before investing in any company that is vulnerable to currently deteriorating economic conditions.  There is plenty to say about price risk and it is here that the fourth dimension of time, and of course timing, comes into play.

 Both Warren Buffett and Bill Mott have gone on record recently to say that all the risk is currently in cash.  This is not because of prospective bank insolvencies but because interest rates are going to fall to very low levels so that real returns from holding cash are likely to be negative, even if one allows interest to roll-up.  On the other hand equity investment at this historical point in the market is likely to offer both decent yields and substantial capital growth, so long as one follows the basic rules of investment – of which number one is diversification and number two is to invest for the medium to long term (the fourth dimension).

I believe that equity value in the markets is greater than at any previous point in my lifetime and likely to be greater than at any point in the rest of my lifetime.  Of course prices could go lower (although I doubt they will go much lower) but in years to come this period will be looked back on as a once in a lifetime opportunity to make big money from equities – especially in the sectors which have bombed so badly in recent days and weeks.  Personally I am borrowing what I can to buy banks, builders and miners right now, many of which are down 90% or more from their recent peaks.  Even a recovery to only 25% of previous levels equates to a performance of several hundred percent from this point!

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 28th October, 2008 |
Comments: Have Your Say

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 |
Comments: Have Your Say

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