Chapter 7: Wills and Tax Planning Flashcards

Question

Considering 1) above

Answer 1

When considering 1) above: adopted children, step-children (if their parent was married to the deceased), foster children and children for whom the deceased was a guardian or special guardian are included. The deceased’s siblings, parents, nieces, nephews are not direct descendants.

Answer 2

A man died this year, leaving his entire estate (worth £500,000) to his children. He has a full basic NRB available. The estate includes the family home (worth £250,000). Without the RNRB, the estate would not all be covered by the NRB. The family home is a QRI and the man’s children are direct descendants. The conditions for using the RNRB are therefore met. As the family home is worth more than the RNRB, the full amount of the RNRB is available. The man therefore can use both his NRB of £325,000 and RNRB of £175,000. Together they cover the value of the man’s estate. There is therefore no IHT to pay on the man’s estate.

Answer 3

It is also possible to transfer any unused RNRB to a surviving spouse. The transfer of the RNRB is relevant when the survivor of a married couple dies and their pre-deceased spouse did not use their own RNRB. This may arise where the first of the couple to die: · did not own a QRI e.g. they did not own a residential property; or · they did not qualify for the RNRB because they left a QRI to someone who was not a lineal descendant e.g. they left their entire estate to the surviving spouse.

Answer 4

Note that providing the survivor dies after April 2017 they will be able to claim a transferred RNRB even if their pre-deceasing spouse died before this date. A transferred RNRB can only be used if the surviving spouse leaves a QRI to a direct descendant (i.e. conditions for the RNRB must be met on the second death).

Answer 5

The home that the surviving spouse leaves to their direct descendants does not have to be the same house that they lived in with their deceased spouse(s) (the deceased spouse does not need to have owned any QRI). Transferring the RNRB works in the same way as transferring the basic NRB, allowing the surviving spouse to increase the value of their RNRB by up to 100% (based on the percentage remaining of the deceased spouse’s RNRB). Where a full transfer occurs, an estate may qualify for a RNRB of £350,000 (£175,000 + £175,000).

Answer 6

The tapered withdrawal of the RNRB for net estates worth more than £2 million applies with reference to the total RNRB. Where the survivor’s estate could claim £350,000 RNRB this amount is reduced by £1 for every £2 in excess of £2m, and no RNRB can be claimed for net estates worth £2,700,000 or more.

Answer 7

A died five years ago, leaving her entire estate to civil partner, B. B died this year, leaving her estate to daughter, C. The estate includes the family home (worth £350,000). B’s PRs can make a claim for the unused RNRB from A’s estate. The total RNRB available for B’s death estate is £350,000 (B’s own RNRB of £175,000 plus an additional 100% uplift in respect of A’s RNRB). Where the RNRB is claimed it is applied to the death estate as a whole, rather than set-off against the gift of the QRI separately.

Answer 8

Broadly, to qualify: the deceased must have given away their QRI or downsized to a less valuable QRI on or after July 2015 (i.e. have lost the benefit of the full RNRB) the former home would have been a QRI if it had been retained a direct descendant inherits the replacement QRI and/or other assets The amount of the addition is calculated with reference to the amount of the RNRB which would otherwise be lost because the former QRI is no longer owned (or a less valuable QRI has taken its place).

Answer 9

A claim for the downsizing addition is made by the PRs within 2 years of the end of the month of death, not when the sale/gift of the former home takes place. However, details of the lifetime sale/gift will be needed by the PRs to bring the claim. The downsizing addition is only relevant if there is no QRI in the estate when the deceased died (but there was historically), or the value of the new QRI following a downsizing move is less than the current maximum RNRB. The downsizing rules are not relevant if: · there is no loss of the RNRB because the value of any new QRI in the estate is the same/more than the maximum available RNRB, or, · the RNRB is not available, because the new QRI or assets are not left to a direct descendant Application of the rules is complex and beyond the scope of this module but will never produce a total RNRB greater than the maximum otherwise normally available.

Answer 10

It is possible for a person’s estate to qualify for a total NRB amount of £1million. Consider the following: · A and B are married. A dies leaving all of their estate to B. A made no lifetime gifts. · On A’s death no NRB is used because the whole of A’s estate passes to their spouse and is spouse exempt. · B then dies leaving the whole of their estate to their children. B made no lifetime gifts. · B’s estate is worth £1million and includes a family home worth £500,000

Answer 11

When B dies, B’s PRs can claim: · B basic NRB of £325,000 · B’s RNRB of £175,000 (the house passes to a direct descendent) · A’s unused basic NRB of £325,000 (TNRB) · A’s unused RNRB of £175,000 (transferred RNRB) This gives a total combined NRB of £1 million (£325,000 + £325,000 + £175,000 + £175,000). No IHT is payable on B’s death.

Answer 12

· Each individual is entitled to a basic nil rate band of £325,000 (‘NRB’). Chargeable transfers up to the value of the NRB are taxed at 0%. · The NRB available is reduced by a person’s cumulative total. The cumulative total = total value of the chargeable transfers made in the previous 7 years. · The PRs of a surviving spouse/civil partner can claim the unused % of the NRB of the pre-deceased spouse/civil partner (the transferred NRB (‘TNRB’)). The TNRB is capped at 100% of the basic NRB at the date of the survivor’s death.

Answer 13

· On death, an additional nil rate band of £175,000 can be claimed if the deceased left a ‘QRI’ to a direct descendant, referred to as the ‘residence nil rate band’ (‘RNRB’). There is a tapered reduction in the RNRB for estates worth more than £2 million. · The PRs of a surviving spouse/civil partner can claim the unused % of the RNRB of the former spouse/civil partner (the transferred RNRB). The transferred RNRB is capped at 100% of the amount of the RNRB at the date of the survivor’s death. · Estates without a QRI (or a QRI worth less than the maximum RNRB) might benefit from the downsizing rules.

Answer 14

Correct: A surviving spouse can make use of their own basic NRB (£325,000) and RNRB (£175,000) and receive a transfer of up to 100% of the basic NRB and RNRB from the estate of their deceased spouse.

Answer 15

In this element we look at the full process of calculating the inheritance tax (‘IHT’) due on lifetime transfers. There are two separate calculations that may be required: The tax due on an immediately chargeable lifetime transfer (LCTs only).The tax due as a result of the transferor dying within seven years of making a lifetime transfer (LCTs and failed PETs). You will need a calculator to follow the examples in this element.

Answer 16

A PET is a lifetime transfer of value to another individual. If the individual doesn’t survive for seven years after making the transfer, it becomes chargeable alongside their death estate. The rationale behind PETs is to prevent individuals avoiding IHT by giving away property shortly before their death. The tax treatment of a PET is as follows: * The transfer is not chargeable at the point it is made. No IHT is payable yet. * It becomes fully exempt if the transferor survives seven years from the date of the PET. * If the transferor dies within seven years of making the PET, the PET ‘fails’ and becomes a chargeable transfer and thus subject to IHT.

Answer 17

All lifetime transfers of value made by a person into a trust on or after 22 March 2006 will give rise to an LCT. The tax treatment is as follows: * An LCT is a chargeable transfer when it is made. IHT is payable on the chargeable value of the LCT at the lifetime rate of 20%. * If the transferor survives 7 years following the LCT there is no further charge to tax. * If the transferor dies within 7 years, the LCT will be reassessed to tax at the death rate, using the NRB at the date of death.

Answer 18

Practice Alert: There are different rules for trusts set up for disabled people provided that statutory requirements are met. These rules are outside the scope of this module.

Answer 19

The following formula should be used when calculating IHT on lifetime transfers: Step A Calculate cumulative total Step B Identify value transferred Step C Apply exemptions and reliefs Step E Apply taper relief Step F Give credit for tax paid in lifetime Note that Steps E and F only apply when the IHT is being calculated after death.

Answer 20

The cumulative total is relevant to lifetime transfers as it tells us how much of the nil rate band (‘NRB’) is available for the transfer. The cumulative total is calculated by adding up the value of all chargeable transfers made in the 7 years prior to the transfer. Although cumulation only takes into account chargeable transfers made in a 7 year period, where an LCT or PET is reassessed, this can mean looking back as far as 14 years before the transferor’s death. For example, if an LCT was made 7 years before the transferor’s death, it will be reassessed to tax at the death rate when the testator dies. It is then necessary to calculate the cumulative total for the LCT based on the 7 years prior to the LCT (i.e. the 7 year period starting 14 years before the death).

Answer 21

A man makes the following transfers: * 10 years before death: An LCT (chargeable value £4,000) * 6 years before death: PET 1 (chargeable value £50,000) * 2 years before death: PET 2 (chargeable value £10,000) Both PETs have failed, making them chargeable. The LCT is also a chargeable transfer. It is not reassessed (it was made more than 7 years before death) but is relevant to the cumulative total.

Answer 22

* The cumulative total applicable when calculating the IHT due on PET 1 is £4,000 (as the LCT was made 4 years before PET 1). * The cumulative total applicable when calculating the IHT due on PET 2 is £50,000 (as PET 1 failed, has become chargeable and was made 4 years before PET 2. NB: the LCT is not considered as it was made more than 7 years before PET 2). * The cumulative total applicable when calculating the IHT due on the death estate is £60,000 (as both PETs have failed) If a PET fails, it is chargeable

Answer 23

A ‘transfer of value’ is a ‘disposition’ which results in an immediate decrease in the value of the individual’s estate (s 3(1) IHTA). Broadly, this means gifts but it can also include transactions at an undervalue (e.g. selling your house to a family member for less than it is worth – the difference in value counts as a gift). It applies to gifts of all forms of property (i.e. anything with a monetary value). For lifetime transfers, the value of a transfer is assessed by reference to the loss in value to the donor at the date of the transfer.

Answer 24

* Spouse exemption * Charity exemption * Family maintenance exemption * Annual exemption * Small gifts allowance * Normal expenditure from income * Marriage exemption * Business property relief * Agricultural property relief

Answer 25

After applying all relevant exemptions and reliefs you will reach a figure for the chargeable value of the transfer. There are a lot more exemptions and reliefs available for lifetime transfers than for the death estate, so make sure you make use of them in the most efficient way. A man makes a wedding gift of £12,000 to his daughter. He has made no other gifts in the last two years. Apply reliefs in the following order: - Marriage exemption: £5,000 - Current Annual Exemption (‘AE’): £3,000 - Last year’s AE: £3,000 Deduct total value of exemptions from value of gift to reach chargeable value: £12,000 - £11,000 = £1,000

Answer 26

Once you have established the chargeable value of the transfer, the basic NRB can be applied against the remaining taxable value. Establish the value of the NRB. Reduce the total NRB by the value of the cumulative total (from Step A). Apply a rate of 0% to the value of the remaining taxable estate up to the total NRB amount. Apply the relevant rate to the rest to establish the IHT due. Key points to note: * The residence NRB never applies to lifetime transfers. * The NRB applicable to an LCT when it is first made is the NRB at the date of the transfer. * The NRB that applies to a failed PET or re-assessed LCTis the NRB at the date of death. As the NRB has been fixed at £325,000 since April 2009, this is the figure you should use unless a question tells you otherwise.

Answer 27

After deducting the NRB, it is necessary to apply IHT to the remaining amount at the appropriate rate. This rate will differ depending on whether you are dealing with the tax due immediately on an LCT or are re-assessing a lifetime transfer (LCT or PET) because the transferor has died within seven years. LCTs: When calculating the tax due immediately on an LCT, the tax is payable at the lifetime rate of 20%. Step D is the final step in the calculation. Failed PETs and re-assessed LCTs: Tax is payable at the death rate of 40%. If the transferor dies 3-7 years after making the transfer, it is also necessary to apply taper relief at the relevant rate to reduce the IHT payable.

Answer 28

Step A: Calculate cumulative total £0 (as the earlier PET has not yet failed) Step B: Identify value transferred £400,000 Step C: Apply exemptions and reliefs AE for year of LCT: £3,000 AE for previous year: £3,000 Chargeable value: £400,000 - £6,000 = £394,000 Step D: Apply basic NRB and calculate tax Nil rate: £325,000 Lifetime rate: (£394,000 – £325,000) = £69,000 £69,000 @ 20% = £13,800

Answer 29

PETs or LCTs made in the 7 years before death must be reassessed to IHT. This is separate to the calculation of IHT on the death estate. Although death is the trigger for the lifetime transfer being reassessed, these transfers do not form part of the death estate. The tax payable on a failed PET or reassessed LCT must be calculated separately. If a PET or LCT is being reassessed it is necessary to consider Step E of the calculation (which involves applying taper relief to transfers made 3-7 years before the death) If tax was paid on an LCT during the transferor’s lifetime and it is later reassessed at the death rate, it may also be necessary to consider Step F (which involves giving credit for tax paid in the transferor’s lifetime).

Answer 30

The rates of taper relief are set out below. You will see these rates expressed either as a % reduction in the amount of IHT due, or confirmation of the % that remains payable. Both produce the same outcome.

Answer 31

Where an LCT is being reassessed at the death rate, it is also necessary to factor in any tax that was paid at the lifetime rate. This is done by deducting the IHT paid previously from that due as a result of the death (after taper relief has been applied). Only the balance needs to be paid to HMRC. If the balance is reduced to nil as a result of crediting the previous payment, there will be no further tax to pay. It is not possible to obtain a refund for the lifetime payment if the balance is negative.

Answer 32

Fact Pattern: A man settles £400,000 on trust for his grandchildren (an LCT). Tax of £13,800 was paid on the LCT during the man’s lifetime. He made one PET (chargeable value £50,000) three years before the LCT. He dies three years after the LCT. He has made no other transfers. Calculate the IHT due on the LCT after the man’s death.

Answer 33

£50,000 (because PET has failed)

Answer 34

AE (£3,000) x 2 = £6,000 Chargeable value: £400,000 - £6,000 = £394,000

Answer 35

Nil rate: (£325,000 - £50,000) = £275,000 @ 0% Death rate: (£394,000 – £275,000) = £119,000 £119,000 @ 40% = £47,600

Answer 36

LCT 3 years ago. 80% of £47,600 = £38,080

Answer 37

£38,080 - £13,800 = £24,280 Total IHT Payable = £24,280

Answer 38

If IHT is payable as a result of a lifetime transfer and the transferor pays the tax (in addition to the gift itself), the reduction in the value of his estate includes the amount of IHT paid as well as the gift itself. The value of the gift must be ‘grossed up’ to find the total value transferred before the tax due is calculated. Grossing up is outside of the scope of the module but it is something to be aware of if you encounter IHT (or indeed other taxes) in practice.

Answer 39

· LCTs are lifetime transfers into a trust. PETs are lifetime transfers to an individual. · LCTs are immediately chargeable to IHT at a rate of 20%. Use the following process to calculate the tax due: A. Calculate the cumulative total B. Identify the value transferred C. Apply exemptions and reliefs D. Apply basic NRB and calculate tax at the appropriate rate

Answer 40

Step 1 Calculate cumulative total Step 2 Identify assets included in the taxable estate Step 3 Value the taxable estate Step 4 Deduct debts/expenses Step 5 Apply exemptions & reliefs Step 6 Apply RNRB Step 7

Answer 41

The cumulative total is relevant to the death estate as it tells us how much of the nil rate band (‘NRB’) is available. The cumulative total is calculated by adding up the value of all chargeable transfers made in the 7 years prior to the death. Consider the example below. (Note this is a simplified example which doesn’t take into account the availability of any exemptions or reliefs.) A man died last week. He made the following chargeable transfers in the last 7 years: * A PET, three years ago (chargeable value £20,000). This has now failed. * An LCT, two years ago, (chargeable ,value £5,000). The man's cumulative total is £25,000. His NRB is therefore reduced from £325,000 to £300,000.

Answer 42

It is crucial to appreciate that the rules determining the property included in a person’s estate for tax purposes are different to those which govern the property included in a person’s succession estate. Therefore, the value of a person’s taxable death estate will frequently be different to the value of their succession estate. The general rule is that all property to which the deceased was beneficially entitled at the date of death is included in the estate for IHT purposes. This would include property situated both in the UK and abroad (where the taxpayer is UK-domiciled). However, certain items of property may appear to belong to the deceased but are excluded for IHT purposes and conversely other types of property which do not belong to the deceased before death are included in the taxable estate.

Answer 43

The following assets are included in the taxable estate even though, in some cases, it may not be immediately obvious why (e.g. because the deceased did not actually own the asset when they died): * All jointly owned property * Property subject to a reservation * Donationes mortis causa * Statutory nominations * Some interests in possession

Answer 44

Where the deceased owned property as a tenant in common, this share passes into the deceased’s estate for both tax purposes and distribution purposes. Where the deceased owned property as joint tenants with another/others the distribution of the property and the tax position are considered separately. Although the survivorship rule applies for distribution purposes, for IHT purposes there is a deemed severance of the joint tenancy immediately before death. This means that the deceased’s ‘share’ of the property will be included in their taxable estate.

Answer 45

A testator’s estate consists of: * House in sole name: £300,000 * Chattels (joint tenants): £8,000 * Cottage (tenants in common in equal shares): £200,000 The succession estate is worth: £300,000 (house) + £100,000 (1/2 cottage) = £400,000. The chattels pass by survivorship. The taxable estate is worth: £300,000 (house) + £4,000 (half chattels) + £100,000 (1/2 cottage) = £404,000.

Answer 46

If a person gives an asset away during their lifetime but reserves a benefit in that asset, the value of the asset at date of death will be included in the donor’s IHT estate when they die at the date of death value (s 102 Finance Act 1986). The most common example is where a parent transfers legal ownership of a property e.g. a holiday cottage to their children on the condition that the donor can continue to use it whenever they wish and free of charge. The parent in this case has reserved a benefit in an asset they previously owned and on the parent’s death the value of the holiday cottage at that date will be included in their estate for IHT purposes. Individuals can avoid the gift with reservation of benefit (‘GROB’) rules by ensuring that they either do not derive any benefit from the assets they have given away, or, by paying a market value rent for the time they do derive benefit e.g. paying rent each time the donor uses the holiday cottage.

Answer 47

A donationes mortis causa (‘DMC’) is a lifetime gift which is made conditional on death. At the date of death the donor no longer owns the asset as it has been given away while they are alive. However, the conditional nature of the gift (and the donor’s ability to revoke it up until death) means that for IHT purposes the subject matter of the DMC is still part of the deceased’s estate and IHT will be payable on its value as at the date of death.

Answer 48

A person can make a written nomination of monies in any of the following accounts: * Friendly Society * Industrial Society * Provident Society The amount in each account must not exceed £5,000. On the death of the deceased, the monies in the relevant account(s) pass to the nominee, do not enter the distribution estate and may be distributed without a grant. However, such monies do form part of the IHT estate.

Answer 49

Before 22 March 2006, the capital value of all interest in possession trusts was treated as being owned by the person with the interest in possession (i.e. the life tenant) for IHT purposes (s 49(1) IHTA). It was therefore included in the life tenant’s taxable estate. This is still the case for existing interest in possession trusts provided they were created before 22 March 2006.

Answer 50

A man died last week. At his death, the man’s estate was worth £200,000. He was also the life tenant of a trust created in 2004. The capital value of the trust fund at the man’s death s £150,000. The taxable value of the man’s estate is £350,000 as it includes the value of the trust fund.

Answer 51

After March 2006, if a life interest trust is created following someone’s death e.g. by will, the life interest is referred to as an ‘immediate post death interest’ (s 49A IHTA). When a life tenant with an immediate post death interest dies, the capital value of the trust is included in their taxable death estate. If a new inter vivos life interest trust is created i.e. during the lifetime of the settlor, on or after 22 March 2006, the life tenant’s interest is not included in their taxable estate

Answer 52

Where the initial trust was created before that date, the rules on the previous page continue to apply, although there are special rules for 'transitional serial interests' (trusts with successive life interests, e.g. to A for life, then to B for life, then to C absolutely) where the successive life interests arise on or after 22 March 2006. You do not need to know about transitional serial interests

Answer 53

A woman died last week owning assets worth £200,000. She was also the life tenant of a trust created following her father’s death in 2012. The capital value of the trust at creation was £30,000, but had increased to £50,000 when the woman died. The taxable value of the woman’s estate is £250,000 because it includes the value of the trust fund when she died. The life interest trust was created following the death of the woman’s father so she had an immediate post death interest.

Answer 54

* ‘Excluded property’ * Insurance policies written in trust for a third party * Discretionary pension scheme payments

Answer 55

The most common example of excluded property is a remainder interest (sometimes called a reversionary interest) in a life interest trust. If the remainderman of a life interest trust dies before the life tenant, the trust fund that would have passed to them on the life tenant’s death is not included in the remainderman’s taxable estate. In contrast, where a life tenant dies, the value of the trust fund is included in their taxable estate.

Answer 56

If the deceased had an insurance policy on their own life where the sum payable on death was written in trust for another the proceeds of the policy are not included in the deceased's estate for IHT purposes. If the policy proceeds were payable to the deceased’s estate then the amount would be included in the taxable estate.

Answer 57

If the deceased was a member of an employer’s pension scheme any discretionary lump sum payment made by the pension fund trustees is not included in the taxable estate. As the payments are made entirely at the trustees’ discretion the deceased is not deemed to have any entitlement to the money, and the amount paid out (whether to a third party or to the deceased’s PRs) does not form part of the deceased’s estate for IHT purposes.

Answer 58

Many pension schemes allow contributors to indicate during their lifetime who should receive the money (often in an ‘Expression of Wish’ form) if the trustees exercise their discretion to make a payment after their death. The contributor’s expression of wish is not binding on the trustees as the nature of the payment is discretionary and they are not legally obliged to pay the person(s) indicated by the contributor, although in practice they almost always do. Pension lump sums payable by rightto the estate of the deceased are included in the taxable estate.

Answer 59

The general rule is that the assets in the estate are valued at market value at the date of death. However, some special rules apply in certain circumstances: Quoted shares: If the deceased owned quoted shares there are special rules for establishing the date of death value linked to the stock exchange prices on that date. They are valued by taking the lower of the two prices on the Stock Exchange Daily List and adding one-quarter of the difference between the higher and the lower value. An example can be found in another element. Related property: If assets owed by spouses are worth more when valued together (e.g. because they form a set), each party’s share is valued at their proportionate share of the combined pair.

Answer 60

Joint property: Where land is co-owned (whether as joint tenants or tenants in common) the value of the deceased’s share is reduced (by 10-15%) to reflect the difficulty of selling a share of the property rather than the whole. The deduction is not applied where the co-owners are married, as the related property rules apply and take priority. The valuation of other jointly owned property e.g. chattels does not commonly attract this discount. NB: Although HMRC has discretion as to the amount of the deduction, for the purposes of this module we apply a deduction of 10%.

Answer 61

A set of two vases is worth £100,000 but each vase alone is only worth £20,000. If the vases are owned one each by a husband and wife, for IHT purposes each party’s share will be valued at half the value of the combined pair i.e. £50,000, and not at the stand-alone value of the one vase each party in fact owns (£20,000).

Answer 62

Two siblings own a house together in equal shares. The whole house is worth £300,000. Each half share is therefore worth £150,000. When the first sibling dies, their taxable estate will include the value of the jointly owned asset as £135,000 (90% of £150,000). N.B. The same analysis would apply whether they were joint tenants or tenants in common in equal shares.

Answer 63

Now that you have calculated the value of the deceased’s assets, you must then deduct the following debts from the value of the estate: The deceased’s debts due at the date of death:This is money the deceased owed e.g. outstanding balance on a credit card or loan at the time of death.Post-death debts/expenses: The only post death debt/expenses that can be deducted for tax purposes are reasonable funeral expenses and the cost of a tombstone. Other post-death expenses are payable from estate assets but cannot be deducted from the value of the IHT estate to reduce the overall tax due.

Answer 64

It is then necessary to deduct any available exemptions or reliefs to reach the value of the taxable estate. For the purposes of this module the only exemptions and reliefs relevant to the death estate that you may be required to apply when calculating IHT on the death estate are: * Spouse exemption * Charity exemption * Business property relief (‘BPR’) * Agricultural property relief (‘APR’)

Answer 65

Once you have a figure for the taxable death estate, you can then calculate the tax due on that estate. There are several stages to this tax calculation. At Step 6 you should: Establish the value of the residence NRB (‘RNRB’) available. This includes the transferred RNRB if applicable.Apply a rate of 0% to the value of the taxable estate up to the total RNRB amount. If any value remains, consider Step 7.

Answer 66

Once you have considered the RNRB, the basic NRB and transferred NRB can be applied against the remaining taxable value. Establish the value of the NRB and any transferred NRB. Reduce the total NRB by the value of the cumulative total (from Step 1). Apply a rate of 0% to the value of the remaining taxable estate up to the total NRB amount. Apply the death rate of 40% to the rest to establish the IHT due.

Answer 67

The following steps must be taken in order to calculate IHT on the death estate: Calculate the cumulative total – This is the total chargeable value of all the chargeable transfers made in the previous 7 years. Identify the assets included in the taxable estate – Remember that this will not necessarily be the same as the assets included in the succession estate. Value the taxable estate – Assets are generally given their market value although there are exceptions for related property and joint property. Deduct any debts – This includes lifetime debts and funeral expenses. Deduct available exemptions and reliefs – Consider the availability of spouse exemption, charity exemption, BPR and APR. Apply 0% rate up to the value of the residence NRB and any transferred amount. Apply 0% rate up to the value of the basic NRB and any transferred amount (after having taken away the cumulative total), then apply 40% rate to the remainder.

Answer 68

You are already aware that a charge to inheritance tax (‘IHT’) may arise in the event of: Lifetime Transfers PET LCT A PET is a gift to a person. An LCT is a gift into a trust. PETs are not chargeable unless they fail (donor dies within 7 years). LCTs are chargeable when made and are re-taxed again if the donor dies within 7 years.

Answer 69

When a person dies there is a deemed transfer of their death estate. The charge to IHT is based on the value of assets in the deceased’s estate on the date of death.

Answer 70

When calculating the liability to IHT following a chargeable event (failed PET, LCT or death) IHT exemptions and reliefs can be used to reduce or eliminate the charge. Exemptions and reliefs work in slightly different ways (and are distinct from the nil rate band which is a 0% rate of tax and neither an exemption nor relief).

Answer 71

Certain gifts to individuals or other entitles are exempt from IHT. They can be made completely free from IHT and have no effect on the NRB. Gifts of particular assets benefit from relief. This means that, where the conditions of the relief are met, the amount of IHT payable is reduced (sometimes by 100%).

Answer 72

The exemptions and reliefs below are those you will focus on for this module. You will see reference to additional exemptions, and should be aware of them, but you are not required to apply them. Spouse exemption (s 18) Charity exemption (s 23) Family maintenance exemption (s 11) Annual exemption (s 19) Small gifts allowance (s 20) The statutory requirements governing IHT exemptions and reliefs are set out in the Inheritance Tax Act 1984 (‘IHTA’). The relevant sections are noted below. Normal expenditure from income (s 21) Marriage exemption (s 22) Business property relief (s 104) Agricultural property relief (s 116) Taper Relief (s 7)

Answer 73

Some exemptions and reliefs can only be applied to transfers made during the donor’s lifetime – this means the exemption or relief could be used in respect of: failed PET (donor died within 7 years of making a gift) LCT (taxed when made) LCT (if re-taxed following the donor’s death within 7 years) but not when calculating the IHT due in respect of the death estate. Other exemptions and reliefs apply only to the death estate and cannot be applied to a failed PET or LCT. Further exemptions and reliefs apply to both lifetime transfers and the death estate and should be applied in respect of all chargeable transfers.

Answer 74

As a practitioner it is important for you to know which exemptions and reliefs exist, when each will apply, and any criteria that must be satisfied before they can be used. Tax advice is commonly required when clients e.g. wish to carry out personal tax planning are liable to pay tax and the amount due must be calculated want to make a will or set up a trust. Failing to advise on the effective use of exemptions and reliefs may mean a solicitor is negligent. A table summarising the IHT exemptions and reliefs is set out on the following page.

Answer 75

There are different exemptions and reliefs which can be used to reduce or eliminate a charge to IHT. Some apply to lifetime gifts only and others only to the death estate, and some apply to both. Exemptions and reliefs are distinct from the nil rate band which is a 0% rate of tax. IHT exemptions and reliefs are contained in the Inheritance Tax Act 1984. Practitioners needs a good understating of exemptions and reliefs to properly advise their clients.

Answer 76

The Annual Exemption (‘AE’) allows individuals to make gifts of up to £3,000 each tax year free from IHT. The AE is applied chronologically to transfers (PETs or LCTs) when they are made. If more than one transfer is made on one day, the annual exemption is applied pro rata, irrespective of the order in which the gifts were made.

Answer 77

The AE should be used after any other available exemption or relief is applied to ensure the AE is available for later transfers. Once the AE for the current tax year is used first and in full a transferor may look back to the previous tax year (but no further) and use any part of the AE from the previous tax year that was not used at the time.

Answer 78

Therefore, a maximum of 2 x AE (£6,000) may be available to use against a transfer (assuming no other transfers have been made in that tax year or the previous tax year). A tax year runs from 6 April one calendar year to 5 April the following calendar year.

Answer 79

Shayla made a gift of £1,000 to her sister in January (Gift 1) and a gift of £4,500 to her brother (Gift 2) a few months later in May. These are the only gifts made by Shayla. Her AE could be used as follows: January: Gift 1 falls towards the end of a tax year in which no other gifts have been made. The AE of £3,000 for the tax year of Gift 1 is available. Shayla only needs to use £1,000 to cover the full value of Gift 1. £2,000 of this AE remains unused.

Answer 80

May: Gift 2 takes place in the following tax year. We know no other gifts have been made. The AE of £3,000 for the tax year of Gift 2 is available. In addition, a further AE of £1,500 from the previous tax year can be used to cover the full value of Gift 2. The amount of AE from the tax year of Gift 1 which still remains unused (£500) is effectively wasted – it cannot be carried forwards to any future tax years. NB: the current AE must be used first before any carried forward AE can be applied.

Answer 81

Shayla made a gift of £10,000 to her sister this tax year. Shayla has made no other gifts. Her AE could be used as follows: As Shayla has made no other gifts: The AE of £3,000 for the current tax year is available, and The AE of £3,000 from the previous tax year can also be used. Once the total AE (£6,000) has been applied to her gift the amount of £4,000 remains. Shayla has therefore made a PET to the value of £4,000 - she must survive 7 years to avoid any IHT consequences of making this gift.

Answer 82

Maintenance payments are not treated as transfers for IHT purposes if made to: A spouse (or former spouse if part of a divorce settlement) The minor child of either party to a marriage for maintenance, education or training, or if over 18 and otherwise in full time education or training A dependent relative to make reasonable provision for their care. ‘Care’ is not defined but HMRC suggest that payments to cover the provision of services, whether privately or in an institution, would be covered (but not payments which go beyond maintenance).

Answer 83

Although the spouse exemption would normally apply for transfers between spouses, the maintenance exemption can be used in cases where the spouse exemption would not apply (e.g. if the recipient is domiciled outside the UK).

Answer 84

Small gifts (of up to £250 per recipient) can also be made free from tax. A transferor can make multiple gifts of up to £250 to as many different people as they like. It differs from AE in that AE is an upper limit to the total value of all transfers in a tax year, whereas the small gifts exemption applies separately to each recipient with no limit to the number of different recipients. The small gifts allowance is not available if combined with any other exemption, including the AE.

Answer 85

If an individual wishes to make gifts of more than £250 to any one person they should rely on the AE instead. If a donor wants to give away e.g. £3,250 they cannot give this amount to one person and claim the AE and the small gifts allowance to cover the full value. However, if they gave £3,000 to one person and £250 to another person both reliefs could be claimed.

Answer 86

This exemption is most useful where a client has a number of different people to whom they wish to make gifts. For example, they may have a large family and want benefit different children or grandchildren. Clients could set up different accounts and make yearly transfers of £250. The exemption is often used for Christmas or birthday presents. If gifts to any one person in the same tax year exceed £250 the exemption does not apply at all for that donee. A gives £250 to B - small gifts exemption applies. A gives £100 to B and later in the same tax year gives a further £150 to B – small gifts exemption applies. A gives £250 to 20 different people in a single tax year (total £5,000) – small gifts exemption applies to each gift. A gives £251 to B - small gifts exemption does not apply as the total value given to B exceeds £250.

Answer 87

A gift given in consideration of a marriage to a party of that marriage is exempt up to: £5,000 if made by a parent of one of the parties £2,500 if made by one party of the marriage to the other £2,500 if made by their remoter ancestor e.g. grandparent or great-grandparent; and £1,000 in any other case. NB: marriage exemption and the annual exemption can both be claimed in respect of the same gift. For the purposes of s 22 IHTA, ‘child’ includes an illegitimate child, an adopted child and a step-child. The gift must be made in relation to a specific marriage – contemporaneously, or, before and conditional upon it, or, after if satisfying a previous legal obligation. The relief applies per donor in respect of a marriage so each parent of both parties could give £5,000 to their own child and together in total claim a maximum relief of £20,000

Answer 88

NB: marriage exemption and the annual exemption can both be claimed in respect of the same gift. For the purposes of s 22 IHTA, ‘child’ includes an illegitimate child, an adopted child and a step-child. The gift must be made in relation to a specific marriage – contemporaneously, or, before and conditional upon it, or, after if satisfying a previous legal obligation. The relief applies per donor in respect of a marriage so each parent of both parties could give £5,000 to their own child and together in total claim a maximum relief of £20,000. The relief applies per donor.

Answer 89

A transfer of value is exempt if made: from the donor’s income (not capital) as part of a normal/regular pattern of giving, and do not affect the donor’s standard of living. There is no upper limit to this exemption. Lightman J in Bennett v IRC said “as regards quantum, it is sufficient that a formula, or standard has been used, so that the amount can be identified”. It is a question of fact whether the requirements are satisfied. HMRC are more likely to accept the relief applies if transfers are made under a legal obligation, or there is clear history of a settled pattern of giving e.g. monthly payments.

Answer 90

A donor could mandate specific income e.g. dividends from certain shares, to be paid to the donee. Or, a donor could give away income generally each year e.g. 10% of total income.

Answer 91

Taper relief is not an exemption. Instead, it reduces the amount of IHT that would otherwise be payable. To apply both of the following conditions must be met: A lifetime transfer was made 3 – 7 years prior to the transferor's death (i.e. a PET has failed / LCT will be re-assessed) IHT is payable in respect of the lifetime transfer (i.e. separately and in addition to IHT due in respect of the death estate)

Answer 92

This means: transferor must have died (taper does not apply to the charge when an LCT is made). the value of the lifetime transfer must have been large enough to trigger IHT (you cannot taper a tax liability of zero). In basic terms, IHT will only be due on a lifetime transfer where the amount transferred was greater than the available nil rate band (‘NRB’)

Answer 93

Where taper relief applies it does not reduce the value of a lifetime transfer, nor does it alter the rate of IHT. Instead it takes effect as a proportionate reduction of the final tax bill. The amount of the reduction depends on the number of years between the date of transfer and death. The rates by which the IHT charge is reduced are set out in the table on the following page. For taper relief to make sense it is important to appreciate that: when someone dies their death can trigger an IHT charge in respect of the death estate and a separate IHT charge in respect of lifetime gifts. It is always necessary to calculate the tax due on lifetime transfers separately from tax due on the death estate. Although taper relief is only applied after someone has died, the relief has no effect on the IHT payable in respect of their death estate.

Answer 94

Do you understand why lifetime exemptions and reliefs benefit a taxpayer? While the advantage of taper relief is clear (it reduces a tax bill) it may not be immediately obvious what benefit is afforded by the other provisions mentioned in this element. If a transfer of value is made during a person’s lifetime this will be either a PET (which might fail) or an LCT. There are IHT consequences for both; a failed PET and LCT can give rise to an IHT charge in their own right, so provisions which reduce the value of the transfer subject to tax will result in a smaller tax bill.

Answer 95

However, even if the value of a PET or LCT is not high enough to trigger a charge, if death occurs within the 7 years that follow, the chargeable value of these transfers “uses up” the NRB available for the death estate. As a result, a greater proportion of the death estate will be taxed at 40%. Therefore, any provision which reduces the chargeable value of a PET or LCT, in whole or part, leaves the taxpayer with a larger NRB than would otherwise have been the case.

Answer 96

Different exemptions and reliefs can be used to reduce or eliminate the charge to IHT. This element considered those which only apply to lifetime gifts (those applying to both lifetime and death transfers are not considered in this element). The AE is £3,000 per tax year. A previous year’s AE can also be claimed if needed (to the extent this was not previously used). Family maintenance exemption can be particularly useful with regards provision for minor children (or adult children in full time education) and dependent relatives.

Answer 97

Small gifts allowance applies gifts up to £250 per tax year (but not at all to any gift above this amount). Small gifts can be made to an unlimited number of individuals. Gifts made in contemplation of marriage qualify for an exemption. The amount available depends on the relationship between the donor and donee. Normal expenditure from income is useful where a person does not need or use all of their income. Taper relief reduces the amount of IHT due in respect of a lifetime gift which becomes taxable following the donor’s death.

Answer 98

Gifts between spouses during life and following death are completely exempt. Provided both parties are domiciled within the UK (which will always be the case in this module) there is no upper limit to the value of the exemption. It does not matter why the spouse inherits. The relief applies to the value of assets received under a will, intestacy, survivorship or any combination etc. Unmarried couples cannot claim spouse exemption, irrespective of how long they have been in a relationship or living together and there is no concept of a “common law” spouse. A gift may be conditional provided the condition is satisfied within 12 months of death. A common example of a conditional gift is a 28 day survivorship clause.

Answer 99

A man gives his spouse £1M during his lifetime and on his death leaves his spouse a collection of paintings worth £3M. The spouse also inherits the man’s house by survivorship. The lifetime transfer of cash, and the death transfer of assets (both paintings and property) are entirely exempt from IHT.

Answer 100

Life Interest Trust Life Interest (right to income) Remainder Interest (right to capital on end of life interest) On a person's death, spouse exemption will apply to the value of assets transferred to a life interest trust if the surviving spouse receives a life interest i.e. named as the life tenant. However, spouse exemption does not apply if they receive a remainder interest i.e. named as the remainder beneficiary.

Answer 101

A woman dies and leaves her whole estate worth £2M “on trust to my husband for his life, remainder to my children”. The woman’s estate will qualify for spouse exemption as her surviving spouse has received a life interest following her death. The amount of the exemption is £2M.

Answer 102

A woman dies and leaves her whole estate worth £2M “on trust to my son for his life, remainder to my civil partner”. Spouse exemption does not apply-her civil partner did not receive a life interest. The woman’s estate will be subject to IHT.

Answer 103

All transfers to registered charities during life and following death are exempt irrespective of the amount given provided the gift is used exclusively for the purposes of the charity. The gift can be conditional provided the condition is satisfied within 12 months. The gift must be immediate and not in remainder for the exemption to apply. The gift must normally be absolute. The following is an example of a charitable gift found in a will that would attract the charity exemption: I GIVE to RSPCA of Wilberforce Way, Southwater, Horsham RH13 9RS RCN: 219099 (“the Charity”) the sum of one hundred thousand pounds (£100,000) absolutely for its general purposes. It is important to check the recipient’s charitable status for IHT purposes.

Answer 104

To qualify for an IHT exemption a gift must be made to a charity that comes within the jurisdiction of the High Court in England, Wales or Northern Ireland or the Court of Session in Scotland. A search of the UK national register of charities will reveal whether a charity is registered in the UK - generally registered charities are likely to qualify for IHT charity exemption. From a trust law perspective an organisation's charitable status may be questioned if it is not clear whether a gift is made for charitable rather than e.g. private purposes. These considerations are important as they can determine the effectiveness of a gift. However, even if a gift is confirmed as being made for charitable purposes, the IHT exemption will not apply unless the charitable body meets the other statutory requirements.

Answer 105

You should be aware of the following if a charitable gift is made under a will: In addition to charity exemption, which will apply to the charitable gift itself, a reduced rate of IHT (36% instead of 40%) may be available in respect of the chargeable assets in the estate. The reduced rate applies where a deceased leaves at least 10% of their estate to charity. When drafting a will that includes a charitable gift, it is worth checking how close it comes to 10% of the net estate. It can be beneficial for the client to increase the amount of the proposed gift in order to ensure that the 36% rate applies. Rules regarding the reduced rate are complex and fall outside the scope of the module. In this module you will only be required to apply the death rate of 40%.

Answer 106

Spouse and charity exemption are the focus of this element. However, you should be aware of the other exemptions shown below in bold which also apply to lifetime transfers and the death estate. Spouse exemption Charity exemption Business property relief Agricultural property relief Political party exemption Exemptions for gifts for national purposes or to heritage maintenance funds Exemption for gifts to EBTs Exemption for gifts to housing associations

Answer 107

Gifts to established political parties are exempt from IHT. In order to qualify for the exemption, one of the following conditions must apply (as at the last general election): The party had at least two MPs elected The party had at least one MP elected and at least 150,000 votes given to candidates representing that party.

Answer 108

A gift of land is exempt from IHT if it is made to a housing association or to a registered social landlord.

Answer 109

Gifts are exempt from IHT where they are made for designated ‘national purposes’. There is a list of bodies institutions in Schedule 3 which are covered by the exemption. The list includes museums and galleries which exist for specified purposes that are for the public benefit (such as the National Gallery and British Museum).

Answer 110

A similar exemption applies to gifts to funds which are designated as ‘heritage maintenance funds’. These are trusts which maintain historic buildings or land of scenic, scientific and historic interest. Gifts to the fund do not incur IHT, nor is the fund itself required to pay IHT (as long as it continues to be meet the requisite approval criteria).

Answer 111

There is another exemption for transfers of shares made into Employee Benefit Trusts (known as ‘EBTs’), providing they satisfy strict conditions set out in s28 IHTA. The law relating to the taxation of EBTs is complicated and is not assessed in this module. However, it is important to be aware of them as you may come across them when advising on corporate transactions or litigation matters, as well as if you work in a specialist tax or employment department.

Answer 112

EBTs are a tax-efficient way of remunerating employees. Historically they were also used for quite aggressive tax avoidance. This led to a significant amount of litigation by HMRC and the introduction of quite complicated anti-avoidance rules attempting to restrict their use. Attempts to avoid employment taxes using EBTs can give rise to unintended IHT charges so it is essential that specialist tax advice is sought whenever you encounter an EBT in practice.

Answer 113

There are a number of different exemptions and reliefs which can be used to reduce or eliminate the charge to IHT. This element considered those which apply equally to lifetime gifts and the death estate. Spouse exemption enables spouses to make lifetime and testamentary gifts to each other completely free from IHT. Spouse exemption for couples who are married applies equally to civil partners within a civil partnership. Charity exemption means a person can make lifetime and testamentary gifts to a registered charity completely free from IHT. There is no financial limit to the amount of spouse or charity exemption that can be claimed. Other exemptions and reliefs apply to lifetime and death transfers which are not assessed in this module, but which have been covered in this element for completeness.

Answer 114

Correct: Spouse/civil partner exemption applies to lifetime transfers and to gifts made under a will – any assets passing to the man’s civil partner will be entirely free of IHT.

Answer 115

Correct: Charity exemption applies and this gift is fully exempt. The size of the gift and the value of the other assets in her estate are irrelevant. The reduced death rate of IHT at 36% is only ever applied to the chargeable assets within an estate – it is not a rate of tax applied to a charitable gift itself.

Answer 116

Business Property Relief (‘BPR’) reduces the IHT payable on qualifying business property. Although a taxpayer can benefit from BPR at 100%, it is considered a relief rather than an exemption. The effect of BPR is to reduce the value of a taxable transfer by the amount attributed to the business property. A person must have owned qualifying business assets for the qualifying period of time

Answer 117

Unquoted shares: includes all private company shares (i.e. in a “ltd” company) irrespective of the size of value of shareholding Quoted shares: shares listed on a recognised stock exchange (i.e. in a UK “PLC”) but these are only business assets if the taxpayer controls the company (50%+)

Answer 118

A business (or interest in a business), or shares in a company, are not business property if the business concerned consists wholly or mainly of dealing in securities, stocks or shares, land or buildings, or making or holding investments. Rental property is considered an investment asset. These exclusions causes problems for property management companies, furnished holiday lets and also, historically, for caravan sites and assets within a business which are not used for trade. There is much case law in this area and it is important to appreciate that in practice it will not always be clear whether assets are held for ‘investment purposes’ or not.

Answer 119

To qualify the transferor must have owned the business assets continuously for at least 2 years immediately prior to the relevant transfer. The type of business does not need to be the same throughout the 2 year period but there must have been a business for all of that time. The following are exceptions to the two-year rule: If qualifying assets are sold and replaced with new qualifying assets within a certain period of time, the taxpayer’s period of ownership is usually treated as continuous. If a person inherits business assets following someone’s death, they are deemed to acquire the assets on the date of death (even though the assets will have been transferred to them after this date). If a person inherits business assets following the death of their spouse, they are deemed to have owned the property from the time it was originally acquired by their deceased spouse irrespective of how long they had been married (the survivor ‘inherits’ the period of ownership).

Answer 120

Where a taxpayer makes a PET or LCT of qualifying business assets and this transfer is assessed to IHT following the death of the transferor within 7 years, BPR is only available for the lifetime transfer if the qualifying property transferred (or replacement qualifying property): - is owned by the transferee; and -qualifies for BPR when the transferor dies (or on the death of the transferee if earlier). -There is no minimum ownership requirement of 2 years for the transferee.

Answer 121

Agricultural Property Relief (‘APR’) reduces the IHT payable on the agricultural value of qualifying assets. The ‘agricultural value’ may not be the same as the market value. The definition of ‘agricultural value’ is outside the scope of the module. The effect of APR is to reduce the value of a taxable transfer by the amount attributed to the agricultural property. Although a taxpayer can benefit from APR at 100%, it is considered a relief rather than an exemption. A person must have owned qualifying assets for the qualifying period

Answer 122

Qualifying agricultural property Agricultural property includes: Agricultural land and buildings: used for purposes connected with agricultural activity. Farmhouses and cottages: may qualify if they are of a ‘character appropriate’ to the associated agricultural land and have been occupied for the purposes of agriculture e.g. farmhouse occupied by a farm worker or their surviving spouse and not someone who occupies for purely domestic reasons.

Answer 123

Qualifying property must have been: * occupied for agricultural purposes by the transferor throughout the two years immediately before the transfer, or, * owned by the transferor and occupied by them or another for agricultural purposes throughout seven years immediately before the transfer.

Answer 124

Note the following exceptions which also apply to BPR: * If qualifying assets are sold and replaced with new qualifying assets within a certain period of time, the taxpayer’s period of ownership is usually treated as continuous. * If a person inherits qualifying assets following someone’s death, they are deemed to acquire the assets on the date of death (even though the assets will have been transferred to them after this date). * If a person inherits qualifying assets following the death of their spouse, they are deemed to have owned the property from when it was originally acquired by the deceased spouse irrespective of how long they were married (the survivor ‘inherits’ the period of ownership).

Answer 125

100% relief is available if the transferor was the owner occupier (or would be entitled to vacant possession within 12 months from the date of the transfer), or, the property was let on a tenancy beginning on or after 1st September 1995. This is usually the case. 50% relief applies less frequently, and usually in respect of tenancies created before September 1995. Example If a person purchases a farm and occupies it for farming purposes the property will qualify for APR after two years of owner occupation. If a person purchases a farm and lets it out (after 1995), and the tenant occupies the land for farming purposes, the property will qualify for APR after seven years of occupation. In both cases the rate of relief will be 100%.

Answer 126

A man dies leaving his estate to his children. His estate includes agricultural land with an agricultural value of £2 million and a market value of £2.3 million. The man has owned and occupied the land for agricultural purposes for sixty years. The remaining assets in his estate are valued at £500,000. The value of the man’s estate is £2.8 million (£2.3 million + £500,000). APR of £2 million (the agricultural value of the land) can be claimed. The estate qualifies for relief at 100% (so no IHT is payable on this amount). The remaining estate will be taxed at 40% above the available NRB.

Answer 127

Where a taxpayer makes a PET or LCT of qualifying agricultural property and this transfer is assessed to IHT following the death of the transferor within 7 years, APR is only available for the lifetime transfer if the qualifying property transferred (or replacement qualifying property): -is owned by the transferee; and -qualifies for APR when the transferor dies (or on the death of the transferee if earlier). -There is no minimum ownership requirement of 2 years for the transferee.

Answer 128

A makes a PET of a farming partnership worth £400,000 to B. A had owned the partnership interest for 3 years prior to making the gift. A dies 5 years later. The PET has failed and is now assessed to IHT. When deciding whether A’s estate can claim APR in respect of the failed PET, APR will only be available if B still owns the partnership interest transferred (or replacement qualifying agricultural assets). If B had sold half of the partnership for £50,000 before A died, APR could still be claimed in respect of A’s PET, but only with reference to the proportion retained by B – i.e. on £200,000.

Answer 129

APR is given in priority to BPR in scenarios where both reliefs would apply. It is not possible to claim BPR on a business asset if that asset also qualifies for APR. Both reliefs may apply in the context of commercial farming enterprises. Some assets may qualify for both relief and others for only one. Agricultural buildings may qualify for both – so APR applies in priority Livestock is not included in the definition of agricultural property but its value may qualify for BPR Farmhouses/cottages are unlikely to qualify for BPR, but may qualify for APR

Answer 130

There are a number of different exemptions and reliefs which can be used to reduce or eliminate the charge to IHT. This element considered the reliefs which apply equally to lifetime gifts and the death estate. BPR and APR reduce the value of a transfer to the extent the assets transferred qualify for the relief. 100% BPR applies in respect of all private company shares, partnership interests and to a sole trader business. 50% BPR applies to quoted shareholdings (if the taxpayer had control of the company) and also to assets owned by a taxpayer but used for business purposes.

Answer 131

For APR to apply the property must have been occupied for agricultural purposes for at least 2 years (if transferor occupied) or 7 years (if someone else occupied). APR of 100% of the agricultural value of the property can be claimed in most cases (but if the property was subject to a tenancy that started before September 1995, 50% relief would usually apply). Where APR and BPR both apply, APR takes priority.

Answer 132

Correct. The woman owned shares in a private company (it ends with “ltd”) for more than 2 years before she died. BPR applies at 100%, ie £100,000. The other options were incorrect because: The 50% rate is not applicable (these are not quoted shares) There is no requirement to have a controlling interest for a private company shareholding to qualify The qualifying period of ownership is 2 years, not 3 The period of time her daughter owns the shares for is irrelevant when considering the availability of BPR for the woman’s estate

Answer 133

Correct: The woman has owned and occupied the land for the purposes of agriculture for more than 2 years. The conditions of APR are met. APR can be claimed at 100% of the agricultural (not open market) value of the land. The other options are incorrect because: APR applies at 100% in this case, not 50% APR applies to the agricultural value, not market value, of the land Where both APR and BPR apply, APR takes priority.

Answer 134

This element explores the anti-avoidance rules that you need to consider when advising on inheritance tax. It is likely that you will be aware of the issue of tax avoidance because of high profile cases that have been in the news in recent years. HMRC considers tax avoidance to involve**“**bending the rules of the tax system to gain a tax advantage that Parliament never intended”. Often this involves taxpayers entering into convoluted, artificial arrangements to hide their true nature and affect the consequential tax treatment.

Answer 135

Since the 1980s, these sort of arrangements have been challenged by HMRC taking a purposive interpretation to the relevant legislation. This is similar to the mischief rule of statutory interpretation and involves the courts looking at the purpose behind the legislation, and applying the tax rules based on the underlying substance of the transaction rather than its form. This is known as the Ramsay Principle.

Answer 136

Although the Ramsay Principle is still a valid method of statutory construction, it has been supplemented by a series of legislative reforms which are aimed at preventing aggressive tax avoidance. These include both targeted and general anti-avoidance rules. This element introduces you to the most common anti-avoidance rules you need to be aware of when advising on wills and estates.

Answer 137

You should be aware of the distinction between the following: · Tax avoidance / tax planning: the efficient and lawful arrangement of a client's affairs in a manner which minimises their liability to tax.

Answer 138

· Aggressive tax avoidance: a form of tax avoidance which often involves the taxpayer entering into complex or artificial arrangements which have the overall effect of reducing their tax liability. These schemes comply with legislation but often do not reflect the intention behind the law. This kind of tax planning may involve exploiting loopholes or inadvertent gaps in drafting. Once HMRC become aware of a particular arrangement, ‘anti-avoidance’ legislation is often introduced to prevent further exploitation.

Answer 139

· Tax evasion: wherea taxpayer withholds information about assets or income, or otherwise takes steps to avoid paying the tax they are liable for. This is unlawful.

Answer 140

Restriction on deduction of loans for IHT purposes Gifts with reservation of benefit (‘GROB’) rules Pre-owned assets charge (‘POAC’) General anti-abuse rule (‘GAAR’) Disclosure of Tax Avoidance Schemes (‘DOTAs’) Although the focus of this element is avoidance of IHT you will note that not all of the rules covered relate directly to IHT liability. It is important to be aware that attempts to avoid one tax can give rise to a liability for a different tax. For example, the POAC is an income tax charge which penalises IHT avoidance. It is therefore essential in practice that you have a broad understanding of tax law (and seek specialist tax advice if you are uncertain of the potential tax implications of a course of action).

Answer 141

When calculating the chargeable value of a deceased’s estate for IHT purposes, it is necessary to deduct the deceased’s debts. It is also possible to deduct financing costs when ascertaining the taxable value of a lifetime transfer. However, there are anti-avoidance rules which restrict deductions in the following circumstances**:** Loans made to acquire, maintain or enhance assets that qualify for BPR. (This also applies to agricultural and woodlands relief.) Loans which are not repaid from the estate. Loans made to acquire, maintain or enhance excluded property (i.e. property which is not subject to IHT). Loans which fund a qualifying foreign currency account. The first two are considered in more detail in this element. The others are outside the scope of the module but you may need to be aware of them in practice.

Answer 142

If a loan was made to acquire, maintain or enhance assets that qualify for BPR (or agricultural / woodlands relief) the costs of the loan must first be set against the value of the qualifying assets. This reduces the value of assets which attract relief. If the loan exceeds the value of the relievable assets the remainder can be deducted from the value of the chargeable estate.

Answer 143

The effect of this restriction is shown by the examples on the following page. Both examples consider an estate of the same size, comprising the same assets and liabilities. The only difference is the purpose for which the loan was taken out. In the first example, the loan was used to acquire shares which qualify for BPR. The costs of the loan must therefore be set against those shares, reducing the relief available. In the second, the loan was used for home improvements. The costs of the loan are not restricted to a particular asset, meaning BPR is available for the entire value of the shares, reducing the value of the taxable estate.

Answer 144

Loans are only deducted from the value of the estate at death if they are repaid from the estate. Most loans will be commercial, arm’s length arrangements which HMRC expects will be repaid and does not investigate. Debts owed to the deceased’s family, related trusts or companies and those made as part of tax avoidance arrangements will only be deducted if they are actually repaid. HMRC will look at these more closely.

Answer 145

A woman lends her brother £200,000 to help him buy a house. The brother dies a year later, leaving his entire estate to his son. The estate consists of the house (£600,000) and cash in a bank account (£50,000). The man’s funeral expenses are £5,000. He has not paid any of the £200,000 back to his sister. He has no other debts.

Answer 146

The woman tells her brother’s executors that she does not want to enforce the debt. It therefore cannot be deducted from the value of the man’s estate. The man’s taxable estate is worth £645,000. If the loan had been repayable, it could have been deducted from the value of the estate, reducing the taxable value to £445,000.

Answer 147

The gifts with reservation of benefit (‘GROB’) rules were first introduced in the Finance Act 1986 (‘FA 1986’). The purpose of the rules is to prevent individuals attempting to manipulate the IHT regime by giving away property during their lifetime but retaining a personal benefit in that property. The rules work by treating such property as remaining part of the donor’s estate, ensuring that it is taxed upon their death (unlike genuine gifts which will only be taxed – as failed PETs - if the donor dies within 7 years of making the gift).GROB: When do the GROB rules apply?

Answer 148

The GROB rules are set out in s 102 FA 1986. A lifetime gift will be treated as a gift with reservation of benefit (‘GROB’) in one of two situations: · The donee does not assume “bona fide possession” of the property at or before the start of the “relevant period”. · At any time during the “relevant period” the property “is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor and of any benefit to him by contract or otherwise”.

Answer 149

The relevant period is the seven year period before the donor’s death (or a shorter period if the gift is less than seven years before death). Note that it is not simply the seven years after the gift is made. A gift can be caught by the GROB rules many years after it is made if the donor reacquires an interest in the property. (This prevents donors avoiding the GROB rules by temporarily giving up an interest in the property.)

Answer 150

For a donee to be treated as having bona fide possession of the gifted property for the purposes of the GROB rules they must: · Obtain a vested, beneficial interest in the property. · Have actual enjoyment of the property. · Assume possession and enjoyment at the start of the relevant period.

Answer 151

Actual enjoyment of property may consist of physical enjoyment (e.g. occupation of land) or receipt of the income produced by the property. For example, if a donor transfers legal title to their home but the donee allows them to live in it rent-free, while the donee lives elsewhere, the donee has not obtained bona fide possession. Although they have a vested, beneficial interest, they do not have actual enjoyment of the property. In contrast, if the donor pays the donee market rent to remain in the home, the donee will have actual enjoyment of the property.

Answer 152

The donor must be entirely or virtually excluded from benefitting from the property. There is no statutory definition of “virtually” but HMRC consider it to mean “to all intents” or “as good as”. HMRC gives examples of situations where they deem the benefit to be de minimis. These include, for example, the donor giving away their home but returning for social visits and occasional overnight stays. In contrast, if the donor were to remain living in the house rent-free, this would be an example of a GROB.

Answer 153

Where the gift is into a trust, a GROB will arise if the settlor (i.e. the donor) is a potential beneficiary, whether or not they actually obtain a benefit. An obvious example is where the settlor is included as one of the objects of a discretionary trust. Practice Alert: There are also income tax and capital gains tax consequences of naming the settlor (or their spouse or unmarried minor children) as the beneficiaries of a discretionary trust. These are outside the scope of this module.

Answer 154

The effect of a reserving a benefit depends on for how long the benefit is reserved: · If the GROB subsists at the date of the donor’s death, the property is treated as if it were part of the donor’s estate for inheritance tax purposes. It is valued at the date of the donor’s death. · If the donor no longer retains the benefit at the date of their death, they are treated as having made a PET on the date the reservation ceased. This deemed PET is charged in the same way as any other PET on the donor’s death but because it does not involve an actual transfer of value it will not benefit from the Annual Exemption (‘AE’).

Answer 155

Because the original gift may also be chargeable as a failed PET (if it was made within the 7 years prior to death) the GROB could end up being charged to tax twice. Relief is available to prevent a double-tax charge in these circumstances. This is outside the scope of this module.

Answer 156

Where a donor makes a GROB the property becomes the donee’s property for the purposes of capital gains tax (‘CGT’). This means that CGT may be payable by the donor on the increase in value of the property since they acquired it. If the donee later sells the property, CGT will be calculated based on the increase in the value of the property between the date of the gift and the date of transfer (even though, because it is a GROB, the donee may not have actually obtained any real benefit from the property until the GROB ceased or the donor died).

Answer 157

In contrast, if the gift is made upon the donor’s death, there is no CGT liability in relation to gains accrued during the deceased’s lifetime for the donor’s estate, and the donee is treated as acquiring the property for its market value at the date of death. This is known as the free CGT uplift and can be a significant justification for leaving it until death to make a gift of valuable property.

Answer 158

A man transfers legal title to his house (worth £650,000 at the date of the gift) to his daughter. He continues to live in the house until his death. The daughter lives elsewhere. At the date of the death, the house is valued at £750,000. The man has made a GROB as his daughter does not have bona fide possession and he continues to enjoy actual occupation. The house is included in the taxable value of his estate for IHT purposes at the date of death value of £750,000.

Answer 159

No CGT was payable on the gift of the house when it was made as it is the man’s main residence. The daughter’s acquisition cost for CGT purposes is £650,000. The house is not her main residence so she will be subject to CGT on the gain when she disposes of it. By the date of the man’s death, the daughter has accrued a gain of £100,000 despite having had no benefit from the property. If the gift had been made on the man’s death she would have benefitted from the CGT uplift i.e. inherited the property at the value of £750,000 and then could have sold the house at market value free from CGT.

Answer 160

A man transfers legal title to his house (worth £650,000 at the date of the gift) to his daughter. He continues to live in the house until five years before his death, when he moves into a care home. At this date, the house is worth £700,000. His daughter rents out the house and receives the rental income. The house is worth £750,000 at the man’s death.

Answer 161

As in the previous example, the man has made a GROB. This ceases when he moves out and his daughter receives the income. The man is treated as making a failed PET (£700,000). No AE is available.

Answer 162

Again, the daughter acquires the house at the date of the GROB so her acquisition cost is £650,000 and she loses the benefit of the CGT uplift. Unlike the previous example, she has had the benefit of the rental income in the period since the GROB ceased (but will be subject to income tax on that income).

Answer 163

The pre-owned assets charge (‘POAC’) was introduced in the Finance Act 2004 (FA 2004). It is an annual income tax charge imposed upon individuals who give away certain types of property during their lifetime but subsequently obtain a benefit from that property. (You may also see it referred to as the ‘pre-owned assets tax’ (‘POAT’) but note that it is not strictly accurate as it is not a tax in its own right.)

Answer 164

The POAC was introduced to prevent individuals exploiting loopholes in the GROB rules that allowed them to remove the value of their homes from their estates for IHT purposes, while continuing to live in them rent-free. The POAC does not apply to property which remains within the individual’s estate for inheritance tax purposes. This means that property cannot be taxed under both the GROB rules and as a POAC. It is, however, possible to make an election for property to be taxed as a GROB instead of a POAC. Whether an individual chooses to do this will depend on their personal circumstances and a comparison of their respective income tax and IHT positions.

Answer 165

The POAC is set out in s 84 and Sch 15 Finance Act 2004. It applies to 3 different types of property: Land Chattels Intangible property held in a settlor-interested trust. (For these purposes ‘intangible property’ means any property other than land or chattels. Examples include cash, credits in a bank account and shares.) The rules for each type of property are different and will be considered in turn. We will also consider the circumstances in which a transaction will be excluded from the POAC

Answer 166

Note that there are other exemptions and reliefs from the POAC which are outside the scope of this module but which, generally, are intended to prevent an individual being subject to both IHT and the POAC. There is also a de minimis exemption and a territorial exemption (which prevents the POAC being charged on individuals who are resident or domiciled outside the UK).)

Answer 167

Two conditions must be satisfied for land to be subject to the POAC: · An individual occupies land (either individually or with others). This condition is not always easy to assess as there is no statutory definition of occupation but HMRC’s guidance indicates that it should be construed widely, with each case determined on its own particular facts.

Answer 168

Either the ‘disposal condition’ or ‘contribution condition’ is met. You do not need to know how to apply these in detail but, broadly, they apply to situations where the individual has either disposed of the occupied land or has contributed (directly or indirectly) towards the acquisition of that land without obtaining a beneficial interest in it.

Answer 169

If the POAC applies, the benefit that the individual receives through their occupation is treated as income. Broadly, this means the individual will pay income tax on the equivalent of the market rent they would have had to pay in order to occupy the land.

Answer 170

The rules for chattels are similar to those that apply to land except that the occupation condition instead requires that the individual is in possession of or has the use of the property. Again, there is no statutory definition of either ‘possession’ or ‘use’ meaning it is a matter of fact for HMRC to assess. There is limited guidance on the meaning of either term, although HMRC does consider that the same de minimis thresholds apply here as they would in an assessment for the purposes of the GROB rules. If the POAC applies to a chattel, income tax will be calculated by taking the market value of that chattel and multiplying it by an official rate of interest.

Answer 171

As with land and chattels, two conditions apply: · The trust must be settlor-interested, meaning there are circumstances in which the trust property is, will or may become payable to or for the benefit of the settlor. Examples include discretionary trusts of which the settlor is an object and trusts in which the settlor has a remainder interest.

Answer 172

· The trust property must include intangible property which was settled into the trust by the individual on its creation or subsequently added by them to the settlement. (It includes the invested proceeds of the original settled property – it doesn’t need to remain in exactly the same form.) The settlement or addition must have taken place after 17 March 1986. If the POAC applies, it is calculated by reference to the official interest rate that would be payable on the settled property (with credit for any income tax or CGT paid under other anti-avoidance rules.)

Answer 173

The POAC does not apply to ‘excluded transactions’. These only apply to land and chattels and are broadly equivalent to other IHT exemptions. They include: · Transfers to the individual’s spouse or civil partner are exempt from POAC. · Dispositions for the purposes of family maintenance: If a gift qualifies for family maintenance allowance it is not subject to POAC (whether it would be caught by the disposal or the contribution condition).

Answer 174

· Annual and small gift exemptions: If a gift qualifies for annual or small gift exemption, it is not subject to POAC (whether it would be caught by the disposal or the contribution condition). · Arm’s length sales: Disposals at arm’s length to unconnected persons do not meet the disposal condition. · Occupation seven years after cash gift: If the contribution condition is met more than seven years before the occupation/possession condition, the POAC does not apply.

Answer 175

The general anti-abuse rule (‘GAAR’) was enacted in Finance Act 2013 as an attempt to counteract a wide range of aggressive tax avoidance. It applies to a range of taxes, not just IHT. HMRC guidance on the GAAR indicates that it is intended to catch arrangements which are contrary to the spirit or policy of tax law, seek to exploit perceived loopholes in the law or involve artificial arrangements aimed at avoiding tax.

Answer 176

Where arrangements are caught by the GAAR, it is necessary for the taxpayer (to whom the tax advantage arises) to counteract the abusive effect of the arrangements by making “just and reasonable” adjustments. As a further deterrent, a penalty (of 60% of the counteracted amount) is also payable. HMRC decisions as to the application of the GAAR may be referred to an independent GAAR Advisory Panel for determination.

Answer 177

The following conditions must be satisfied for the GAAR to apply: · There is an arrangement which gives rise to a tax advantage: This can include a reduction, deferral or complete avoidance of tax. HMRC will usually compare the result with the tax consequences of the hypothetical transaction the taxpayer would have most likely entered into in the absence of the arrangements. · The tax advantage relates to a tax to which the GAAR applies: This includes IHT.

Answer 178

· The arrangement satisfies the ‘main purpose’ test: This applies where it is reasonable in all the circumstances to conclude that obtaining a tax advantage is the main or one of the main purposes of the arrangement. · The arrangement is abusive: The test requires HMRC to show that entering into the arrangement “cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances”. This is known as the ‘double reasonableness test’.

Answer 179

The Disclosure of Tax Avoidance Scheme (‘DOTAS’) was introduced in the Finance Act 2004 (‘FA 2004’). It is a reporting regime which is intended to make HMRC aware of potentially unacceptable tax avoidance arrangements at an early stage. It applies to a range of taxes, including IHT. * DOTAS places duties primarily on ‘promoters’ of arrangements to inform HMRC about notifiable arrangements or proposals. Crucially, this can include legal advisers. * Once informed, HMRC may allocate a scheme reference number to notifiable arrangements or proposals. Promoters (and their clients) are then required to provide this number to parties to the arrangements.

Answer 180

* Promoters must provide information to HMRC about any clients to whom they provide services connected to the notifiable arrangements. * Parties to notifiable arrangements must also provide information to HMRC. * HMRC has investigation and enforcement powers under DOTAS. Penalties apply for failure to comply (but non-compliance is not a criminal offence).

Answer 181

Under s 306(1) FA 2004 arrangements in respect of IHT are notifiable if any of the following conditions apply: * The arrangements fall within any description prescribed by HM Treasury by regulations. (These are commonly referred to as ‘hallmarks’). * The arrangements (might be expected to) enable any person to obtain an advantage for a tax to which a relevant hallmark applies.

Answer 182

* The arrangements are such that the main benefit, or one of the main benefits, that might be expected to arise from them is the obtaining of the identified advantage. The hallmarks differ depending on the tax concerned. There are three applicable to IHT. In this module we focus on the specific IHT hallmark, but note that there are two more general hallmarks that apply to IHT in practice.

Answer 183

Two conditions must be satisfied for the IHT hallmark to apply: The main purpose or one of the main purposes of the arrangements is to enable a person to obtain one or more specific advantages in respect of IHT. The specific advantages are: * The avoidance or reduction of specified IHT charges relating to trusts and gifts to close companies. (These are outside the scope of this module.) * The avoidance or reduction of charges arising under the GROB rules (unless the arrangement instead gives rise to POAC). * A reduction in the value of an individual’s estate which does not give rise to a chargeable transfer or PET. 2. The arrangements involve one or more contrived or abnormal steps without which there would be no tax advantage.

Answer 184

HMRC guidance indicates that ordinary IHT planning will not be notifiable under DOTAS. The following are therefore not notifiable: * Ordinary outright gifts, even where they are exempt. * Executing a will, deed of variation or disclaimer which gives rise to an IHT exemption. * Acquisition of property which qualifies for a statutory relief or a transfer which is specifically provided for in the IHT legislation.

Answer 185

The guidance indicates that the following are (or may be) notifiable: * Creation of a reversionary lease to the lessor's children which starts so far in the future that the lessor would not still be expected to be alive. * Creation of an employee benefit trust to benefit the settlor's children after the settlor’s death. * Settlement of shares qualifying for BPR with an arrangement to sell them back to the settlor – This may be notifiable, depending on the specific circumstances.

Answer 186

Aggressive tax avoidance is countered by HMRC taking a purposive approach to tax legislation as well as enacting and utilising a range of targeted and general anti-avoidance rules. The following are the key IHT anti-avoidance rules you need to know: Restriction on deduction of loans for IHT purposes – These rules prevent individuals manipulating the rules on deducting debts to artificially reduce their IHT liability. Gifts with reservation of benefit (‘GROB’) rules –These rules prevent individuals manipulating the PET rules by giving away property but retaining an interest in it. Pre-owned assets charge (‘POAC’) – This is an income tax charge which complements the GROB rules by preventing individuals using assets which they have given away (or contributed towards). General anti-abuse rule (‘GAAR’) – This is an extremely wide measure that penalises aggressive tax avoidance. Disclosure of Tax Avoidance Schemes (‘DOTAs’) – This is a reporting regime that helps HMRC identify and monitor potential tax avoidance at an early stage.