Tax Basics

Before you inundate the comments box with just exactly you are willing to do to get your hands on your inheritance, I'm talking valuation here; specifically stocks and shares valuation for inheritance tax purposes.

Now you may be thinking that this is destined to be a very short article. However, although the basic concept of share valuation is simple, i.e. what would an unconnected party pay for them, there are twists and turns that need explaining in order to arrive at the final answer.

Quoted shares and securities

You would think this would be the simplest valuation of all, and to a certain extent you would be right. It is possible to purchase or view the relevant copy of the FT, run a smudgy finger down the list of share prices and apply the quoted price to the number of shares held. Which is fine if the share price has remained static all day.

If, however, there has been some fluctuation, even a difference in high and low of five or ten pence could make a huge difference if valuing a substantial shareholding.

In an ideal world, HM Revenue & Customs, being naturally sympathetic in the face of a death, would simply allow you to use the lowest daily price. However, in this world, the peculiar practice of 'quarter up' valuation must be employed.

In simple terms, the quarter up method adds a quarter of the difference between the high and low price to the low price. Clear? Let's see an example.

If the share price of Dead in the Water plc has had daily bargains of 125p, 120p, 135p and 132p, the high is 135p and the low is 120p. The difference between these two figures is 15p. One quarter of 15p is 3.75p, so the share price for IHT valuation purposes is 123.75p (120p + 3.75p).

Given a shareholding of 50,000 shares, the valuation for probate (or Scottish confirmation) purposes will therefore be £61,875. This is, of course an increase of £1,875 compared with a low valuation, but a saving of £5,625 from the high valuation at 135p.

Unit Trusts

Unit Trust valuations are less widely reported in the financial press, so you will need to obtain a valuation from the fund manager. As you probably know, unit trust prices are normally quoted at a 'bid' price and an 'offer' price, a bit like what the Post Office does on its foreign exchange counter. When purchasing unit trusts, a bit like depreciation on buying a new car, you instantly 'lose' the value attributable to the difference in the bid/offer spread.

But there is good news. In a rare moment of generosity, HMRC has agreed that the price used for IHT valuation is the lower price only. Result.

Gilts

Up to date valuations on gilts can be obtained from the Debt Management Office www.dmo.gov.uk. Remember to check if there is any accrued interest adjustment required -- see my earlier article on the taxation of gilts.

Unquoted shares

Unquoted shares are notoriously difficult to value, as there is no market upon which the shares are traded.

In order to come up with an IHT value, HMRC's shares and assets valuation (SAV) division recommends you base a valuation on the following information:

• The company's performance and financial status as shown in its accounts for, say, the last three years before the date of valuation, and any other information normally available to its shareholders. In the case of foreign companies you will need to provide copies of the accounts for the three years before the date of valuation.
• The size of the shareholding, and shareholders' rights. If, for example, the holding is one that would give control of a company, it may be necessary to agree the value of all the company's assets and to have much more information about the company's performance and prospects than is in the published accounts.
• The company's dividend policy.
• Appropriate yields and price earnings ratios of comparable companies or sectors.
• The commercial and economic background at the valuation date.
• A full explanation as to how the suggested value has been calculated, including the valuation approach adopted (for example Earnings, Assets, Dividend Yield or industry specific valuation method), any assumptions or adjustments made plus all the supporting evidence used.
• And finally (unhelpfully)... any other relevant factors.

It is also important to note that, for unquoted shares, a minority holding will not merit a value equal to the relevant percentage of the issued share capital; that is to say a 25% holding will not normally be valued at 25% of the whole business. All minority holdings will be subject to a discount of some description, and you may need to obtain professional advice on the level of discount, or indeed the valuation in the first place, especially where large or valuable companies are concerned.

What if you get it wrong?

Clearly HMRC are not going to always assume you have got valuations correct, and particularly for unquoted shares, SAV may prepare their own valuations and ask questions if their valuation and your valuation do not agree. This does not mean that their valuation is right, however, as it is a subjective thing, so keep your papers and calculations and argue your case if challenged!

However, there are going to be situations where an error is made. If, for example, you suddenly find another 25,000 shares in a company, you would be best advised to notify HMRC of the error as soon as possible.

But what if, as has unfortunately been the case in recent times, you prepare a valuation that is correct at the time, but you subsequently sell those shares for a lower price, meaning you could be paying IHT on value that clearly doesn't actually exist?

Well, if you sell shares within one year of the date of death for less than the value upon which you paid Inheritance Tax, you may be able to claim relief for the loss on form IHT35. Note (Stockholm: NOTE.ST - news) that it only applies to quoted shares (AIM and PLUS are not quoted for this purpose) and you cannot claim for a loss on one holding while slyly pocketing a profit on other holdings -- all qualifying holdings sold within the period must be included to work out whether there is an overall loss on sale. Sorry!