Tax considerations for investment selection

Sunday 28 February 2016

by Phillip Dearden, Director - Tax, Equiom Solutions

Background

Tax is often an important part of the investment selection process. This is because it is only the post-tax returns, whether they comprise income or capital profits, which will be available to an investor. This means an investor will be concerned whether or not there is a tax charge and if there is one, the level of that tax charge. The manner in which investments are made and the type of investment vehicle selected can have significant implications for the level of tax which may be borne. This article considers the Inheritance Tax (IHT) issues that may affect Channel Islands residents who hold UK investments.

IHT

One of the biggest issues to affect Channel Islands residents with portfolios of investments is UK IHT. An individual who is not UK domiciled is not subject to IHT, except in respect of UK assets. A portfolio of equities will often include a number of UK-quoted company shares and these will constitute UK assets. If a Channel Islands resident and domiciled person dies holding such assets there could be a requirement for UK probate and before that is given HMRC will require an IHT return to be submitted. There may not be a problem as transfers between spouses are exempt, so assets passing on death to a husband or wife are exempt from IHT. There is also a nil-rate band of £325,000 and if UK assets do not reach this value there should be no problem. In some cases, the amount of the nil-rate band will be increased where a spouse has previously passed away and left some nil-rate band unused. Where the exemption or nil-rate band are not in point tax may be levied at 40% of the value of the shares held.

IHT usually has most effect on death. A Channel Islands resident who dies holding UK assets may have a UK IHT problem. There can also be an issue with lifetime gifts. UK IHT applies so that gifts between individuals are exempt from tax as long as the donor survives seven years from the making of the gift. This rule also applies to Channel Islands residents and a gift by a Channel Islands resident donor of UK shares will be exempt as long as that donor survives for seven years after making the gift. If there is doubt as to whether this will be achieved, it may be better to sell the shares and to make a gift of cash contained in a Channel Islands bank account – such a gift by a person domiciled in Channel Islands would be outside the scope of UK IHT.

Exempt Assets

There are certain categories of UK assets that will not cause a problem. UK Authorised Unit Trusts and Open-Ended Investment Companies (OIECs) are exempt from IHT when held by individuals who are non-UK domiciled, such as someone resident and domiciled in the Channel Islands. Additionally, UK gilts are Excluded Property, where held by an individual who is Channel Islands resident.

Offshore Funds

Where an investor wishes to have an exposure to UK equities but wishes to avoid an IHT charge then he or she may consider investing via offshore funds. If the fund is located in the Channel Islands or another offshore jurisdiction then the investor will not have a UK asset even if the fund’s investment rationale is to invest in UK shares. For example, the investment strategy might be to invest in large PLCs or mid-sized unquoted companies. In either of these cases the investor would get a return related to the investment sector he or she wishes to be exposed to, but for IHT purposes he or she holds a non-UK asset.

Shares held by a Channel Islands-resident company

Where a Channel Islands resident holds investments via a personally owned company this should serve as an effective protection from IHT – the Channel Islands resident will hold shares in a non-UK company and so will not have either a need for UK probate or an exposure to UK IHT. The company must actually own the shares and not be a nominee for the individual, so the nominee provided, for example by a stockbroker, would not provide an effective shelter from UK IHT.

Summary

For a Channel Islands resident to be generally outside the scope of UK IHT, they need to be non-UK domiciled. A UK anti-avoidance provision means this cannot be achieved in the first three years after leaving the UK; this period is shortly to be extended to five years. After that, holding UK assets is still a problem but this can be overcome by only holding exempt assets, by investing via offshore funds or by holding UK assets in a Channel Islands company.