Professional Connection Newsletter

25th May 2007

Welcome, to the Cockburn Lucas Professional Connection Newsletter. For further details on any of the articles below please contact us on:

Telephone: 0115 9476005. Website: cockburnlucas.co.uk E-mail: tr@cockburnlucas.co.uk

Richard Martin of T Bailey Asset Management comments on the Property Band Wagon.

The dogs bark and the property band wagon moves on.

For several years now investors have been piling into UK bricks and mortar as if there were never to be a downside. Now with borrowing rates well above rental yields in most sectors the mood is changing, at least for some.

Interestingly the big institutions remain buyers as their overall weightings are still low and they have been slow to catch up. In other words their super tankers are still turning. "Wheel amidships, Captain?"

In contrast private investors are moving on - overseas. Particularly into Europe where rental yields of 6-7% are still available.

T Bailey have long been enthusiasts for European and Asian real estate and the holdings in Dawnay Day Treveria and the Celsius Asian Real Estate Fund have done well for our investors.

Just recently we are starting to get worried that the enthusiasm for European bricks and mortar is becoming overheated, with new offerings snatched up before the ink is dry on the prospectus. The offer of Matrix European Invesment Trust (Western Europe) is oversubscribed several weeks before closing. A £100 million placing of Dawnay Day Carpathian (Eastern and central Europe) was completed in days while Cazenove are telling applicants for Dawnay Day Sirius (flexible workspace in Germany) to form an orderly queue and if they are smarly dressed they may be shown a copy of the prospectus.

Time for the dogs to bark perhaps?

As returns on UK commercial property start to drag, diversification into global property makes sense. Cockburn Lucas have a number of approved funds and managers which offer direct exposure to this asset class both in Europe, Asia and across all sectors of the globe. Contact us for further information.

HMRC clarify their approach to Discounted Gift Schemes (DGS).

Inheritance Tax continues to attract the attention of the press and following the recent Phizackerley case involving house schemes HMRC have now moved the spotlight onto Discounted Gift Trusts but is it bad news?

We should make clear that HMRC state in their brief that they have "not made any fundamental changes to its overall approach to DGS" and this is a statement with which one would have to agree.The HMRC Technical Release now clarifies their approach to some valuation issues in relation to these schemes and although not binding is like any health warning, ignored at your own risk.Discounted Gift Schemes have been available for some time and the recent press release from HMRC is not an attack on the existence of such schemes but to quote HMRC is intended to " set out HMRC's approach to Discounted Gift Schemes (DGS) and their interaction with the Inheritance Tax (IHT) legislation".

So what is a Discounted Gift Scheme and what have HMRC done? A DGS allows a donor to make a gift, usually involving a single premium investment bond, into a trust.The donor retains the right to a fixed "income stream", typically 5%. The retained right to income is set aside when the gift is made and is calculated by reference to health, income level and life expectancy - this is the discount. The remaining rights are held under trust for the donor's beneficiaries.

An example: A female aged 76 next birthday invests £100,000 into a Discounted Gift Scheme. She is in good health and will receive regular withdrawals of 5% per annum from the scheme. Underwriting has been undertaken to ascertain her state of health and life expectancy and this determines that a fund of say £46,000 is required to meet the withdrawals she will require in her lifetime. The balance then represents the gifted (or transfer of value) part of the arrangement (PET or CLT) which could be viewed as follows:£100,000 initial investment into DGS Less £ 46,000 settlor's retained rights - (ie the discount) £ 54,000 value of gift (ie transfer of value for inheritance tax purposes)

What are the points at issue? Obviously the valuation of the "discount" is dependent upon the withdrawals to be taken and the life expectancy of the settlor, which in turn depends on their state of health. The calculation of the discount can not only have an impact on creation of the DGS but may also impact after the settlor has died, resulting in the executors having to settle the matter with HMRC. HMRC's Technical Release now clarifies their approach to some valuations issues in relation to these schemes. If followed, it should give more certainty at outset as to the impact of the scheme during both lifetime and on death.

Underwriting Approach HMRC clearly want all insurance companies to adopt a similar approach to the issue of underwriting, which assesses the health of the individual entering the scheme and is required to determine the discount. Insurance companies have until now taken different approaches from no underwriting or the sealed envelope to full underwriting. HMRC indicate that their preference is for full underwriting to be undertaken at outset as this will prevent problems at a later date. The statement specifically refers to problems encountered when following the death of the settlor it has been necessary to approach the executors of the estate, this they state is "intrusive and upsetting ... at difficult time". They go on to state that the medical evidence should be obtained at outset. Although this may not be welcomed by all it would seem to be a logical approach to such matters and on the whole should again help reassure individuals who wish to participate in such schemes.

Joint Settlors HMRC has in the past treated a joint settlement as being effectively a 50:50 contribution. So, prior to this statement, if Mr. and Mrs. Jones made a contribution of £100,000 before the discount and the discount was agreed at £50,000 the value of the transfer after the discount would be deemed to have been £25,000 each. HMRC have confirmed that this "pragmatic approach" will change from 1 June 2007 . The difficulty with the previous approach was that Mr. and Mrs. Jones may have been in different states of health, or even had a large age difference, when the scheme was set up. In such cases the "pragmatic" approach may have given a more favourable result than if Mr. and Mrs. Smith had been looked at on an individual basis. The "pragmatic" approach taken in the past will not apply from 1 June 2007 and HMRC will approach joint settlements in a different way. In future valuations will be based upon the open market value of each settlor's retained rights. In HMRC's view this will give a fairer picture when determining the discount. In effect the discount will be calculated by reference to each settlor's state of health and contribution. HMRC do however reserve the right to enquire into cases established before the 1 June 2007 where the "pragmatic" approach produces an unreasonable valuation and substantial sums are involved. Therefore joint life cases written before 1 June 2007 involving spouses of differing health and/or substantial age differences may still be challenged by HMRC. Interestingly HMRC state that they have seen a number of such cases since the Finance Act 2006!

Other valuation issues The valuation of the retained rights is often seen as an issue only addressed by rocket scientists and actuaries. It involves the use of the Jellicoe formula which is 1-p/p+i. Enough said on that! However certain factors affect the application of the above and again HMRC have set out their approach to these influencing factors and the providers of DGS should now be pleased to see HMRC set out their method of applying the factors. In truth the majority of the providers of such schemes will have been using these anyway, but it is nice to see it set out in black and white. HMRC also state that it is there intention to publish details of any future changes to the valuations on their website. Again this is reassuring to both providers and investors alike.

Over 90's And finally. HMRC have reaffirmed their view that, however ageist this may seem, lives older than 90 next birthday true or equivalent (mortality rated) are uninsurable "with resultant ramifications". DGS have apparently been written for individuals over 90 and this clearly expresses their attitude toward these. However it is understood that a major provider will soon be testing this approach through the appeals tribunal and we will have to await the outcome.

Summary On the face of it this is a positive move by HMRC. By setting out their understanding of the finer points of these schemes it will enable the providers, IFAs and investors who adhere to the guidelines, to have more confidence in the way such schemes are used. HMRC have been asked to provide further guidance on the more practical issues which arise from their technical note, namely in relation to their underwriting approach. Our understanding however is that based on discussions involving the ABI and HMRC Canada Life's current approach is acceptable.

The information regarding taxation is based on Canada Life's understanding of current legislation, which may be altered and depends on the individual financial circumstances of the investor.

This article was kindly provided by Peter Baroth of Canada Life. For further information please contact us.

There are many situations where BPR and EIS can offer extremely cost effective tax planning solutions. Our friends at William de Broe present a series of examples.

Tax Planning Solutions

IHT Relief & EIS Portfolio Services

Example 1. Immediate 100% IHT Relief

Where an individual sells a company that is Business Property Relief (BPR) qualifying, such as a family business, reinvestment into BPR qualifying AIM shares will see the assets remain outside of their estate.  There would be no requirement for the new assets to be held for the normal two year qualifying period, provided the qualifying business had been owned for more than two years.

Example 2. IHT Efficient Trusts

The interaction of BPR qualifying shares with trusts can also provide some tax efficient solutions.  Shares can be gifted free of IHT into trust on death of the first spouse, in addition to the assets that can pass into a nil-rate band trust.

In addition, the lifetime transfer of  BPR qualifying assets into trust is not liable to the lifetime IHT charge normally levied on such gifts.

Example 3. IHT Relief on CGT Laden Investments

The use of EIS qualifying investments can enable IHT planning to be facilitated, even on the most CGT laden of investment portfolios.  Gradual sale of an asset and reinvestment into EIS means that the potential for any ‘double whammy’ of CGT and IHT is removed and, two years after investment, the assets are potentially free of IHT.   

Example 4. Fast IHT Relief & CGT Deferral

Where a gain has already been crystallised, we can invest the funds immediately into BPR qualifying shares to get the two-year clock ticking and then gradually sell this element down and reinvest in EIS qualifying shares.  This means that after two years the assets are fully IHT free and the gain has been deferred.

We, at Cockburn Lucas, would never let the tax tail wag the investment dog! Nevertheless, we recognise the importance of good tax planning. The team at Williams De Broe has a well respected track record and we would be happy to introduce them to our partners or discuss joint seminars to clients looking to make IHT savings now or in the future. Contact us.

Octopus Launch New IHT Product.

There are a number of ways to limit your exposure to inheritence tax. However, these can be risky, take years to implement or mean that you permanently lose control of and access to your money. What's more a number of these solutions don't provide you an annual income from your investment.

It is for these reasons Octopus have launched the Octopus IHT Income Fund which offers a simple solution to individuals looking to reduce their inheritence tax liabilities at the same time as generating an income from their investment.

It offers investors four clear advantages:

Speed - Unlike gifts and transfers, which generally take 7 years before they are fully exempt form inheritence tax, investments made through the Fund are exempt after just 2 years.

Income - The income will be paid out twice a year and the targeted level of income is at least 3%.

Control - You retain access to your investment. If you need to you can dispose of your holding, although money withdrawn may not be sheltered from Inheritence Tax.

Lower risk - The Fund will be investing in unquoted companies that qualify under the rules relating to business property relief. These target companies operate businesses that are able to use credit insurance to protect themselves from their main risk (the risk that customers are not able to pay their bills).

We, at Cockburn Lucas, believe this new scheme will offer low correlation to AIM portfolios, therefore, further spreading risk for clients whilst offering the win–win scenario for the client of income and control. For more information please contact us at:

Cockburn Lucas.

Telephone: 0115 9476005. Website: cockburnlucas.co.uk E-mail: tr@cockburnlucas.co.uk

The views/opinions expressed in this newsletter do not constitute personal advice or a recommendation - it is important to seek independent financial advice.

Cockburn Lucas Independent Financial Consulting Limited. Authorised & regulated by the Financial Services Authority. Registered address Milton Chambers, 19 Milton Street, Nottingham NG1 3EU. Registered Number: 3365186

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