OCTOPUS INHERITANCE TAX SCHEME
WHAT DOES THE SCHEME OFFER?
The ability to move assets out of your estate for Inheritance Tax (IHT) purposes in 2 years rather than the more normal 7 years, yet still have access to (i.e. complete control over) those assets.
The scheme is designed to deliver a return of 3%p.a. after charges. If this return is not achieved, Octopus will make good the shortfall.
HOW ARE THE ABOVE BENEFITS ACHIEVED?
To achieve the 2 year IHT benefit Octopus takes advantage of legislation that has been in place for over 20 years. The legislation is called Business Property Relief (BPR). It is the BPR which gives the 2 year IHT benefit.
If you own shares in a company which qualifies for BPR the value of those shares, on your death, is 100% exempt from IHT provided you own the shares at death and have held them for 2 years in the 5 years preceding death.
As your date of death is unknown, it is best to regard the investment as ‘for life’ but with permanent access despite being regarded for IHT purposes as outside your estate after 2 years.
As regards the 3%p.a. return Octopus has identified BPR qualifying companies which carry on trading activities that can be regarded as low risk. These BPR qualifying companies offer a high degree of capital protection. Indeed the primary objective of the Octopus ITS is preservation of capital. The scheme is not designed for those who desire high returns for which they are prepared to accept high risk.
SO MUCH FOR THE BENEFITS, WHAT ABOUT THE RISKS?
There are two elements of risk. These relate to the investment element and the aspect of BPR.
Investment Risk
Octopus has created a Holding company whose activities qualify for BPR. It is a private limited company whose shares are not traded on any stock exchange. This means the value of its shares are not subject to the whims of stockmarket traders.
When an investor has decided to invest in the Octopus ITS, Octopus receives cash and uses this cash to buy shares in the Holding company on behalf of the investor.
The Holding company now has cash to invest and it does so by providing loans to subsidiary companies it wholly owns. The finance (loans) which these wholly owned subsidiary companies receive allows them to undertake low risk BPR qualifying activities.
A good example of a subsidiary company would be a ‘service’ provider which is dependant upon being paid for the services it provides.
To cover this risk the subsidiary company will buy an insurance contract which will payout in the event that it is not paid for its services. It is important to appreciate, however, that this insurance must be in place before the subsidiary company has provided any services.
If the insurers believe the company needing the services being provided is a bad credit risk it will not issue any insurance cover to the subsidiary company. In these circumstances the subsidiary company simply walks away and looks for business from more creditworthy organisations.
Thus at every point, steps are taken to reduce risks to an absolute minimum.
Business Property Relief
The risks here are straightforward.
First, what is the risk of this attractive relief being withdrawn by the government? One way of answering this question is to ask another. Why does the Government allow a tax relief (BPR) which has the potential significantly to reduce the amount it collects in Inheritance Tax?
The answer is that all governments want to stimulate and encourage economic activity because that activity leads to an increase in the number of people employed and profits for the companies involved and their shareholders.
What the Government is giving away with one hand (potential IHT revenues) it is taking back with the other, i.e. it receives income tax and national insurance contributions on the wages of the employees and corporation tax and capital gains tax from the companies and their shareholders.
What the Government will not allow is artificial schemes or structures which endeavour to exploit BPR but which do not result in a genuine economic benefit. It is for this reason that there are very strict rules which must be adhered to if a company (and its activities) is to qualify for BPR.
Second, there is the possibility that a company which qualifies for BPR will lose its qualifying status.
It is the nature of the business activities of a company which, to a large extent, determines whether a company qualifies for BPR.
To ensure that your capital remains invested in BPR qualifying companies, Octopus employs Price Waterhouse Coopers to monitor the continuing qualifying status of the companies concerned. This monitoring is ongoing.
It must be understood that the Government could withdraw BPR at any time but we consider this to be unlikely given the very real and significant economic benefits BPR qualifying companies bring to the UK economy as a whole.
SO MUCH FOR THE RISKS, WHAT ABOUT THE 3%p.a. RETURN?
First and foremost, although the word ‘income’ is used in the scheme literature, please think in terms of either:
1. An investment return which can be taken as growth, i.e. an increase in the value of your capital,
or
2. As a regular cash return.
We put the word income in inverted commas because the return may be subject to income tax and/or capital gains tax (CGT).
The exact position is that the Octopus ITS has been designed to provide an investment return, after charges, of not less than 3%p.a. If Octopus does not achieve 3%p.a. it will make up the difference to ensure you receive 3%p.a.
To receive the return as cash it is necessary to sell the appropriate number of shares. This gives rise to potential income and/or capital gains tax implications. Your shares can be sold back to the Holding company or sold to other shareholders.
In a nutshell, if the Holding company buys back your shares the proceeds are subject to income tax rules. If the shares are sold to another shareholder the proceeds will be subject to the Capital Gains Tax rules.
To complicate matters, investors can choose to receive a ‘return’ on their investment of between 0%p.a. and 10%p.a. This provides excellent flexibility. You can shelter from IHT as many assets as you wish with the knowledge that you can at any time access as much or as little of those assets as you wish.
To assist investors Octopus will provide, each year, relevant documentation confirming whether or not the ‘return’ is subject to income or capital gains tax (or a mixture of both).
HOW DOES THE OCTOPUS ITS ACTUALLY WORK?
As already explained, investors provide cash to Octopus. Octopus, on behalf of investors, buys shares in a BPR qualifying Holding company. The Holding company loans that cash to wholly owned subsidiary companies which themselves carry out BPR qualifying activities.
It is these low risk activities which generate the low returns. But to further protect these returns all payments due to the subsidiary companies are protected, for example, by credit insurance contracts. In this way the business risks have been reduced as far as possible.
With stockmarket listed companies the share value can be radically affected by sentiment and other factors outside the control of the business or its shareholders. For the Octopus Secure ITS this stockmarket risk has been removed.
This is because of the private limited company status of the Holding company. Its shares (and those of the subsidiary companies) are valued independently each month and a share price established. The monthly valuation will take into account both its assets and liabilities.
This independent valuation of the shares, as opposed to the normal fluctuating values of stockmarket shares, is one of the reasons why, since this scheme commenced, at no valuation has the value ever been lower than the value at the previous valuation.
CONCLUSION AND WHAT NEXT
The benefits of the Octopus ITS are attractive: assets out of your estate for IHT purposes in two years even though you retain total control and a 3%p.a. return which can be taken or rolled-up as growth.
Porter Brown believes that for the appropriate people the Octopus Inheritance Tax Scheme is virtually a ‘must’.
It is impossible for Octopus (or anyone) to eliminate risk. But in our opinion the measures put in place by Octopus to reduce the risk of failure are robust and thorough and should result in investors achieving modest returns with preservation of capital and significant IHT benefits.
But if you still have any doubts or would like to learn more, come to Porter Brown for reassurance. For more information about Porter Brown please click on the ABOUT US link above.
CAVEAT
You must please appreciate that the above is no more than an outline of the Octopus Inheritance Tax Scheme (SITS).
Also current Revenue laws and practice could change in the future.
Whilst unquoted shares are typically regarded - quite correctly - as higher risk, Porter Brown believes this Octopus scheme offers a low risk solution with a high degree of capital security.
Please ask for further details.
Note: For those who wish to know more about how the Octopus ITS companies operate profitably, please go to the Appendix.
