Review: Octopus Inheritance Tax Service
Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.
The Octopus Inheritance Tax Service gives investors the opportunity to invest in the shares of unquoted trading companies that are expected to qualify for Business Property Relief (BPR). After two years, the investment should become free from inheritance tax, provided the investment is still held at the time of death. The service has the aim of preserving capital and delivering a consistent, but modest, level of return.
- Capital preservation a priority
- Target return of 3% per annum (not guaranteed)
- Regular liquidity: investors can withdraw funds on request
- Renewable energy, healthcare and property
- Good BPR claims track record: no known HMRC challenge on almost 1000 deaths of shareholders to
Octopus Investments launched in 2000 and has since built market-leading positions in tax-efficient investment, smaller company financing, renewable energy and healthcare. Octopus now manages £6.9 billion of assets, of which £4 billion is in unquoted investments. There are over 150 investment professionals at Octopus Investments across their energy, healthcare, property finance, ventures and general investment teams. Paul Latham, one of the senior directors at Octopus, is integral to this service.
Target return and strategy
The target return is 3% per annum net of annual fees. The target is not guaranteed. Octopus’s annual management fee is rolled up and not paid until investors cash in and have received a minimum of 3% compound per annum return.
Investors buy shares in an unquoted trading company called Fern Trading Limited (Fern). Fern was established in 2007 and has grown to become the parent company of a larger trading group. This group now comprises more than 200 companies, with business interests spread across the UK and France. Paul Latham is Fern’s Chief Executive, and the majority of the activities of Fern are overseen by Octopus staff. Fern employs more than 350 people across its business including its biomass and landfill gas sites, and provides additional employment indirectly through the contracts it places.
Fern has a diverse trading strategy but focuses on areas where Octopus has extensive experience, such as renewable energy, healthcare and property. These areas are expected to be capable of generating predictable returns over the longer term and are consistent with the capital preservation target of the Octopus Inheritance Tax Service.
Fern has three main business lines. Owning and operating renewable energy businesses currently accounts for 59% of its operations; construction financing accounts for 23% and short-term property financing accounts for 18%.
Fern owns more than 220 renewable energy sites ranging from commercial solar installations, wind farms, biomass plants and landfill gas sites. Sites are either acquired when they are operational or when they are ‘shovel ready’, meaning they have been granted planning permission and construction can begin. Fern earns revenues from the sale of energy and many sites will also generate revenues from long-term government incentives, such as Renewable Obligation Certificates (ROCs).
Fern’s construction financing business lends to companies that own land on which they have been granted planning permission to build top-quality healthcare facilities, including retirement communities, private hospitals and care homes. These loans fund part of the cost of construction and are typically due for repayment once each site is complete, which is expected to be between three and five years from the date the loan is made. Loans are typically secured by debenture over the shares of the borrower, and by a first ranking charge over the site under construction.
Fern also provides loans to companies that are constructing renewable energy sites. To date, Fern has provided £900 million of construction finance to help build 116 commercial-scale solar sites. Once the site is complete, Fern’s loan will either be repaid by the borrower or, Fern may decide to acquire the completed site to own and operate for the longer term as part of its renewable energy business.
Fern’s short-term property financing business involves offering short-term bridging loans directly to experienced property professionals. Fern receives all of the revenues generated from each of its loans, including arrangement fees, interest and early repayment fees. A typical property loan made by Fern will be between three and 36 months in duration, secured against a residential property and secured via a first legal charge. This means Fern will be the first party to be repaid by the developer when the property is sold or re-mortgaged. Fern lends at what it considers to be sustainable loan-to-value (LTV) ratios. The current average LTV is 59%. Fern currently has more than 230 live property loans issued to independent borrowers.
To deliver a 3% return to investors, Fern needs to deliver a gross return of approximately 8% from its blended trading activities. This seems high, however Octopus receive an annual fee of 2.5% for managing Fern on a day to day basis as Fern does not incur the typical costs of running a business directly, such as wages and office rent. HMRC receives about 1.5% of this figure in corporation tax (Fern paid £8.8m in corporation tax in the previous financial year on profits of c.£41.5 million) and VAT and there is the cash drag effect of not having all the money invested all the time. Octopus’s 1% (plus VAT) annual management charge accrues within the portfolio but is only payable at the end of an investor’s term, and only then if the share price performance is sufficient for Octopus to be paid and for the investor to receive 3% compounded. This AMC is included in the deductions.
Fern has three directors, two of whom are independent of Octopus. Fern’s board annually reviews the fees paid to Octopus to cover its running costs.
Investors can request withdrawals when they want. They also have the option to set up regular withdrawals. Withdrawal requests are typically met within ten days but could take longer.
Below is a graph showing the share price for Fern Trading Limited (at December each year). Please note this is an unquoted company and the share price is based on Fern’s own valuation.
Source: Fern Trading, May 2017. The chart above shows share price in December each year, since inception. Past performance is not a guide to the future. This information is available on Fern’s website https://ferntrading.com.
With any unquoted investment the key risk is liquidity and not being able to dispose of your holding when desired. Octopus has two buffers against this. Firstly, a large part of the investments are short-term loans to property owners, often for periods of under one year; this has the added benefit of ensuring that if interest rates do rise, the underlying investments aren’t locked in to lower rates. Secondly, there is also between 5%-10% held of the net asset value of Fern as cash. However, if the whole portfolio needed to be liquidated in a very short period of time, this could be a problem. Another risk is that the monthly share price is set by Fern’s directors and will not necessarily have a direct correlation to the underlying net asset value of Fern. They are valuing the business on a going concern basis, not on day to day cash flow.
Capital is at risk and you should not invest money you cannot afford to lose.
Eligibility for BPR is assessed at the date of death and will depend on the company remaining qualifying. Remember, tax rules can change and the value of tax benefits depends on circumstances.
There is an initial charge of 5.5%, before Wealth Club discount. At a product level, Octopus charge an annual management charge of up to 1% plus VAT per annum. Octopus defer this and only receive it upon encashment if the investor has received 3% per annum compound growth over the lifetime of their investment, something they refer to as the "Growth Shield". If the portfolio hasn’t delivered the expected growth, the annual management charge will be reduced or eliminated. Please note, this does not mean the value is guaranteed: you could get back less than you invest.
In addition, the underlying portfolio company, Fern Trading Limited, also has costs associated with running its business. Fern Trading pays Octopus 2.5% plus VAT per year to run the business as it has few managerial staff of its own – in the last financial year Octopus received £48 million from Fern. Fern’s directors annually review the level of this payment. There is no performance fee as the focus is on predictability of returns.
Octopus is the market leader in inheritance tax investments. This service has consistently delivered its aim of providing liquidity and steady returns. This consistency has led the Octopus service to acquire assets of £1.7 billion. The mix of short term loans with renewable assets provides an interesting mix of long term stability and short term higher return deals. The Growth Shield provides reassurance on returns, however it is relatively expensive so investors need to decide if they are getting value for money.
This review is not intended to be advice or a personal recommendation to buy the investment mentioned, nor is it a research recommendation. Wealth Club aims to highlight investments we believe have merit, but investors should form their own view on any proposed investment and read the provider’s documents carefully. Information correct at April 2017.