Chapter: 2 - Inheritance Tax Mitigation: The Basics

Possibility of conflicting IHT & 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 up 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 4.8.4, 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: the son will inherit Blackacre at the trustees’ historic base cost.   (If Brian died before 6 October 2008, Bruce’s life interest will 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 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 (or his spouse/civil partner) by more than two years.