- 1. The Scope of the Book: Estate Planning Introduced
- 4. Trusts: Tax-Efficient Management
- 6. The Family Business
- 6.1.3 Capital Gains Tax angles
- 6.3.2 The detail of the legislation
- 6.5.2 The scope of employment income for Income Tax and National Insurance purposes
- 9. Investments
- 10. Life Assurance
- 11. Pensions
- 12. Charitable Giving
- 15. Leaving the UK
- 15.2.4 Occasional residence abroad not enough
- 15.2.8 Residence of Companies
- 15.2.9 HMRC’s proposals for a comprehensive statutory test for residence from 2013/14 (deferred from 2012/13)
- 16. Non-UK Domiciliaries Living in the UK
- 18. Wills
2 - Inheritance Tax Mitigation: The Basics
Chapter 2
Inheritance Tax Mitigation: The Basics
Overview of the Chapter - and the Subject
2.1
A brief perspective
2.1.1
In 1986 IHT replaced Capital Transfer Tax (CTT), which itself had taken the place of Estate Duty in 1975. Estate Duty was primarily a death duty, but also caught certain lifetime gifts made within seven years before death (as indeed does IHT). The introduction of CTT sent shockwaves through both the professions and the public at large, in combining a genuine lifetime gifts tax with a death duty, together with a comprehensive regime for taxing discretionary trusts. However, the introduction of the potentially exempt transfer (PET) with IHT in 1986 went some way to mitigating the burden of the gifts tax. That year saw also the introduction of the reservation of benefit (GWR) regime, a revival from Estate Duty, in an attempt to prevent a taxpayer in making a lifetime gift from ‘having his cake and eating it’.
A variety of successful attempts to get round those GWR rules, as upheld in the courts, led to some piecemeal tinkering with the regime before the introduction of the pre-owned assets (POA) income tax from 2005/06. The POA regime imposes an Income Tax charge on donors of land, chattels or ‘settled intangibles’ who had managed successfully to circumvent the GWR rules while still enjoying a benefit from the asset given away. And then, in 2006, what was presented as the ‘Inheritance Tax Alignment for Trusts’ was in substance a concerted attack on both non-discretionary trusts existing at 22 March 2006 and new lifetime trusts, by making it generally rather more expensive in IHT terms to hold assets in trust than to hold them beneficially. While the full consequences of this are still becoming clear as the impact of FA 2006 works its way through the system, the new regime quite evidently does not spell the death of trusts (as explored in Chapters 3 and 4).
This core Chapter of the Book surveys in brief the avenues down which a person wishing to mitigate the burden of IHT might walk, most of those topics to be expanded in subsequent Chapters. First, however, it is worth saying something about the scheme of IHT as a whole as we now have it in IHTA 1984 (renamed in 1986 from the original Capital Transfer Tax Act 1984) and, for the GWR regime, FA 1986. IHT having been introduced as a ‘new’ tax, albeit subject to some subsequent amendments, the scheme of the Act generally follows a fairly logical order.
The main charges and definitions
2.1.2
(a) Transfers of value and chargeable transfers
IHT is charged on the value transferred by a ‘chargeable transfer’ (IHTA 1984 s1), which is a ‘transfer of value’ made by an individual except an ‘exempt transfer’ (IHTA 1984 s2(1): see 2.1.5 and 2.2). A transfer of value is a disposition made by a person which causes the value of his estate immediately after the disposition to be less than the value immediately before it (IHTA 1984 s3(1)) but, in this, no account is taken of ‘excluded property’ (IHTA 1984 s3(2)).
(b) Excluded property
Excluded property is, generally, (i) property situated outside the UK owned by someone domiciled outside the UK, both under the general law and for IHT purposes (IHTA 1984 s6(1)); (ii) a reversionary interest (except where owned by the settlor or his spouse/civil partner) to the type of life interest in a settlement which is taxed as if the beneficiary owned the underlying property - a so-called 'estate' interest in possession (IHTA 1984 s48(1)); and (iii) property in a settlement situated outside the UK where the settlement was made by someone domiciled outside the UK for IHT purposes when made (IHTA 1984 s48(3)). Categories (i) and (iii) represent the territorial limitation on the operation of IHT: see 2.12.
TAX TIP: An individual who is prospectively entitled under a settlement, that is on the death of the current beneficiary who has a qualifying interest in possession, could give away his interest under the settlement (called a ‘reversionary interest’) with no IHT consequences (even if he were to die the following day, ie as excluded property he will not have made a PET). Nor indeed will there be any CGT implications, assuming that the settlement has always been UK resident and he did not acquire his interest for value (TCGA 1992 s76).
(c) Potentially exempt transfers and chargeable transfers
Accordingly, the tax looks for chargeable transfers, whether made during lifetime or on death, and taxes them.
However, there is a significant category of lifetime chargeable transfers, as PETs, which are transfers of value (of whatever amount) made by an individual to another individual, or into a trust for a disabled person, which are assumed to be exempt when made and do not become chargeable except in the event of the transferor’s death within seven years (IHTA 1984 s3A). Such treatment was, before 22 March 2006, also extended to a gift into trust in which an individual had a right to income (interest in possession) – called a ‘qualifying interest in possession’, the legislative expression for an 'estate' interest in possession - or into a favoured accumulation and maintenance trust for children (see 2.3.3(c)).
In the case of a chargeable lifetime transfer, whether immediately chargeable, eg a gift into trust (of whatever kind on or after 22 March 2006, other than a disabled trust) or a PET which becomes chargeable by reason of death within seven years, the rate of tax charged will be 40% unless the amount of the chargeable transfer falls within the transferor’s nil-rate band (£325,000 for 2010/11 and 2011/12), in which case the rate will be 0%.
The rate of IHT on an immediately chargeable lifetime transfer is 20% to the extent that it exceeds the nil-rate band as reduced by chargeable transfers made within the previous seven years (IHTA 1984 s7). If death follows within seven years of this new chargeable transfer the rate is increased to 40%, with a credit for any tax already paid. The nil-rate band is given according to the order of gifts within a seven year period. In the case of gifts made on the same day it is allocated pro rata.
Example 2.1
For the last five years on 6 April Belinda (who is married) has made gifts of £3,000 per annum to a favourite God-daughter, effectively using her £3,000 annual exemption in each year. Otherwise she has made gifts as follows:
• on 1 March 2006 £250,000 into an accumulation and maintenance settlement for her grandchildren (with no chargeable transfers in the seven years before that). This was a PET when made – though even if Belinda dies within the following seven years so as to make the gift chargeable, there will be no IHT to pay (as within her nil-rate band);
• on 1 July 2008 £125,000 to her son. This again was a PET and will become chargeable if Belinda dies before 1 July 2015. There will be IHT to pay if at that time the nil-rate band is less than £375,000 (the sum of the gift to the A& M Trust and the gift to her son); and
• on 1 January 2010 £75,000 to her daughter. This was also a PET. Should Belinda die when the combined total of that plus chargeable transfers made in the previous seven years exceeds the then nil-rate band, for example on 1 January 2012 (tax year 2011/12, when the nil-rate band is £325,000), the excess viz £125,000 will attract IHT at 40% of £50,000, whether the IHT is paid by Belinda’s son and daughter (rateably) or by Belinda’s executors.
TAX TRAP: A PET which becomes chargeable on death within seven years may trigger IHT which could have been avoided if there is a surviving spouse/civil partner, by letting the value in excess of the nil-rate band fall into exempt residue and having the survivor make a PET in the hope of survival for seven years. The moral: always when planning a PET consider the impact of death within the following seven years.
Death
2.1.3
(a) The deemed transfer of value
On death the deceased is treated as if immediately before he died he had made a transfer of value equal to the value of his estate immediately before his death (IHTA 1984 s4(1)). The estate includes all the property to which he is beneficially entitled (IHTA 1984 s5). This will include certain, but not all, interests in possession under a trust (see 2.3.3). Liabilities may be deducted provided either they were imposed by law or were incurred ‘for a consideration in money or money’s worth’. Such a deemed transfer of value on death may be exempt, for example on passing to a surviving spouse/civil partner or to charity, or it may be chargeable. If chargeable it may be subject to a relief at either 50% or 100% for qualifying business and agricultural property or, to the extent that the chargeable value exceeds the prevailing nil-rate band (£325,000 in 2010/11 and up to and including 2014/15), it will attract tax at 40%. Any balance of the nil-rate band not taken up by chargeable transfers made in the seven years before death will reduce the IHT otherwise attracted by chargeable transfers on death. Where with a married couple or registered civil partnership all or part of the nil-rate band on the first death is unused, the unused proportion can augment (up to 100%) the nil-rate band on the death of the survivor after 8 October 2007 (see 18.4.3) – the so-called ‘transferable nil-rate band’.
(b) Changes occurring on death
A person’s estate may be subject to changes which occur on account of the death. Where such a change is an addition to the property in the estate, or an increase or decrease in value of any such property, such changes are treated as if they had occurred before the death (IHTA 1984 s171). Expressed exceptions to this principle are alterations in the capital of a close company within IHTA 1984 s98 and the passing of an interest by survivorship under a joint tenancy. This means, for example, that a decrease in the value of the pre-death property which is triggered by the death, for example personal goodwill in a sole trade which dies with the deceased (albeit otherwise attracting business property relief), is excluded from the death estate.
A similar candidate might be an option over property which comes to an end on death. That was the argument raised by the executors of Mr McArthur in relation to options to convert unsecured loans to two companies to £1 ordinary shares at par. The effect of exercise of the options immediately before death (or before) would have been to create a majority holding in the companies neither of which attracted business property relief. The Special Commissioner agreed with HMRC and held that both the loans and the related conversion rights or options were valid, subsisting and enforceable immediately before the death (McArthur’s Executors v RCC [2008] SSCD 1100 (SpC 700)).
TAX TIP: Be sure, in advising on estate planning, to identify the existence of any options (especially in relation to shares in companies which do not attract business property relief) which have a value and take steps accordingly. At least, in the McArthur case mentioned above, the exercise of the options after his death (within whatever was the permitted period) would have occasioned an increase in the value of the shares.
(c) The Estate Duty surviving spouse exemption
Where Estate Duty was paid (or would have been payable but for reliefs or the threshold) on the death before 13 November 1974 of the first spouse to die and the survivor has a life interest under the Will, no IHT is chargeable on the second death (IHTA 1984 Sch 6 para 2). However, the related property rules may affect the chargeable value of the free estate or other property taxed on death.
Note that there will also be no IHT implications arising from an inter vivos termination of the life interest (even if death follows within seven years), though in that event the CGT-free uplift on death would have been wasted.
A claim to the Estate Duty transitional relief failed in circumstances where the estate of the husband (who died in 1969) was left to the wife outright. She vainly tried to argue that there was a legally enforceable secret trust under which on the wife’s death the property in question would be left to their two daughters. The First-tier Tax Tribunal held that there was no evidence for that argument, nor indeed for the alternative assertion that the 1965 Wills made by the spouses were mutual Wills, so that on the husband’s death the widow held the relevant property on a constructive trust for the daughters (Davies and Rippon (Goodman’s Executrices) v RCC [2009] UKFTT 138 (TC 106)).
TAX TIP: An ‘Estate Duty protected life interest’ should be kept in place until the death of the survivor. The fund will be free from IHT and the acquisition cost of the assets will be market value, with the CGT-free uplift in value on death.
Dispositions which are not transfers of value
2.1.4
There are some dispositions which on the ‘estate before less estate after’ principle reduce the estate but are not transfers of value, viz.:
• those not intended to confer a gratuitous benefit, provided either they were made in a transaction at arm’s length between unconnected persons (eg a ‘bad bargain’ to other than a member of the family) or they were such as might be expected to be made in an arm’s length transaction between unconnected persons (IHTA 1984 s10);
• dispositions for the maintenance of the family (IHTA 1984 s11). A member of the family includes a spouse/civil partner, an ex-spouse/civil partner and a child (including a step-child and an adopted child). A disposition will not be a transfer of value if made to a spouse/civil partner or a child of the transferor or spouse/civil partner which is either for maintenance or, where for a child, for maintenance, education or training up to the age of 18 or later cessation of full-time education or training. The disposition may take the form of a transfer of capital (see 13.2.1 and McKelvey v HMRC [2008] SSCD 944 SpC 694);
• a disposition which is allowable in computing profits or gains for Income Tax or Corporation Tax or, specifically, a contribution under a registered pension scheme (IHTA 1984 s12);
• a disposition of property made to trustees by a close company for the benefit of its employees (IHTA 1984 s13);
• the waiver or repayment of remuneration to the extent that it would be taxable employment income (IHTA 1984 s14);
• a waiver of dividends within twelve months before the right accrues (IHTA 1984 s15);
• the grant of an agricultural tenancy in the UK, Channel Islands or Isle of Man if for full consideration in money or money’s worth (IHTA 1984 s16); or
• certain post-death variations or disclaimers or transfers on ‘precatory trusts’: see 2.13 and Chapter 19 (IHTA 1984 s17). So, for example, a written variation or disclaimer by the original beneficiary of an inheritance under a Will or an intestacy, made within two years after the death, is treated as if it were made by the deceased under his Will (IHTA 1984 s142).
These provisions protect only an inter vivos disposition from being a transfer of value. That is, for example, a gift under a Will for the maintenance of a member of the family (other than a spouse/civil partner, which is exempt) will be a chargeable transfer, whereas had it been made by the individual on his deathbed, it might not have been a transfer of value at all: see the second bullet above for s11.
Exempt transfers
2.1.5
The basic lifetime exemptions are dealt with at 2.2: viz. the £3,000 annual exemption, the £250 small gifts exemption, the normal expenditure out of income exemption and gifts in consideration of marriage or civil partnership. The two main exemptions which apply to both lifetime gifts and gifts on death are as follows:
• transfers between spouses/civil partners (IHTA 1984 s18). Where the transferee spouse/civil partner is, but the transferor spouse/civil partner is not, domiciled in the UK for all IHT purposes (see 15.3 and 16.4), the exemption is limited to £55,000, on a lifetime basis; and
• the charities exemption, which depends on the definition in the Income Tax Acts (IHTA 1984 s23 and s272), originally a UK registered charity, though as from 24 March 2010 the UK tax reliefs have been extended to charities within the EU, Norway and Iceland (see 12.2.5).
There is also a minor exemption for both lifetime gifts and gifts on death to gifts to political parties (IHTA 1984 s24). To qualify, at the last General Election, either at least two members of the party must have been elected to the House of Commons or one member elected and not less than 150,000 votes cast for candidates who are members of the party.
Gifts to the National Trust etc (including Government Departments) are exempt (IHTA 1984 s23: see IHTA 1984 Sch 3 for the list of bodies).
Certain transfers of value are ‘conditionally exempt’, broadly where of national heritage property or where such property is offered in lieu of IHT or CGT (IHTA 1984 s30-s35A). This is considered in more detail in Chapter 14: see also 2.11 for a summary.
There is a complete exemption from IHT for the estate of a member of the armed forces who dies on active service against an enemy – or from a wound inflicted, accident occurring or disease contracted at that time (IHTA 1984 s154). Traditionally, the exemption is construed favourably by HMRC (in relying on an assessment from the Ministry of Defence) and there is no time limit on the period elapsing between the date of the wound, accident or disease and the death.
Reliefs
2.1.6
A transfer of value may be a chargeable transfer, though in computing the value transferred may attract a relief. The principal reliefs (whether given at 100% or at 50%) are for qualifying business and agricultural property, considered at 2.5 in summary and at 6.2 and 7.2 in more detail (IHTA 1984 ss103-113B for business property relief (BPR) and ss115-124C for agricultural property relief (APR)).
A very limited deferral relief is given to woodlands insofar as they do not attract relief as agricultural or business property (IHTA 1984 ss125-130): see 7.4.
A relief called informally ‘quick succession relief’ or QSR is given where property is subject to two or more chargeable transfers within a five year period (IHTA 1984 s141), the second or latest transfer occurring usually on death. In that event the tax chargeable on the second transfer is reduced by a percentage of tax charged on the first, on a sliding scale depending upon the period elapsing between the two transfers: see 18.1.2.
A particular relief (albeit not expressed as such) is given on post-death events (considered in more detail at 2.13.2 and at 19.6). For example, where a Will creates a ‘relevant property’ trust, an appointment by the trustees within two years after the death escapes the normal ‘exit’ charge (IHTA 1984 s144).
Relief may be given under a double tax treaty or, as ‘unilateral relief’, where in the absence of a treaty tax similar to IHT is charged on the asset in that jurisdiction (IHTA 1984 ss158 and 159).
Settlements
2.1.7
There are two main regimes for settled property, with a third, minor, regime, all of which are discussed at 2.3 and in more detail throughout Chapters 3 and 4.
Anti-avoidance
2.1.8
With the introduction of IHT in 1986 came the ‘reservation of benefit’ or ‘GWR’ rules, inherited from Estate Duty (FA 1986 s102 and Sch 20). In broad terms, if when a person dies he is enjoying a benefit from something he has given away since 18 March 1986, that asset is treated as forming part of his chargeable estate. If the benefit ceased during his lifetime he is treated as having made a PET, so that if more than seven years elapsed after the cessation of benefit there are no IHT implications. If the benefit ceased within the seven years before his death, it is treated as a chargeable lifetime transfer. See 3.2.2.
Following well-publicised successful attempts by taxpayers to devise ways around the GWR regime, such that they would continue to enjoy the benefit of the gift while having made an effective transfer for IHT purposes, the draconian pre-owned assets (POA) regime was introduced from 2005/06 (FA 2004 Sch 15). The charge applies where (subject to certain exclusions) a person enjoys some benefit from land or chattels which he has given away and which do not form part of his estate either under general principles or under the GWR rules. In that case, subject to an annual de minimis of £5,000 of value per taxpayer, the value of the benefit attracts Income Tax each year. A POA charge also arises where an intangible asset (eg cash or shares) is comprised in a settlor-interested trust. There is then an annual Income Tax charge at 4.00% (for 2010/11 and 2011/12) on the market value of the trust property. See 3.2.3 for more detail.
The DOTAS regime has been extended from 6 April 2011 to cover the avoidance of IHT through trusts (see 1.5.12(c)).
The Basic Lifetime IHT Exemptions
2.2
The principle
2.2.1
If a gift (or, technically, a ‘disposition’) is exempt when made, it does not matter, in IHT terms at least, that the donor dies within the following seven years – or, indeed, even a day later. Note, incidentally, that to be effective the gift must be ‘perfected’, that is if made by cheque the cheque must have been cleared (Curnock (Curnock’s personal representative) v CIR [2003] SSCD 283 (SpC 365)). Two of the exemptions mentioned below, those for gifts to spouse/civil partners or gifts to charities, apply whether the gift is made during lifetime or on death. But most of the exemptions apply only to lifetime gifts: once the prospective donor has died, it is too late. The first exemption (potentially exempt transfers or PETS) is conditional on survivorship for seven years, whereas the following seven are absolute.
Exemptions should be distinguished from ‘reliefs’, especially for qualifying business or agricultural property (see 2.5): an exempt gift is not a chargeable transfer, whereas a gift of qualifying business or agricultural property is a chargeable transfer, albeit reduced to either 50% or nil.
Potentially exempt transfers (PETs)
2.2.2
The scope of the PET regime was dramatically cut down by Budget 2006, as no longer can a PET be made into a trust (other than a trust for a disabled person). However, in broad terms, a gift to an individual which he survives for seven years is IHT exempt, whatever the amount (IHTA 1984 s3A). If he dies within the seven year period the gift is chargeable. The nil-rate band is attributed to gifts made in the seven years before death according to the order in which they were made (after of course having knocked off any exemptions).
Tapering relief is available if death follows at least three, but less than seven, years after the gift:
Years between transfer and death Percentage of full tax rate
Not more than 3 100%
More than 3 but not more than 4 80%
More than 4 but not more than 5 60%
More than 5 but not more than 6 40%
More than 6 but not more than 7 20%
There is no benefit from tapering relief if the whole gift falls within the nil-rate band, because no IHT is chargeable. However, even if death does follow within three years, making a PET could bring valuation advantages, as the taxable value is that on the date of the gift, not at the date of death.
Certain points need to be borne in mind with PETs, as outlined below.
(a) The danger of premature PETS
The effect of the legislation (IHTA 1984 s7(1)) can easily go unnoticed. In particular, it can render the IHT effects of making a PET worse than if the assets concerned had been left in the transferor’s estate on death.
Example 2.2
Bertie made a gift of £500,000 to a discretionary trust on 1 September 2004. This was a chargeable transfer and IHT was paid accordingly. Five years later he made a PET of £200,000 to his daughter. Bertie died on 1 October 2011 with a fully chargeable estate of £800,000 (after the 2004 chargeable transfer had ceased to be taken into account).
IHT on the failed PET is £80,000, since the 2004 transfer constituted Bertie’s cumulative total in 2009 – and exceeded the nil-rate band.
IHT in the death estate will be calculated by including the failed PET in the cumulative total, that is a chargeable total of £1m, producing a taxable amount of £675,000 after the nil-rate band of £325,000 and a tax liability of £270,000.
By contrast, had the PET never been made and had instead Bertie’s daughter taken a share of residue under the Will, with the consequence that a further £200,000 would form part of the death estate, tax on the enlarged estate of £1m would again be £270,000.
On these facts therefore extra IHT arising out of the PET is £80,000.
TAX TRAP: This ‘7+7=14’ trap is easily overlooked. Even where the transferor of a chargeable transfer is likely to survive that transfer by seven years, caution should await their elapse before making a PET, to avoid the possibility of an unnecessary IHT liability.
(b) Falls in value since date of PET or chargeable lifetime transfer
What happens where the asset given away falls in value following the gift, so that its value at the date of the transferor’s death within seven years is lower than its value at the date of the gift? There is a measure of relief: subject to conditions, the person liable to pay the tax on the PET or chargeable lifetime transfer may claim that the lower value be taken, for purposes of calculating the IHT or additional IHT (IHTA 1984 s131). It is the transferee who has the primary liability for the tax. There is no prescribed form and the claim is made simply by an informal letter (within four years after death).
However, note that this relief cannot apply where the asset given is a wasting asset, or to the extent that the fall in value occurs within the nil-rate band. The latter may seem unfair, since it has the effect of pushing up the IHT liability on the rest of the estate by denying it part of the nil-rate band, but the rule is apparently so drawn intentionally. Indeed, this restriction seems to be the legitimate corollary of the principle that appreciation in value of the subject-matter of a PET which becomes chargeable escapes IHT. Where the transferee has sold the asset before the transferor’s death, the lower sale value may be taken into account instead of the market value at the date of death, provided that the sale has been made by the transferee or his spouse/civil partner in an arm’s length sale to an unconnected purchaser.
The eventuality can easily arise with development land where, for example, in the intervening period the development potential, secured typically by options, disappears.
TAX TRAP: Do bear in mind the IHT downside of a fall in value of the subject-matter of a lifetime gift. The loss of the nil-rate band on death to that extent could be an unwelcome twist.
(c) When does the transfer of value take place, to establish a PET? At what point does the seven year period start running?
While this was not the specific issue in the Court of Session case Linlithgow & Anor v RCC [2010] CSIH, the decision established a point which is also relevant to that broader question. The point in the case was whether the gift had been made before 22 March 2006, following which gifts to accumulation and maintenance trusts were no longer PETs. The transfers in land were made on 15 March 2006, but were not recorded in the Register of Sasines until 10 October and 16 November 2006 respectively. HMRC argued as a result that the transfers of value were not PETs. However, the Court held (unsurprisingly) that a transfer of value for IHT purposes occurred when the gratuitous disposition of heritable subjects in Scotland was delivered to the transferee rather than when it was recorded in the Register of Sasines.
HMRC’s arguments seem very odd (although perhaps the amounts at stake might have been large), certainly in the context of clear findings by the Court in eg Re Rose [1949] Ch 78 with share transfers that it is the date of the transfer form not the date of registration in the company’s books which determines the date of transfer. There is a clear distinction between the legal and (as relevant for tax purposes) the beneficial interest. That said, there may be cases, typically involving private companies, where the transfer of value will follow the date of the transfer form, for example where there are pre-emption rights (when it will not be until all potential purchasers of the shares have been eliminated) or perhaps where certain transfers of shares require board approval: even so, in either case, this may be before the date of registration.
(d) Ensure no reservation of benefit
If a benefit is reserved from the gift, the asset will not effectively leave the chargeable estate until such time (if ever) as the benefit ceases (FA 1986 s102(3) and (4)). See 3.2.2.
(e) The pre-owned assets regime
The POA charge with effect from 2005/06 can catch successful attempts made since March 1986 to avoid the reservation of benefit rules. If a person has disposed of land or chattels – or contributed to their acquisition – and he occupies the land or possesses the chattels, there is, subject to some exemptions, an annual Income Tax charge on the benefit. A similar point applies in relation to ‘intangible’ property (life assurance policies and the like) owned by a trust from which the settlor can benefit. See 3.2.3.
(f) Other taxes
See 2.14 for the possible impact of Capital Gains Tax (CGT), Stamp Duty Land Tax (SDLT) and even Value Added Tax (VAT).
The spouse/civil partner exemption
2.2.3
The exemption is unlimited except where the donor is UK domiciled and the donee is or is deemed to be non-UK domiciled, in which case there is the (rather odd) historic limitation to £55,000, on a lifetime basis (IHTA 1984 s18). The days of this £55,000 limitation in a case where the transferee spouse is EU domiciled may be numbered following a consultation launched by the European Commission in June 2010 (‘Inheritance Tax Hinders Freedom of Movement’). See 13.2 and, for domicile, 15.3 and 16.4.
As to transfers between spouses/civil partners, it has been traditionally axiomatic that on death (and you never know who is going to go first) each individual should own at least £325,000 (for 2011/12) of chargeable value to pass to a beneficiary other than the survivor. This can be achieved by careful Will drafting – see Chapter 18. Otherwise the wastage of the exemption could cost up to £130,000 (40% of the nil-rate band for 2011/12). However, the advent of the transferable nil-rate band from 9 October 2007 (see 18.4.3) has made this unnecessary – and indeed, in the usual case, perhaps ill-advised.
The annual exemption
2.2.4
Gifts of £3,000 in a tax year are exempt (IHTA 1984 s19). To the extent that the allowance in one year is unused, it can be carried forward for one year (only). This exemption is ‘per donor’ (whereas the £250 exemption is ‘per donee’). While it might not seem very much (and was raised from £2,000 as long ago as 1981), regular use can get £30,000 IHT-free out of the chargeable estate over a ten-year period – or £60,000 per married couple/ civil partnership.
HMRC Trusts & Estates interpret the statute (specifically, IHTA 1984 s19(3A) in circumstances where more than one transfer of value is made in a particular tax year as follows: the annual exemption should be deducted from the first gift (not otherwise exempt), whether a PET or not: see IHTM 14143 http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM14143.htm. This is disadvantageous to taxpayers where the donor survives seven years and the annual exemption may be wasted on a gift which subsequently proves to be wholly exempt. The practical advice is in any tax year to make a chargeable transfer before a PET. Where more than £3,000 is given in any tax year, any unused balance from the preceding year may be used.
The annual exemption might be used to pay premiums on a life assurance policy written in trust for others or to make gifts in kind – a painting worth up to £3,000, for example. Alternatively, consider setting up a stakeholder pension for a child or grandchild: a payment of £2,880 (net of 20% basic rate tax in 2011/12, ie £3,600 gross) can be made for a minor beneficiary, although of course the benefits cannot be taken until (currently) age 55 (which many might consider an advantage).
In the case of a parental gift, there is no income to be caught by ITOIA 2005 s624. However, somewhat strangely, s624 will apply to the income from a £3,000 cash ISA set up from 6.4.01 for a 16 or 17 year old unmarried child of the donor (though not to income from the new Junior ISA to be established following Budget 2011).
TAX TIP: It is axiomatic that regular (and recorded) use should be made of the annual exemption. In the absence of other contenders for the gifts, stakeholder pensions might be thought quite a sensible thing to set up, within the annual exemption and/or the normal expenditure out of income exemption (see 2.2.6).
The £250 small gifts exemption
2.2.5
A gift of up to £250 (but no more) to any individual in a tax year is exempt (IHTA 1984 s20). Note that this exemption cannot be used in conjunction with the £3,000 annual exemption (IHTM 14180). So a gift of £3,250 to a particular individual, in circumstances where the previous year’s annual exemption has been used and so cannot be carried forward (but with no other transfers of value in that tax year), will be covered by the annual exemption as to £3,000 and, as to £250, if not within the normal expenditure out of income exemption, will be a PET.
TAX TIP: Consider the advantages of occasional or even annual £250 gifts to (say) God-children made during one’s lifetime rather than by Will – and the donor might even get the bonus of a thank you letter.
Normal expenditure out of income
2.2.6
A transfer will be exempt only if (taking one year with another) it was made out of income leaving the transferor with sufficient net income to maintain his usual standard of living, ie without resort to capital (IHTA 1984 s21). HMRC used to argue that a pattern of expenditure of at least three years must be shown, though the Bennett decision in 1994 (see below) roundly disapproved this. A pattern of giving should be started as early as possible. Records should be kept to back up any claim if necessary. The gifts must be made out of income (which, not surprisingly, does not include the proceeds of sale of shares: see Nadin v CIR [1997] SSCD 107 (SpC 102)).
Expenditure will of course include Income Tax and all regular expenditure of an income nature – as opposed to capital, eg extending the house. This exemption is quite extraordinarily useful and has been generally underused (though the advent of the 50% Income Tax band from 2010/11 has reduced the quantum of post-tax ‘spare’ income which can be the subject of s21 gifts). It is important to keep careful records, in the event that death falls within seven years after a gift in a series, in order to convince HMRC that that gift was exempt. Where the exemption is used over a number of years, it does not matter if in one of those years there was a deficit (out of which of course no gift can be made), so long as ‘taking one year with another’ there was a surplus and gifts were made out of that surplus.
Note the helpful principles set out in the leading case (by Lightman J in Bennett & Others v CIR [1995] STC 54):
• 'normal expenditure’ means expenditure which, when it took place, accorded with the settled pattern of expenditure adopted by the donor;
• a settled pattern can be established either by examining the donor’s expenditure over a period of time, or by showing that the donor has assumed a commitment, or adopted a firm resolution, regarding future expenditure and has thereafter complied with it;
• there is no fixed minimum period during which expenditure has to be incurred; a single payment implementing the commitment or resolution may be sufficient;
• where there is no commitment or resolution, a series of payments may be required;
• a pattern need not be immutable, but it must be intended to remain for a sufficient period (barring unforeseen circumstances); thus, ‘death bed’ resolutions would be excluded;
• the expenditure need not be fixed nor need the recipient be the same on each occasion. The amount of the gift may be fixed by a formula, eg a percentage of earnings, or by reference to an ascertainable liability, eg the cost of nursing home fees, and the donees may be a general class, eg family members or needy friends; and
• tax planning does not disqualify the expenditure.
In Bennett, the deceased was the life tenant of her late husband’s Will Trust. The trustees had on her instructions paid to her three sons total income of some £28,000 in February 1989 and then £180,000 in February 1990, a few days before the deceased’s death. Nevertheless, applying the above criteria, Lightman J was satisfied that ‘normality of expenditure’ had been achieved. He said that the donor had had a single and continuing intention regarding the surplus trust income and that that intention was put into effect. The decision in this case is likely to prove helpful in situations where a life assurance policy has been written in trust and where the grantee of the policy has died unexpectedly having paid only one or a very limited number of the regular premiums which would have been due had he survived.
The status of regular withdrawals from investment bonds for the purposes of the normal expenditure exemption was the subject of a series of postings on the Trusts Discussion Forum in November 2010. The better view is that they are not income either under ‘normal accountancy rules’ or for Income Tax purposes (see HMRC’s Inheritance Tax Manual at IHTM 14250). While it appears that at a CIOT presentation in 2005, shortly before he retired from the then Capital Taxes Office (CTO), the late Peter Twiddy expressed the CTO view that withdrawals from single premium insurance bonds are regarded as income for the purposes of IHTA 1984 s21 provided that the capital of the bond is maintained, this is not now the HMRC view. So the point cannot be raised as something of a ‘last ditch’ argument to try and save a gift made within seven years before death being converted from PET to a chargeable transfer. The supplemental form IHT 403 (lifetime transfers) to Inheritance Tax account form 400 does refer to income for Income Tax purposes.
John Woolley of Technical Connection reports that HMRC have replied to him in their letter as follows: 'It is our view that the regular withdrawals of 5% of the premium from a single premium insurance bond are payments of capital and, as such, they do not fall within the description of income for the purpose of the IHTA 1984 s21 exemption.
'We are aware that contrary opinions have been expressed in the insurance industry and we intend to make our position clearer in an update to the guidance in the Inheritance Tax Manual in due course.'
(Taxation 18.08.11 article by John Woolley of Technical Connection Ltd, p16) [22 September 2011]
TAX TIP: As with the annual exemption, it is axiomatic that where the taxpayer does have post-tax income surplus to normal living requirements this extraordinarily valuable exemption is used. Clear records should be prepared each tax year to provide the necessary evidence in case of death within the following seven years, ideally in the format provided in Schedule 403 to the Inheritance Tax account form IHT 400.
HMRC change their guidance
HMRC have substantially rewritten the sections of their IHT guidance manual dealing with gifts claimed to be ‘normal expenditure out of income’, in particular the distinction between income and capital.
The redraft of sections IHTM14231 to IHTM14255 is intended to ‘reflect HMRC's current practice’ on granting or withholding the exemption, as set out in IHTA 1984 s21.
An important part of the new guidance relates to what HMRC regard as income rather than capital. It is not defined in IHTA 1984 and is not the same as income for Income Tax purposes.
HMRC advise their staff to deny taxpayers' claims that the exemption applies on gifts made out of several years of accumulated income. But they admit that in some cases there is room for dispute. Contentious cases cited by HMRC in the new guidance are annuities and insurance policy payouts (which HMRC say are not counted as income for IHTA 1984 s21 purposes even when they charge Income Tax on them).
The guidance goes into some detail on the status of lifetime care plans, which have become increasingly popular for the elderly in recent years. The idea is that the individual makes a single advance payment to the plan provider, who then pays the fees for future nursing or residential care.
HMRC assert that these fee payments by the plan provider are not income for s21 purposes; instead they represent a return of part of the capital originally provided by the purchaser. However, there may still be a way for taxpayers to include them in their income for a s21 claim, by noting that part of the payment represents income produced by the unused part of the premium while it is held by the plan provider. In that case, the tax inspector has to refer the claim to HMRC's technical department, along with specifics of the care plan (STEP UK News Digest 22.09.11).
Further observations
It seems that a lifetime care plan has the character of an insurance contract, rather like an annuity under which if you die soon after taking out the policy then (subject to a guarantee period) the capital is lost. It appears that under at least some lifetime care plans a death benefit may be payable. It is presumably the analogy with an annuity which might lead HMRC to accept that part of the sum provided each year represents income in the hands of the individual. Any such argument has been firmly kicked into touch by HMRC in relation to the 5% annual withdrawals from a non-qualifying insurance policy (see above). This would have been on the basis (apparently accepted by the late Peter Twiddy in 2005) that insofar as the capital of the bond was maintained, that is with annual growth at more than 5%, the withdrawals could be accepted as income. Does it seem a bit tough to deny the possibility of a s21 claim on the latter case, while granting it on the former? [18 October 2011]
The marriage/civil partnership exemption
2.2.7
Quite a bit of value can be extracted from the chargeable estate(s) when a son or daughter (or step-son or daughter) gets married or enters into a civil partnership (IHTA 1984 s22). The exempt amounts depend on the relationship between donor and donee, as follows:
• £5,000 per parent;
• £2,500 for grandparents; and
• £1,000 for all others.
Gifts in kind as well as in cash are exempt, as are certain types of settled gift. The gift must be an outright gift to or for a party to the marriage/civil partnership: hence there is no exemption if the celebrations are called off.
The charities exemption
2.2.8
This exemption applies to gifts on death just as to lifetime gifts (IHTA 1984 s23). However, one advantage of lifetime gifts of course is the possibility of Gift Aid Income Tax relief, both basic rate recovery for the charity and higher rate relief for the donor. See 12.2 and 12.3. Budget 2011 has proposed that, for deaths on or after 6 April 2012, the current 40% rate will be reduced to 36% where 10% or more of a deceased’s net estate (after deducting IHT exemptions, reliefs and the nil-rate band) is left to charity. HMRC issued a consultation document on 10 June 2011, for response by 31 August 2011. See further 12.3.6.
Gifts of shares to employee trusts
2.2.9
To secure the IHT exemption, the beneficiaries of the trust are restricted to a class defined by particular employment or type of employment and their relatives (IHTA 1984 s28, with the conditions set out in s86). Where there is a particular employment, the class must comprise all or most of the employees or the trust must be an approved profit-sharing scheme. Trustees must hold at least 50% of the company and no participator (broadly a shareholder with 5% or more) must be able to benefit.
Gifts for national purposes
2.2.10
Gifts to the National Trust etc (including Government Departments) are exempt (IHTA 1984 s24: see IHTA 1984 Sch 3 for the list of bodies).
The Use of Trusts
2.3
A convenient recipient of lifetime gifts
2.3.1
Where a gift is to be made but either the donor wishes to ensure some protection and/or a suitable donee does not present himself, a trust can be a useful mechanism. Even if death follows within seven years, the value charged to IHT will be that prevailing at the date of the gift, not at the date of death, by when the asset(s) may have appreciated. The full range of exemptions and reliefs is available for transfers into trust as for other types of property. Note that, on termination of a qualifying or ‘estate’ interest in possession, use of the life tenant’s annual exemption(s) requires notice by the life tenant to the trustees (IHTA 1984 s57). The same point applies to the life tenant’s marriage exemption.
Settlor and spouse/civil partner should be excluded
2.3.2
To be effective for IHT purposes the settlor must be excluded from benefit to avoid the GWR regime (FA 1986 s102): see 3.2.2. There is no pro rata provision. While generally the pre-owned assets (POA) regime (see 3.2.3) will not apply if either GWR does or would apply but for certain express exceptions, the two regimes are not completely mutually exclusive. Hence, for example, while GWR requires a disposition by way of gift, a disposal for full consideration of land which the donor occupies may be caught by POA. The following comments about the spouse/civil partner apply to the POA regime for settled intangible property just as they do to GWR. The settlor’s spouse/civil partner can be included, although this will have Income Tax implications (under ITTOIA 2005 part 5 chapter 5) and, before 2008/09, also CGT implications (TCGA 1992 s77, repealed from 2008/09). However, these anti-avoidance provisions will not apply if the spouse/civil partner can benefit only after the settlor’s death.
The key IHT distinction
2.3.3
Chapter 3 considers the tax implications of making new trusts and Chapter 4 describes the tax-efficient management of existing trusts. In broad terms, the IHT treatment of a lifetime trust will fall into one of what were two categories before 6 April 2008, but are now just two ((a), and (b) below). The age 18-to-25 trust (category (d)) is essentially a type of Will trust, although before 6 April 2008 property within the accumulation and maintenance regime could be converted into such a trust.
(a) The relevant property regime
This applies to discretionary settlements and almost every other type of lifetime settlement made on or after 22 March 2006, except where the beneficiary is disabled (IHTA 1984 s58 and see 3.4.3).
The general principle with such settlements is that at commencement the settlement inherits a cumulative total equal to that of the settlor on the day prior to creation plus the value of other funds settled by the settlor on the day of creation (related settlements). There are then two principal charges:-
(i) a ten-year anniversary charge, which is applied to the then value of the trust fund, given the initial cumulative total and funds leaving the trust in the preceding ten years (IHTA 1984 s64 and see 4.7.4). This is computed so that over the course of an assumed generation, some 331/3 years, the trust fund attracts tax at the 20% lifetime rate. This means a maximum tax charge every ten years of 6% and very often less than that, given availability of the nil-rate band and any reliefs; and
(ii) an exit charge, which varies according to whether it occurs in the first ten years or thereafter (IHTA 1984 s65 and see 4.7.5). In the first ten years the notional value charged is equal to that of the assets advanced, by reference to a given fraction of the rate at which tax would be payable at the exit date on the funds settled, given the initial cumulative total, any related settlements and any added property. This means that if the gross value of the initial funds settled and of any other (non-charitable) settlements made on the same day, plus that of any additions to the settlement, fall within the nil-rate band in force at exit within the first ten years, there is no exit charge whatever the then value.
TAX TRAP: The rate of tax on exit within the first ten years is found by reference to the value of the assets when settled before BPR or APR (IHTA 1984 s68(5)(a)). It is not enough therefore for the initial value to be within the nil-rate band solely because of APR/BPR, as this could give rise to a positive rate of tax. However, this will matter only if the property concerned does not itself attract APR or BPR at exit. The exit charge after the first ten year anniversary is the appropriate fraction of the rate charged at the previous anniversary.
(b) ‘Estate’ interests in possession
These are settlements which are treated as if the underlying trust property were owned beneficially by the beneficiary (IHTA 1984 s49(1)), namely interest in possession settlements made before 22 March 2006 so long as the interest in existence at that date continues or is replaced by a qualifying ‘transitional serial interest’ (see 4.6.7). This point applies also to life interests under Wills whenever the death occurs (called ‘immediate post-death interests’ or IPDIs): see 18.3.3. That means that, for example, on death of the beneficiary the trust property to which he has had a right to income is added to his free estate, and a single ‘estate rate’ is calculated, to be applied separately to the free estate and the settled estate (subject of course always to exemptions such as the spouse/civil partner exemption).
(c) Accumulation and Maintenance trusts (A&M trusts) made before 22 March 2006
These are a special category of settlement (defined in IHTA 1984 s71), made broadly for children or grandchildren of the settlor, which received special treatment as discretionary settlements from 1975 to 2006 through an exemption from the ten year anniversary and exit charges (see 4.4.1). However, no new such settlements can be made on or after 22 March 2006 and a transitional regime which applied to such A&M trusts in being at that date came to an end on 5 April 2008 (see 4.5). That said, the A&M regime continues for trusts where the vesting age was made 18 before 6 April 2008 (see 4.5.3).
(d) The ‘age 18-to-25’ trust
This type of trust, whether arising out of an A&M trust for the settlor’s children or grandchildren or created under a Will for the testator’s children (IHTA 1984 s71D), suffers an exit charge at a maximum of 4.2%, rather as under the A&M regime (see 18.5.4).
Impact of Finance Act 2006
2.3.4
For the rich (however one defines that term), it is clear that the FA 2006 ‘Inheritance Tax Alignment of Trusts’ has had a significantly damaging effect. This is because one of the great advantages of making a trust for one’s children or grandchildren – and of course the spouse/civil partner can safely be a trustee, while being excluded from benefit – is that the capital is not available to creditors nor indeed will it generally be vulnerable in matrimonial proceedings. But now, making any lifetime trust with an initial chargeable value – or any addition to a trust - which causes the settlor to exceed his nil-rate band triggers to that extent an IHT liability at 20% (to rise to 40% if he dies within seven years). The only exceptions to this rule are an exclusively charitable trust (exempt) or a qualifying trust for a disabled person (a PET). See also 3.4 and 3.5.
The Family Home(s)
2.4
The problem
2.4.1
The relentless rise in house prices over the last 20 years or so, albeit more recently suffering something of a reversal, is a problem not just for the first-time buyer but also for the next generation on the deaths of the older property-owning generation. This is of course especially the case if one (or more) of the children wants to carry on living in the home which may have been in the family for some generations. So, what does one do, other than simply moving out and making a gift which one survives by seven years?
It was in response to several well-publicised successful attempts to avoid the GWR regime (by making an effective gift for IHT purposes while remaining in occupation) that the POA rules were introduced from 2005/06: see 3.2.2 and 3.2.3. While there are various planning possibilities open, the overriding concern must be the taxpayer’s own security of tenure if contemplating any form of lifetime gift. There is an obvious commercial risk in making a gift of the house to the children, even if the donor manages to avoid both the GWR and POA regimes. If the children then become insolvent or embroiled in matrimonial difficulties the house may have to be sold. Also, there is probably not much point in entering into an arrangement which might escape the rules on a technicality but which is more than likely to be attacked by HMRC later on.
Some solutions
2.4.2
The above said, there are certain well-established routes, for example:
• Giving the house away and occupying it thereafter for ‘full consideration’. This may mean either paying a rack rent on a three-year renewable lease on arm’s length terms or ‘buying a lease’ for one’s life expectancy by paying a capital sum (on part of which, the term being likely to be for less than 50 years, the recipient will have to pay a measure of Income Tax): see 5.6.
• Alternatively, if one of the children is sufficiently wealthy, it may be possible to enter into the sort of equity release scheme one might otherwise do with a financial institution, whereby the parent sells the house to the child for full value and then buys back a lease for life (on the standard terms of a tenancy, but without having to pay rent): see 5.7.
• Further, likely to be more than an option perhaps with a second or holiday home, a person could give away a share in the house and occupy it from time to time with the children, each of them paying a fair share of expenses. Such an arrangement if properly structured avoids both the GWR and POA regimes: see 5.8.
• A person might simply sell a large house and trade down for less cash, giving away the balance (after paying off any mortgage) to the children.
• Where the house is substantial and lends itself to physical division into two dwellings, the parents could retain one part (ideally the smaller one) and give away the other as a PET, with no continuing benefit to trigger either the GWR or the POA regime.
The important point in all this is obviously that relationships between the family and the extended family are happy and likely to remain so.
One should also be aware of the main residence relief from CGT. If the house or a share in the house is owned by one or more of the children who do not in fact live there, then the gain will be building up for charge on ultimate disposal by them – except perhaps in the event that they do come and live there and stay in occupation until death.
All this is the subject of Chapter 5.
The Reliefs for Qualifying Business and Agricultural Property
2.5
Outline description
2.5.1
These reliefs are given in most cases at 100%, and are generous indeed. It was a major surprise that successive Labour Governments did not between 1997 and 2010 seek to reverse the rate increases introduced by a Conservative Government in 1992. The rules for both reliefs (business property relief and agricultural property relief – BPR and APR) are complex, covered in Chapters 6 and 7 respectively. In each case one must determine the type of property which qualifies and the time it has been owned or (in the case of agricultural property) occupied – generally two years. Neither relief is given if at the date of transfer the property is subject to a binding contract for sale (IHTA 1984 ss113 and 124). Certain types of business or agricultural property attract relief at only 50%.
Business Property Relief
2.5.2
(a) ‘Relevant business property’
The property must, wherever in the world it is situated, be (IHTA 1984 s105):
• a business, or an interest in a business, which must be carried on with a view to profit;
• unquoted securities which confer control, either by themselves or with any other unquoted securities or shares;
• any unquoted shares;
• a controlling holding of quoted shares;
• land or buildings, machinery or plant used in a business by a company controlled by the deceased, or by a partnership of which he was a partner; or
• land or buildings, machinery or plant owned by trustees and used in a business where the deceased had an estate life interest.
(b) Period of ownership
The taxpayer must have owned the relevant business property for at least two years, subject to relieving provisions for replacement property and for property inherited on the death of a spouse/civil partner (IHTA 1984 ss106, 107 and 108).
(c) Rate of relief
100% relief will be given for the first three categories above, otherwise 50% (IHTA 1984 s104). Shares in AIM companies are treated as unquoted companies.
(d) Type of business
The business must not be wholly or mainly an investment or a dealing business (IHTA 1984 s105(3)). Generally speaking, BPR is given only to trading businesses. Accordingly, a business of owning property which is let residentially or commercially will generally not attract BPR. Some businesses will be ‘mixed’, comprising a number of different elements. Relief will be given only if the trading side predominates.
(e) Excepted assets
There may be some assets in a qualifying business which constitute ‘excepted assets’ (IHTA 1984 s112). These will be excluded from relief where broadly not used in the business nor required for future business use. The proprietor of a business cannot simply ‘park’ spare cash, surplus to business requirements, in the business and necessarily expect to get BPR on all the cash: that said, however, see 6.2.6(d).
Agricultural property relief
2.5.3
(a) 'Agricultural property'
This is defined as (1) agricultural land or pasture; (2) woodland and buildings used for intensive rearing of livestock or fish, if the occupation of the woodland or building is ancillary to agricultural land or pasture; and (3) such cottages, farm buildings and farm houses together with their land as are ‘of a character appropriate’ to the property (IHTA 1984 s115(2)). The agricultural property must be situated within the EEA (or, in cases where tax was paid or due before 23 April 2003, within the UK, the Channel Islands or the Isle of Man). A controlling interest in a farming company will also attract APR.
(b) The occupation or ownership test
The deceased must have occupied the agricultural property for agricultural purposes for at least two years, or must have owned the agricultural property for at least seven years, with continuous occupation by someone for agriculture (IHTA 1984 s117). There are reliefs for replacement of property within that period and for property inherited on the death of a spouse/civil partner (IHTA 1984 ss118 and 119).
(c) Rate of relief
The rate is 100% if (IHTA 1984 s116):
• the deceased has vacant possession, or the right to obtain it within 12 months (24 months by concession) after his death – had he survived;
• the deceased had owned his interest in the land since before 10 March 1981 and would have been entitled to the old ‘working farmer’ relief from CTT, with no right to vacant possession since then; or
• the deceased was the landlord of a tenancy commencing on or after 1 September 1995.
Otherwise, the transfer will attract only 50% relief, typically where he is the landlord of property let under a tenancy granted before 1 September 1995 under which he does not have the right to get vacant possession within 24 months.
(d) 'Agricultural value'
APR is given not on the market value of the property (like BPR), but on the ‘agricultural value’ only; this presumes that the property is subject to a perpetual covenant prohibiting non-agricultural use (IHTA 1984 s115(3)). District valuers have been using this to argue for a discount of one-third on the market value of the farmhouse, with support from the October 2005 Lands Tribunal decision in Lloyds TSB (as personal representative of Antrobus deceased) v IRC, under reference DET/47/2004.
A comparison
2.5.4
BPR is given only broadly to businesses which, or shares in unquoted companies (including AIM companies) which, trade – and which trade at a profit. By contrast, APR can be obtained by an agricultural landlord, whether at 100% or at 50%: here the qualifying period of ownership is seven years. Nor is the view to a profit required for APR. BPR is given on a worldwide basis, whereas APR is limited to property in the EEA. BPR is applied to market value, while APR is limited to ‘agricultural value’ (see 2.5.3(d)). The big advantage which farmers have over other businessmen is that APR can be given to the farmhouse, though this has been exciting recent adverse scrutiny from both HMRC and the Courts (see 7.2.2).
Woodlands can attract BPR, provided that they are managed in a business-like way (annual accounts, VAT registration etc), even if it is hard to show a profit on an annual basis: see 7.4.3.
Chattels
2.6
Overview
2.6.1
It often comes as something of a shock to people to discover quite how much the contents of their house (or houses) and other personal possessions are worth. But all that value is potentially subject to IHT on death; subject of course to the spouse/civil partner (and possibly the charities) exemptions. There remains still a widespread but mistaken belief that in valuing chattels on death there is a permissible discount from market value of something up to one-third. That is not the case, as HMRC Trusts & Estates have been reminding us at various points over recent years. The statutory valuation rule is ‘the price which the property might reasonably to fetch if sold in the open market’ at the date of death (IHTA 1984 s160). So, what’s to be done? The answer could be as follows (as developed at 8.3).
Planned lifetime giving (without retention)
2.6.2
Remember for example that the £3,000 annual exemption could be constituted by chattels just as much as by cash. A gift will be a disposal for CGT purposes and so will trigger a liability if the total chargeable gains exceed the annual exempt amount for the year (£10,600 for 2011/12). There is an exemption for a chattel if its value does not exceed £6,000 (which also applies to a set of chattels given away at the same time: TCGA 1992 s262). But of course, to be effective for IHT purposes there must be no continuing enjoyment of the chattel; hence, alternatively:
An effective gift of the chattel followed by continued enjoyment by the donor ‘for full consideration’
2.6.3
So long as ‘full consideration’ is paid (whatever that may mean) there is specific exemption from both the GWR regime (FA 1986 Sch 20 para 6(1)(a)) and the POA regime (FA 2004 Sch 15 para 11(5)(d)). It has been customary for some years now for prospective donor and donee, eg mother and son, to have a gift of chattels by mother to son to be accompanied by a licence or lease arrangement under which typically mother covenants to pay the insurance premium on behalf of son and on that basis to pay such an annual fee independently agreed between qualified agents acting for each party as will constitute full consideration. In the present marketplace this may amount to no more than 1% of market value, to be kept under review every three years. This of course, on which the donee must pay Income Tax, compares rather favourably with the annual amount on which the Income Tax liability is based under the POA regime, assuming no GWR (which is the value at the beginning of each five year period, multiplied by the ‘official rate’ of interest, which is 4.00% for 2010/11 and 2011/12). As noted at 2.6.2, the CGT implications of the gift must be considered.
While such arrangements were being vigorously challenged by HMRC Trusts & Estates some years ago, that threat appears now to have receded. On the other hand, anyone entering into such an arrangement needs to be warned that it is not exactly for ‘widows and orphans’ and so, while taking the best advice and complying with it, nothing can be guaranteed. But of course once seven years have passed after the gift and the PET has become exempt (and full consideration continues to be paid for the rest of the donor’s life or until she ceases to enjoy the assets), the chattels concerned will effectively have been extracted from the chargeable estate free of IHT while enabling continuing enjoyment, at only a relatively small annual cost.
Investments
2.7
Investments within a person’s ownership may take a variety of forms: equities, unit trusts, government stock, PEPs or other rather more weird and wonderful creatures. But, like any other property the market value will fall into charge at death. While, under the Enterprise Investment Scheme and the Venture Capital Trust Scheme, certain Income Tax and CGT reliefs are available during life, the only IHT-saving opportunity open here (other than for family-owned companies) is BPR for shares listed on the Alternative Investment Market (AIM) as to which see 2.5.2 for a summary and 6.2 for more detail.
The GWR regime applies to gifts of investments as much as to any other property. And, in the case where GWR does not apply, and there has been a disposal of investments into a settlor-interested trust, there may be an annual Income Tax liability on 4.75% (in 2009/10) and 4.00% (in 2010/11) of the market value under the POA regime.
The difficulty of course is that everyone needs to live – and usually requires income for that purpose. There is no point in making an effective gift of a substantial amount of investments, surviving for seven years, then only to find that the donor has nothing left to live on. But investments will take their place in the overall family plan. It may be that:
(a) there are some investments surplus to requirements which, subject always to CGT considerations, can be given away;
(b) the balance of the investments can be slanted rather more to the production of income than capital growth on which of course 40% IHT will ultimately have to paid; or
(c) developing the concept of total return, a person may feel that he can ‘afford’ a rather larger gift of investments than might otherwise be the case if he can ‘live off capital’ in relation to the remainder – taking a reasonably conservative view of continuing life expectancy.
All this is developed in Chapter 9.
Scope of the expression
2.7.1
Investments within a person’s ownership may take a variety of forms: equities, unit trusts, government stock, PEPs or other rather more weird and wonderful creatures. But, like any other property the market value will fall into charge at death. While, under the Enterprise Investment Scheme and the Venture Capital Trust Scheme, certain Income Tax and CGT reliefs are available during life, the only IHT-saving opportunity open here (other than for family-owned companies) is BPR for shares listed on the Alternative Investment Market (AIM) as to which see 2.5.2 for a summary and 6.2 for more detail.
The GWR regime applies to gifts of investments as much as to any other property. And, in the case where GWR does not apply, and there has been a disposal of investments into a settlor-interested trust, there may be an annual Income Tax liability at 4.00% (in 2010/11 and 2011/12) of the market value under the POA regime.
Alternative strategies
2.7.2
The difficulty of course is that everyone needs to live – and usually requires income for that purpose. There is no point in making an effective gift of a substantial amount of investments, surviving for seven years, then only to find that the donor has nothing left to live on. But investments will take their place in the overall family plan. It may be that:
(a) there are some investments surplus to requirements which, subject always to CGT considerations, can be given away;
(b) the balance of the investments can be slanted rather more to the production of income than capital growth on which of course 40% IHT will ultimately have to paid; or
(c) developing the concept of total return, a person may feel that he can ‘afford’ a rather larger gift of investments than might otherwise be the case if he can ‘live off capital’ in relation to the remainder – taking a reasonably conservative view of continuing life expectancy.
All this is developed in Chapter 9.
Life Assurance and Pension Arrangements
2.8
Life Assurance
2.8.1
The classic use of life assurance is to build up, outside the chargeable estate, a fund which can be used to pay at least part of the IHT burden on death. There is a wide variety of different types of life assurance policy, of which the main ones are described at 10.2. The ‘traditional’ product for spouse/civil partners or civil partners is the so-called ‘joint lives and survivor’ policy which would pay out on the second death, the spouse/civil partner exemption removing any IHT liability on the first death.
While it is no longer generally possible to obtain Income Tax relief on premiums paid on new policies, the payment of annual premiums within a donor’s financial 'comfort zone’ might be regarded as a sensible investment. In capital terms property is being extracted from the ultimate chargeable estate to fund a growth investment, also outside that estate, to meet part of the ultimate liability. The policy should of course be written in trust, to avoid the policy proceeds falling into the chargeable estate, typically for a class of beneficiaries, and so each premium is a gift which might be protected by either the £3,000 annual exemption or the normal expenditure out of income exemption from IHT.
For those who are minded to do something a bit more adventurous, there are three particular ‘products’ promoted by the life assurance industry which HMRC have confirmed are effective to avoid both the GWR and POA regimes, even though some benefit or possibility of benefit is retained by the donor/settlor. Of course, the use of trusts in such cases has been rather curtailed by FA 2006, since no-one will want to incur an immediate IHT liability at 20% of the excess of the chargeable transfer over the nil-rate band threshold. But such products, namely the gift and loan arrangement, the discounted gift trust and (in my view, to a lesser extent) the flexible reversionary trust, remain attractive in principle. They are described in more detail at 10.5. It will be important to be able to form a positive view on the likely investment performance of the fund(s) underlying the policy.
Pensions
2.8.2
The regime introduced from 6 April 2006 to take the place of a good eight or nine different regimes which preceded it, whether retirement annuities or personal pensions, has rather changed the landscape. This regime is described at 11.2.
As from 2011/12 Income Tax relief at the marginal rate (ie, up to 50%) is given on pension contributions not exceeding £50,000 gross per annum (subject to transitional relief carry-forward from 2008/09, 2009/10 and/or 2010/11).
When it comes to drawing benefits, no longer do any funds remaining in the pension pot at age 75 have to be converted into an ‘alternatively secured pension’, if not taken as annuity. While any funds remaining at death can be used to pay pensions to a surviving spouse/civil partner or financial dependent, residual funds thereafter will attract an Income Tax charge of 55%.
Charitable Giving
2.9
Inheritance tax
2.9.1
The IHT exemption for gifts to charities was outlined at 2.2.8 and is explored further at 12.3.6.
Income Tax and Capital Gains Tax
2.9.2
A payment to a charity, which may be one-off or regular, can attract two forms of tax relief under the Gift Aid regime (ITA 2007 s414). First, a payment to the charity of an amount under deduction of Income Tax at the basic rate enables the charity to recover that basic rate tax from HMRC. So, with a basic rate of 20%, a payment of £80 is treated as a gross payment of £100 on which the charity can recover £20. This assumes that the donor has paid sufficient Income Tax or CGT to cover the tax recovery: if not, there will be an unexpected tax liability on the donor (under ITA 2007 s424). Second, to the extent that the donor is a higher or (from 2010/11) an additional rate taxpayer, he can recover higher or additional rate tax relief on the amount of the gift, that is, (in 2010/11 or 2011/12) £20 or £30 on the above figure. So the cost of putting £100 into the hands of the charity could be just £50.
TAX TRAP: It’s an obvious point, but a potentially expensive one to get wrong: ensure that the donor has paid sufficient Income Tax and/or CGT in the year of the donation to support the tax reclaim by the charity. If not, the charity gets the tax back and the donor gets a tax bill.
Separately, there is also a relief for gifts of shares and securities and of land situated in the UK to charity (ITA 2007 ss431-446). And any gain arising on the gift does not attract CGT (TCGA 1992 s257). The charity is treated as inheriting the donor’s base cost. And so any gain realised by the charity on sale will not attract tax, assuming of course that the proceeds are applied for charitable purposes.
Territorial scope
2.9.3
Traditionally, to benefit from UK tax relief, the charity must have been established in the UK. And any Income Tax relief for gifts of land to charity was limited to UK land. As noted in Chapter 12 these limits were extended in 2010 to the EU, Norway and Iceland following a recent ECJ case from Germany.
The Family Unit
2.10
What is it?
2.10.1
Long gone are the days where the family unit might be generally understood as meaning husband, wife and 2.4 children. And in very many cases, the needs of what might be called ‘the extended family’ must be taken into account. However, for purposes of this Book I am concerned primarily with just two (or possibly three) generations and a fairly close-knit set of relationships. The older generation might be a married couple, a civil partnership, a couple living together or a single parent. The younger generation (if any) might be one or more children or step-children of any of the above, whether minors or aged 18 or over. The basic fiscal framework requires one to consider: (a) whether or not an IHT exemption, and indeed a CGT relief, applies on transfers of assets between members of the older generation; (b) whether an anti-avoidance regime applies for Income Tax and CGT purposes in relation to income and gains accruing to individual minor children or trustees for them; and (c) how gifts to or for the benefit of children are treated for IHT, ie whether made outright or in trust.
Transfers between members of the older generation: Inheritance Tax
2.10.2
The IHT exemption (see 2.2.3 and 13.2) has since 5 December 2005 applied equally to transfers between members of a registered civil partnership as to spouses. The interesting thing is that what matters is the legal relationship of marriage or registered civil partnership, not the fact that (as required by the CGT no gain – no loss rule) the couple are living together. Indeed, they may have separated many years before, but for whatever reason (religious or otherwise) have not broken the legal relationship: the IHT exemption remains. The only point to watch is the case where the transferor is UK domiciled but the transferee is not, for all IHT purposes, in which case the exemption is limited to £55,000 on a lifetime basis (IHTA 1984 s18(2)) – but see 2.2.3 for possible future repeal where the transferee is domiciled within the EU.
Transfers between spouses/civil partners: the Capital Gains Tax position
2.10.3
By contrast, the rule that a transfer of assets between such individuals takes place on a ‘no gain no loss’ basis (TCGA 1992 s58) depends upon the couple living together at some time in the year of gift, even if the transfer follows the date of separation. The test is the old Income Tax one for mortgage interest relief purposes, viz that if there is a separation it is likely to be permanent (now in ITA 2007 s101). Once the separation (or divorce) has happened, a transfer in a subsequent year will be treated for CGT purposes just as any other transfer between individuals, that is, a disposal with the market value being treated as received by the disponor. Interestingly, while the basic exemption applies, it matters not whether the disposal is by way of sale or gift: even if by way of sale the actual sale proceeds are disregarded and the ‘no gain no loss’ rule is applied, so putting the transferee spouse/civil partner in the shoes of the transferor in terms of inheriting his historic base cost.
Providing for children: Income Tax
2.10.4
An anti-avoidance regime operates where income or gains arise to, or to trustees of a settlement for, minor children of the transferor/settlor (see 3.2.5). In broad terms, for Income Tax, subject to a de minimis limit of £100 per transferor per child per tax year, the income is treated as that of the parent (ITTOIA 2005 s629). The only exception is the case where the transfer of assets occurred before 9 March 1999 and the income from those assets belongs absolutely to the child as it arises (ie in particular Trustee Act 1925 s31 has been excluded, so that the trustees have no power to accumulate income, but must retain it for the child until such time as they can get a valid receipt, whether from the parent or guardian or from the child on attaining age 18). Income which is accumulated and then paid out in a subsequent year while the child is still under the age of 18 does not escape assessment on the parent settlor.
Providing for children: Capital Gains Tax
2.10.5
A gift of an asset other than sterling cash may trigger a gain on disposal. Where a positive tax charge arises, ie to the extent that neither the annual exemption of £10,600 (for 2011/12) or allowable losses are available, it may be possible to hold over the gain – with either a defined business asset or a gift into trust (see 3.7.3).
The anti-avoidance rule applying from 2006/07 to 2007/08 inclusive was similar to Income Tax where gains are made by trustees of a settlement under which a minor unmarried child of the settlor can benefit (and child includes a step-child). In that case the gains are treated as those of the settlor and thus can attract any annual exemption otherwise available. Any allowable losses or otherwise would attract tax at his marginal rate (TCGA 1992 s77, repealed from 2008/09). As from 2008/09 the gains of a settlor-interested trust are assessed on the trustees.
By contrast, if the assets are beneficially owned by the child, though because he is under age they are vested legally in someone else as nominee or bare trustee, the gains arising on disposal are treated as those of the child and thus are capable of attracting his annual exemption and/or (before 2008/09) lower CGT rates of 10% or 20% rather than those of the parent. As from 2008/09, in 2009/10 and for disposals in 2010/11 before 23 June 2010 there was a single rate of CGT of 18%. For disposals after 22 June 2010 the rate is 28% to the extent that when added to taxable income the amount of taxable gains exceeds the basic rate Income Tax threshold (of £37,400 in 2010/11 and £35,000 in 2011/12) - and otherwise 18%. In any event, there remains the advantage of the child’s annual exemption.
The availability of the child’s annual exemption and tax rates for gains deriving from parental gifts to a minor may seem something of an oddity, though it is one of which many have historically taken, and continue to take, advantage. The disadvantage of course is that come age 18 the child can call for transfer of the assets into his own name absolutely (see 3.4.2(c)).
Providing for children: Inheritance Tax
2.10.6
Here the issue is whether the gift is made outright or in trust, no doubt for protection reasons. An outright gift will be a PET (ie free from IHT on the donor’s survival for seven years). By contrast, a gift into trust (except for a disabled beneficiary) will be an immediately chargeable transfer, free from IHT only insofar as it does not take the settlor’s seven year cumulative total of chargeable transfers over the nil-rate band of £325,000 (in 2010/11 to 2014/15 inclusive). In either case the chargeable value may be reduced by 100% or 50% business or agricultural property relief. These issues are developed at 3.3 to 3.5.
Heritage Property
2.11
Two categories of favoured IHT treatment are given to qualifying heritage property (IHTA 1984 ss30 - 42). First, conditional exemption is accorded to transfers typically on death, though also during lifetime by way of chargeable transfer. Subject to giving certain undertakings, the contingent IHT liability is deferred until either those undertakings are broken or there is a further chargeable event without a renewal of the undertakings. Second, under the system of ‘acceptance in lieu’, certain heritage property can be offered to and accepted by the nation for lodging in one of the national (or possibly local) museums in satisfaction of a liability to IHT or CGT. See Chapter 14 for further details.
The Foreign Element
2.12
Excluded property: the IHT exemption for non-UK domiciliaries
2.12.1
Where the deceased was domiciled or deemed domiciled in the UK at death, the estate will be liable to IHT regardless of where the assets were situated. If he was not so domiciled, IHT will apply only to assets situated in the UK. The normal domicile rule is extended in two circumstances, as explained at 16.4 (IHTA 1984 s267).
IHT mitigation for non-UK domiciliaries
2.12.2
Any assets which do not need to be situated in the UK from time to time (eg cash surplus to immediate spending requirements, investment portfolios etc) should be kept outside the UK. But it is more difficult with a house or flat and furniture: what can be done there? Some options are explored at 16.7.
Non-UK domiciled settlors and excluded property settlements
2.12.3
With settled property, the trust assets will be excluded property if situated outside the UK and if the settlor was domiciled outside the UK when the settlement was made (IHTA 1984 s48(3)). This applies regardless of a subsequent change of domicile by the settlor or indeed changes in the trust property, provided that the property remains outside the UK. HMRC Trusts & Estates have traditionally accepted, and have recently confirmed, that the GWR rules are ‘out-flanked’ by the excluded property rules. It matters not where the trustees are resident.
This is the rule even if the settlor has an initial 'estate' interest in possession and dies UK domiciled with that interest and if his children also UK domiciled have successive life interests. That said, there is one trap. This applies where the settlement grants initial estate interests in possession to the settlor and/or spouse/civil partner and, at the time when the interest of the last of them to have such an interest ends (typically on the second death), that beneficiary is actually or deemed UK domiciled, but the settlement continues, generally on or after 6 October 2008. Regardless of whether there is a continuing ‘estate’ interest in possession (as a transitional serial interest: see 4.6.7) or the relevant property regime applies, the UK domicile of the deemed settlor will mean that the erstwhile protection of excluded property settlement status is no longer available, even if the trust fund is situated outside the UK (under IHTA 19804 s80). See 16.6.3.
(There used to be thought to be another trap arising from the rule that where (in any case) property ceases to be subject to a reservation, the donor is treated as making a PET (FA 1986 s102(4)). Accordingly, if the trustees were to exclude the settlor from benefit and he dies within seven years, he would be treated as having made a chargeable transfer, even if the property in the settlement is excluded property. Happily, however, in 2011 HMRC Trusts & Estates confirmed that the excluded property rule in IHTA 1984 s3(2) takes priority over s102(4) and so (in their view at least, though not in the view of all commentators) the point falls away.)
Will Planning and Post-Death Rearrangements
2.13
Wills
2.13.1
On death a person can ensure that his possessions go to intended recipients by means of a validly made and executed Will. Remember the trap that neither of the two required witnesses must be a beneficiary, as otherwise any such individual will forfeit the right to inheritance.
Failing a Will for all or part of an estate (as a Will could extend to just part), the property will pass according to the intestacy rules, which can throw up some surprising results. It is a common misapprehension that ‘there’s no need to make a Will as I want everything to go to my wife and she’ll get it anyway’. Well, she will so long as there are no children or remoter issue, brothers or sisters, nephews or nieces, parents or grandparents etc surviving. The intestacy rules (described in detail at 18.2) can mean not only property going to people who the deceased would rather not have had it, but also triggering an IHT bill on death which might easily have been avoided with proper planning. Of course, tax efficiency is not the only aspect of Will planning and other issues such as the appointment of executors as the chosen persons to administer the estate might be just as important. The important thing is to keep the Will (and any letters of wishes) up to date.
The main IHT planning issue applies only to married couples and members of a registered civil partnership – and then on the first death. The structure of IHT was explained at 2.1. For deaths before 9 October 2007, it was axiomatic that full use should be made of the nil-rate band, insofar as not taken up by chargeable lifetime gifts in the seven years before death, in passing assets other than to the survivor on the first death. Otherwise the property would be passed to the survivor, whether absolutely or on what is now called an ‘immediate post-death interest’ trust, so deferring any IHT liability on that estate until the second death. That ‘accepted wisdom’ has been overturned by the introduction of the transferable nil-rate band (found in IHTA 1984 s8A): see 18.4.3. General policy should now be to maximise use of the spouse/civil partner exemption on the first death. In any event, between the two deaths there might be some IHT mitigation which can be undertaken through PETs made by the survivor to limit the impact on the second death.
Post-death rearrangements
2.13.2
Suppose that, in IHT terms at least, the deceased did not ‘get it right first time’ – or even at all. What then? Whether or not a reasonably drawn Will was left, there are three statutory possibilities open to the beneficiaries so as effectively to rewrite the provisions of the Will or indeed intestacy for IHT purposes.
(a) Written variations or disclaimers
The beneficiary, being of full age and capacity, can within two years after death redirect the entitlement, whether as a share in residue or a specific gift, to another beneficiary or indeed to trustees (IHTA 1984 s142). Providing the technicalities are observed, and certain anti-avoidance rules sidestepped, this takes effect as if it had been effected by the deceased’s Will. A similar point applies where a beneficiary ‘disclaims’ the original gift, though a disclaimer cannot be made in favour of a specific person; rather, the destination of the gift depends on the terms of the Will or intestacy and the property will go to the person next in line. The making of a variation or disclaimer will generally not constitute a disposal for CGT purposes. Otherwise, however, the reliefs take effect for IHT only and the disposition which is occasioned by the variation or disclaimer will carry the normal CGT and Income Tax consequences.
(b) Precatory trusts
A husband might leave his personal possessions to his wife, but express the wish that within two years after death she makes certain redirections of specified chattels to particular individuals. If she does this in accordance with the wishes (which may be written or oral), the ultimate beneficiary is treated as the person entitled in the estate (IHTA 1984 s143). This can be quite a convenient, and indeed is a common, way of dealing with chattels under a Will to cater for example with acquisitions of further chattels or changes of mind without the need to make a new Will each time. However, what is on the face of it a relieving provision can carry a trap in the context of the transferable nil-rate band (see 18.4.3(g)).
(c) Appointments out of relevant property trusts within two years of death
A person might leave either his whole estate or a nil-rate band gift on discretionary trusts. If within two years after the death but before any right to income has arisen the trustees appoint any or all of those assets either to individuals outright or to other trustees, the normal exit charge on property leaving a relevant property trust is disapplied: see 2.3.3(a)(ii) and 4.7.5 (IHTA 1984 s144). Typically, trustees would so act in accordance with a fairly detailed (and regularly reviewed) letter of wishes from the deceased as to how they should exercise their discretion. But this can in appropriate circumstances be quite a good way of dealing with the disposition of assets owned by the deceased when circumstances are likely to change between making the Will and the date of death, and indeed, in the case where there is a surviving spouse/civil partner, of maximising that relief as well as generally providing best for the family. New express rules were introduced by FA 2006.
All these options are explored further in Chapter 19.
The Impact of Other Taxes
2.14
The possibility of conflicting IHT and CGT considerations
2.14.1
IHT, and its mitigation, cannot be viewed as a subject in isolation. Applying the maxim ‘one man’s meat is another man’s poison’, what is absolutely the right thing to do in the interests of mitigating IHT might well trigger an unexpected CGT – or indeed SDLT or VAT – liability which eats into the IHT saving. There may of course also be Income Tax implications, though these are not considered further in this context.
Example 2.6
This concerns reverter to settlor trusts, considered further at 4.11.4, as affected by the FA 2006 regime. Brian made a gift of Blackacre to his son Bruce in 2000. Subsequently (but before March 2006) Bruce put Blackacre into a settlement under which Brian has a right to income or occupation for life subject to which it goes back to the son for life (the revertor to settlor), with power for the trustees to advance capital, with ultimate gifts to Bruce’s children. Under the pre-22 March 2006 regime, when Brian dies there is no IHT to pay by reason of the ‘revertor to settlor’ exemption (IHTA 1984 s53(2)) and there is the usual CGT-free uplift to market value within the trust.
Now, however, following FA 2006, on Brian’s death on or after 6 October 2008, the IHT exemption will apply only if Blackacre comes to Bruce outright, with a loss of the CGT-free uplift: Bruce will inherit Blackacre at the trustees’ historic base cost. (If Brian had died before 6 October 2008, Bruce’s life interest would be a ‘transitional serial interest’, treated as if he owned Blackacre outright, ie with reverter to settlor relief.)
Alternatively, if the structure is left as is, the CGT-free uplift will be secured but at a cost of paying IHT on Brian’s death. So, if the IHT saving is more significant than the CGT cost on future disposal, one might consider changing the terms of the trust to ensure that Blackacre passes to Bruce outright. But the issue should be considered while Brian is still alive: once he has died it will be too late.
Happily, however, there is also one other possibility: an outright reverter to Brian’s UK domiciled spouse/civil partner (or, if Brian has died within the last two years, UK domiciled widow/surviving civil partner) will secure the twin benefits of IHT exemption and CGT-free uplift.
TAX TIP: With any reverter to settlor trusts made before 22 March 2006 where the life tenant remains alive, consider action following 5 October 2008 to change the terms of the trust (if necessary) to an absolute reverter to the settlor’s UK domiciled spouse/civil partner - assuming of course that that is a sensible thing to do in the context of family circumstances as a whole. Such an arrangement will turn out to be ineffective to secure the tax savings only if the settlor predeceases the life tenant’s spouse/civil partner by more than two years – or, of course, if the spouse/civil partner fails to survive the settlor.
Capital Gains Tax
2.14.2
Lifetime IHT mitigation will in the normal course (except where sterling cash is given) involve what amounts to a disposal for CGT purposes. The gain in the hands of the transferor will be a chargeable gain computed on normal principles, which, subject to the annual exemption, will attract CGT at up to 28% (since 23 June 2010). Of course, if either the asset is a qualifying business asset or there is a chargeable transfer for IHT purposes, the gain may be ‘held over’ (under TCGA 1992 s165 or s260): see 3.7.3. This assumes that the transferee is UK resident. However, if he becomes non-UK resident within broadly the following six years the held-over gain will crystallise (subject to two qualifications), to be charged first on the transferee and then, if he fails to pay within twelve months, on the transferor (TCGA 1992 s168). So the CGT impact of any gift must be considered.
TAX TRAP: Anyone (but especially trustees) making a gift (capital advance) and deferring the gain by electing for hold-over should recognise the possibility of the deferred tax charge failing on him if the donee/beneficiary emigrates and fails to pay the tax within the statutory 12 months after emigration.
Stamp Duty Land Tax
2.14.3
A gift, pure and simple, of land and buildings does not attract SDLT (FA 2003 Sch 3 para 1), just as under Stamp Duty a gift of shares can be certified as attracting no Duty (The Stamp Duty (Exempt Instruments) Regulations 1987 SI 1987/516). But if the land is subject to a mortgage or is transferred in consideration of the removal of a debt, the amount of the mortgage or debt constitutes chargeable consideration for SDLT purposes (FA 2003 Sch 4 para 8). So, with residential land, if the mortgage debt exceeds £125,000 (£175,000 for transfers after 2 September 2008 and before 1 January 2010), the nil-rate threshold, there will be SDLT to pay. The rate is 1% if the consideration does not exceed £250,000, 3% up to and including £500,000, 4% up to £1 million and 5% where more than £1 million. (For ‘first-time buyers’ as defined the nil-rate threshold is £250,000 for acquisitions after 24 March 2010 and before 25 March 2012.) And in any case there will be compliance implications for making the transfer for a deemed consideration of £40,000 or more (£1,000 or more before 13 March 2008).
There is a further point. If land is transferred to a company with which the transferor is connected (within the meaning of CTA 2010 s1122) or in consideration of shares in a company controlled by the transferor, the consideration is deemed to be not less than the market value of the land – ie it could be more if such actual consideration is paid, but cannot be less (FA 2003 s53). This may be an unlikely thing to happen, though the point should be borne in mind, eg with the grant of a lease to a family company as part of IHT planning arrangements: see 6.6.1.
Value Added Tax
2.14.4
Just as for SDLT, a gift pure and simple should have no VAT implications. But if the subject-matter of the gift forms part of a VAT registered business and involves the removal of one or more assets from that business and those assets are land, there is a liability on the business to pay VAT at 20% (17.5% before 4 January 2011, though 15% from 1 December 2008 to 31 December 2009) on the market value of the asset (VATA 1994 Sch 4 para 5). For example, a gift by her parents to their daughter on her marriage of one of a number of holiday cottages would trigger an unexpected VAT liability on the parents. The only way that this consequence could be avoided might be to have the whole business given away and to arrange things such that the ‘transfer of a going concern’ provisions apply so as to take the transaction outside the scope of VAT.
Checklist
2.15
1. What, and of what value, are the individual's/family's current assets?
2. Do they attract any IHT reliefs, eg for business or agricultural property?
3. Is there an expectation of assets eg under a future inheritance from an aunt (which could perhaps be directed by the aunt’s Will to the next generation, as a reversionary interest constituting excluded property)?
4. Is full use being made year by year, or as the occasion presents, of the basic lifetime exemptions? Is a record being kept of such gifts (in particular)?
5. Has an audit been done of family trusts, especially accumulation and maintenance and life interest trusts in being at 22 March 2006?
6. In terms of IHT mitigation, what are the client’s wishes and how ‘aggressive’ does he wish (or is he prepared) to be?
7. Is there any desire to take action with regard to the family home or homes?
8. Of what assets might the taxpayer be able to divest himself eg chattels or investments, without prejudice to current living standards?
9. What life assurance and pension arrangements are in place?
10. Have death benefits been written under appropriate trusts and letters of wishes kept up to date?
11. For each adult member of the family, is there a Will in place and has it been recently reviewed?