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Following an announcement in the Budget this year, it is now known that there are no plans alter the inheritance tax nil rate band (currently £325,000) in the life of the current Government. This is a far cry from the erstwhile pre-2010 General Election policy statement of the Conservative party, who claimed that they would increase the nil rate band to £1,000,000 if elected. IHT planning therefore remains firmly on the agenda for the foreseeable future. This memorandum summarises the main IHT mitigation techniques which are currently used by specialists in this field for those who are UK resident and domiciled.
Although the unused nil rate band which is not used on the death of one spouse can be carried forward to be used on the death of the survivor, at best this means that the joint estates benefit from a nil rate band of (currently) £650,000. Beyond that the flat rate of 40% applies. This rate of tax soon translates into a substantial liability which will often mean that the main assets in an estate will have to be sold in order to raise the necessary funds. Thus for example, if the joint estates of husband and wife total £2million, even with the full nil rate band carried forward on the first death, the inheritance tax payable on the death of the survivor will be £540,000, this being more than one quarter of their total estates.
Many people find this level of taxation to be quite onerous particularly where it represents lifetime savings out of taxed income and gains. This memorandum summarises the main IHT mitigation techniques which are currently used by specialists in this field.
To begin with the simplest of possibilities, gifts made in lifetime are exempt from inheritance tax, so long as they are outright (i.e. not gifts into trust) and are made more than seven years before the death of the donor. People often wonder whether a gift causes some form of tax liability on the donee, the answer is that it does not in any circumstances whatsoever, where the reason for the gift is to provide a personal benefit for a family member. The only tax liability which could arise in respect of the gift is inheritance tax on the death of the donor within seven years, and in that circumstance the donee may be liable for the tax due. Gifts of other assets may give rise to capital gains tax liability on the donor, but it is sometimes possible to “hold over” the gain so that the asset passes to the donee at the donor’s original cost price, with no gain then arising to the donor.
There are various relatively small inheritance tax exemptions for certain outright lifetime gifts, but these are not detailed here because they will not offer much scope for inheritance tax planning with larger estates. The one such relief which may sometimes be of interest is that for regular gifts out of income. This relief can enable substantial regular gifts to be made by those who have significant levels of annual income.
Certain assets are effectively exempt from inheritance tax because the rate of tax applicable to them is set at 0%. These are as follows.
Subject to certain conditions, agricultural land is not liable to inheritance tax to the extent of its agricultural value. This means that if the land has any element of development value, that part of its value cannot benefit from the relief (although it may benefit from business property relief mentioned below). The land must either have been held and farmed personally by the owner for two years up to the time of its gift, or the owner’s death, or alternatively it must have been held for seven years up to that time and occupied by a third party for the purposes of agriculture under a tenancy beginning on or after 1 September 1995. Land let under older tenancies also qualifies for the relief although in some cases the rate is 50% instead of 100%.
The value of a business operated by a person as a sole trader is not liable to inheritance tax subject to detailed conditions. The most important of the conditions is that the business must have been held for two years up to the time of gift or death, and it must not be a business which deals in securities or property, nor one which is wholly or mainly one of making or holding investments. The relief equally applies to the value of a partner’s interest in a partnership business, so long as the partnership business satisfies the conditions just mentioned.
Unquoted Trading Companies
Shareholdings in unquoted trading companies are also not liable to inheritance tax due to 100% business property relief. For this purpose, shares quoted on the Alternative Investment Market are treated as unquoted.
Most gifts from one spouse to the other are exempt from inheritance tax. The exception is where the asset is transferred from a spouse who is domiciled in the United Kingdom to the other who is not so domiciled; in that event exemption extends to only £55,000, this being the lifetime limit in these circumstances.
One use of the spouse exemption is for an estate to be given to the survivor on the death of the first to die so that the survivor can then make gifts from the inherited estate to their children, or other members of the family. The capital gains tax base costs of all assets are written up to market value as at the date of death and so this enables the survivor to make the gifts free of any capital gains tax liability. However, care needs to be taken with this strategy. For example, if both spouses have a shareholding in the same unquoted company, the two holdings would be amalgamated into one holding when the survivor inherits on the death of the first to die, so that a gift of any of the shares by the survivor will then cause some capital gains tax liability. Where this is a serious problem, it is possible to restructure the position so as to avoid liability. Other more sophisticated arrangements are available through the use of will trusts to achieve substantial savings of IHT on private family investment companies.
Deathbed Planning: Investment of Cash Resources
If a businessman or farmer has significant cash resources, in the ordinary course of events these would be liable to inheritance tax on his or her death. However, if the cash is invested by expanding the business, or the farming assets at any time prior to death, the value represented by invested cash will then qualify for inheritance tax exemption. The key point is that so long as the business or farm already satisfies the conditions for the exemption from inheritance tax, then expanding the business by the investment of cash in it can take place within the two years prior to death. The investment of the funds does not have to take place more than 2 years prior to death.
It may be the case that the second property owned by husband and wife is used by both the two of them and their children as a holiday home. The inheritance tax legislation contains an exemption for situations where a property is owned and occupied by different people on a sharing basis. Accordingly it is very often possible to transfer shares in a holiday home to children and so long as the gift is made more than seven years prior to death the gifted shares will be outside the scope of inheritance tax in relation to the donor. However, the capital gains tax position on such a gift will require attention.
A share in a let property (and the share may be nearly all of the property) may be given away with the transferor retaining entitlement to all of the rents. We can show you how to structure this arrangement so that the gifted share is not liable to inheritance tax.
Estate Freezing Arrangements
Substantial shareholdings in private property companies can effectively be frozen at today’s value by an issue of new B shares to which are allocated profits and growth in capital value over current levels. The new issue of shares can be structured so that it does not give rise to any tax liability but it does require substantial redrafting of the Memorandum and Articles of Association of the company.
In relation to other assets, for example directly held properties, it is possible to freeze the value of these at today’s value by granting children an option to buy the property at current market value at any time within the next 21 years. A price must be paid for the option which must be its proper market price, and that price may be liable to capital gains tax on the grantor of the option, unless the asset is covered by capital gains tax exemption. Note however that if the option is never exercised, the grantees will make a chargeable transfer for inheritance tax purposes and this will not be a potentially exempt transfer.
The Main Residence
As a general rule, it is best not to involve the main residence in inheritance tax planning. One should take particular care where children will have immediate interests in the main home of their parents since, however harmonious family arrangements may be, circumstances may still arise where the parents would regret having entered into such a transaction, for example where children are involved in divorce or bankruptcy or there is an unexpected death of one of them.
In addition, some arrangements marketed in past years, and thought to be secure in tax terms under the legislation at the time before it was amended, are still being contested by HMRC. An appeal case on one scheme is expected to be heard by the Tax Tribunal later this year. The scheme concerned had a variant which, it was thought, could still be successfully run, but because of the continuing controversy about IHT planning with the home, the best advice is at present not to set up complex IHT planning structures involving the home.
This does not eliminate all planning completely, but what remains may be of very limited interest. A cash sum may be given to children who later use it to purchase a home for the benefit of their parents, but with the title being in the names of the children. This can enable the home to fall outside the estates of the parents for inheritance tax purposes, and the cash gift falls out of account if the donors survive for 7 years. But the downsides are an annual income tax liability on the parents under the pre-owned asset legislation (currently on 4% of the value of the property) and capital gains tax liability at 28% on the children in respect of any gain eventually realised on sale of the property.
Parents may also obtain cash under a commercial equity release arrangement over their home and give the cash away, surviving the gift for 7 years. This has no other tax consequences.
Insurance Based Schemes
Some insurance companies offer “discounted gift schemes” by which a cash sum is invested in an insurance bond. The bond is held under arrangements by which 5% of it can be withdrawn tax free by the investor for the rest of his/her life, or for 20 years, which ever is the shorter, with the remaining value in the bond not being part of his or her inheritance tax estate. These arrangements work quite well to save inheritance tax so long as the investor is not too elderly although the downside is that they are very inflexible and it will be difficult to dismantle the arrangements if one should ever want to.
This acronym stands for qualifying non-UK resident pension schemes. Funds are contributed to these out of a person’s private resources and the contributions are not chargeable transfers for IHT. Equally the funds in the scheme are IHT exempt, whilst after retirement the contributor draws pension income from the fund for the rest of his or her lifetime. The fund must be based in a suitable offshore jurisdiction (eg, Jersey or Guernsey) and once the scheme is set up it cannot be reversed. It must also be recognised that the costs of running such arrangements are likely to be higher than with onshore SIPPS.
It will be seen therefore that much can be achieved with the mitigation of inheritance tax liabilities, but the key is always to seek advice in good time and not leave it until time may be short.
FOR GENERAL INFORMATION ONLY
Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.
Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.