Tax planning and anti avoidance

Question 1

What is the difference between tax avoidance, aggressive tax avoidance, and tax evasion?

THIS TOPIC IS QUITE WEIRD MAYBE GO THROUGH LECTURE WHEN YOU REVIEW CARDS

Answer 1

• Tax avoidance = efficient and lawful arrangement of a client’s affairs in a manner which minimises liability to tax
• Aggressive tax avoidance = complex/artificial arrangements which have overall effect of reducing tax liability (not a criminal offence, but do not reflect intention behind the law)
• Tax evasion = unlawful withholding of information about assets/income or otherwise taking steps to avoid tax they are liable for

Question 2

What are the 5 anti-avoidance rules?

Answer 2

1. Restriction on deduction of loans (step 4 of IHT calculation) for IHT purposes
2. Gifts with reservation of benefit (GROB)
3. Pre-owned assets charge (POAC)
4. General anti-abuse rule (GAAR)
5. Disclosure of Tax Avoidance Schemes (DOTAs)

Question 3

What is the restriction on loans made for assets attracting BPR?

Answer 3

If loan made to acquire, maintain or enhance the BPR assets (or agricultural/woodlands relief), the loan must be set off against the value of the qualifying assets
when valuing for IHT purposes

Difference between loan and value of qual assets that gets relief

E.g. shares worth £100,000 and outstanding debt of £25,000 which was used to purchase shares.

• Deduct £25,000 at deducting debts step
• Deduct £75,000 (rather than £100,000) from the shares as the loan has been set off against the qualifying assets

Question 4

What if the loan exceeds the value of the relievable assets?

Answer 4

The remainder can be deducted from the value of the chargeable estate

Question 5

What is the restriction on loans which are not repaid from the estate?

Answer 5

Loans only deducted if they are actually repaid - debts owed to deceased’s family, related trusts or companies and those made as part of tax avoidance arrangements looked at more closely by HMRC

E.g. Woman lends brother £200,000 to help him buy house, brother dies without paying any back and woman tells her brother’s executors that she does not want to enforce the debt = debt cannot be deducted from the value of the man’s estate

Commercial arrangements expected to be repaid (HMRC does not check)

Question 6

What is the purpose of the GROB rules + what is their effect?

I.e. How do they treat the property

Answer 6

• Prevents individuals giving away property during lifetime but retaining a personal benefit in that property
• Treat property as remaining part of donor’s estate ensuring it is taxed upon death

Question 7

What are the 2 situations in which GROB rules apply?

Answer 7

1. Donee does not assume ‘bona fide possession’ of property at/before start of relevant period
2. At any time during relevant period, property is not enjoyed to (virtually) the entire exclusion of the donor and of any benefit to him

Question 8

What is the ‘relevant period’ in the GROB rules?

Answer 8

The 7 year period before donor’s death (shorter if gift made less than 7 years) - not 7 years after gift made

Means gifts can be caught by GROB rules years after made if donor reacquires interest

Question 9

When will a donee have bona fide possession of gifted property for purpose of GROB rules?

Recall - donee must have assumed bona fide possession at start of relevant period for GROB rules not to apply

Answer 9

Donee must:

1. Obtain vested, beneficial interest in property
2. Have actual enjoyment of the property (physical/income)
3. Assume possession and enjoyment at the start of the relevant period

Donor transfers legal title…

• Lives there rent-free = donee has not obtained bona fide possession (beneficial interest but not actual enjoyment)
• Pays market rent to remain in home = donee has actual enjoyment

Question 10

What does ‘exclusion of the donor’ mean?

Answer 10

Must be ‘as good as’ excluded from benefitting from property

Social visits/overnight stays not caught

Question 11

What about when a gift is made into trust?

Answer 11

GROB arises if settlor (donor) is a potential B whether they actually obtain benefit or not

Question 12

What is the effect of reserving benefit if GROB subsists at donor’s death?

I.e. still living there rent-free upon death

Answer 12

Property treated as part of donor’s estate - valued at date of donor’s death

Question 13

What is the effect of reserving benefit if donor no longer retains benefit at date of death?

Answer 13

Treated as having made a PET on the date the reservation ceased

Will not benefit from AE

Can be charged to tax TWICE (if die within 7 years of reservation ceasing)

E.g. man transfers legal title to £650,000 house to daugher and continues to live there until 5 years before death where he moves into a care home and value of house is £700,000 - has made a GROB…

• Man treated as having made a PET of £700,000
• Daughter acquires house at date of GROB so has acquired at £650,000

Question 14

What are the CGT consequences where donor makes a GROB?

Answer 14

The property becomes donee’s property; CGT may be payable by donor on increase in value of property since they acquired it (even if they have not enjoyed it because never technically had it)

So bad for both parties

I.e. if donee later sells = CGT calculated based on increase in value of property between date of gift (GROB) and date of transfer (on selling) even though they (donee) may not have obtained any real benefit from property until GROB ceased or donor died!!!
Bear in mind private residence relief (if it is the main residence passed on, will not be subject to CGT)

E.g. man transfers legal title to £650,000 house to daugher and lives there until death and daughter lives elsewhere. Valued at £750,000 at death. This is a GROB

• House included in taxable value of his estate for IHT purposes at £750,000
• No CGT payable by him (PRR) but daughter’s acquisition cost will be £650,000 - so has made gain of £100,000 despite never living there

Question 15

Why is it better to receive gift upon death than GROB?

Answer 15

No CGT liability when receive gift on death due to free CGT uplife (donee treated as having received property for market value at date of death)

Question 16

What is the POAC (pre-owned assets charge)?

Answer 16

Annual income tax charge imposed on individuals who give away certain types of property during lifetime but obtain benefit from that property

Prevents exploitation of loopholes in GROB rules

Question 17

Can property be taxed under both GROB and POAC?

As both involve giving away property but continuing to benefit from them

Answer 17

No - POAC will not apply to property which remains within individul’s estate for IHT purposes - this is why POAC is an annual income tax charge

Can elect to be taxed as GROB instead!

Question 18

To what 3 types of property does POAC apply?

Answer 18

1. Land
2. Chattels
3. Intangible property held in a settlor-interested trust (property other than chattels e.g. cash, credits, shares)

Rules for each type different

Also a de minimis exemption and territorial exemption (POAC cannot be charged on individuals who reside/are domiciled outside the UK)

Question 19

What are the 2 conditions for land to be subject to POAC?

Answer 19

1. An individual occupies land (construed widely)
2. Either disposal or contribution condition is met

I.e. 2 = individual has either disposed of occupied land or has contributed directly/indirectly to acquisition of land without obtaining beneficial interest in it

Question 20

What is the effect if POAC applies to land?

Answer 20

The benefit an individual receives through occupation is treated as income - pays income tax on equivalent of market rent they would have to pay to occupy land

Question 21

For chattels to be subject to POAC, are the conditions the same as land?

Answer 21

Yes except that occupation condition replaced with possession/use of property

No definition, de minimis thresholds apply

E.g. man makes gift of shares to sister - sister sells shares and uses proceeds to buy car - man uses car everyday to drive to work and parks outside of house
* Possession = satisfied; man has use of car
* Contribution = satisfied; car acquired indirectly through sale of shares
He must pay the POAC

Question 22

What is the effect if POAC applies to chattels?

Answer 22

Income tax will be calculated by taking market value of chattel and multiplying by official rate of interest

Question 23

What are the 2 conditions for POAC to apply to settlor-interested trusts?

Answer 23

1. Trust must be settlor-interested (circumstances in which trust property is/will/may become payable to or to benefit of settlor)
2. Trust property must include intangible property which was settled into trust by individual on creation/subsequently added by them to settlement

Question 24

What is the effect on settlor-interested trusts if POAC applies?

Answer 24

Calculated by reference to official interest rate that would be payable on the settled property (with credit for any income tax/CGT paid under other anti-avoidance rules)

Question 25

What **excluded transactions** does POAC not apply to?

Answer 25

* Transfers to spouse/CP * Dispositions for purpose of family maintenance * Annual/small gift exemptions * **Arm's length sales** (sales to unconnected persons do not meet disposal condition) * **Occupation seven years after cash gift** (if contribution condition met over 7 years before occupation/possession condition, POAC does not apply) | Broadly similar to IHT exemptions

Question 26

What is the General Anti-Abuse Rule (GAAR)?

Answer 26

Intended to catch a wide range of aggressive tax avoidance (applies to range not just IHT)

Question 27

What happens when arrangements are caught by GAAR?

Answer 27

1. The taxpayer must counteract abusive effect of arrangements (just and reasonable adjustments) 2. Penalty of 60% of counteracted amount payable

Question 28

When does the GAAR apply?

Answer 28

1. Arrangement exists giving rise to a tax advantage (reduction, deferral or complete avoidance) 2. Tax advantage relates to a tax to which GAAR applies (inc IHT) 3. Arrangement satisfies the '**main purpose**' test (obtaining tax advantage is main purpose) 4. Arrangement is abusive (cannot reasonably be regarded as **reasonable course of action** re relevant tax provisions) | Will compare arrangement to hypothetical version without arrangement

Question 29

What is DOTAS (Disclosure of Tax Avoidance Scheme)?

Answer 29

Reporting regime to make HMRC aware of potentially unacceptable tax avoidance arrangements at an early stage (applies to range inc IHT)

Question 30

How does DOTAS work?

Answer 30

Duties placed on **promoters** of arrangements to inform HMRC about **notifiable arrangements or proposals** | Penalties for failing to comply but non-compliance not criminal offence

Question 31

What should promoters do?

Answer 31

* Provide scheme refrence number (allocated by HMRC) to parties to arrangement * Provide info to HMRC about any clients to whom they provide services connected to notifiable arrangements

Question 32

When are arrangements in respect of IHT **notifiable**?

Answer 32

1. Arrangements fall within description prescribed by HM Treasury (**hallmarks**) 2. Arrangements enable any person to obtain an advantage for a tax to which a relevant hallmark applies 3. Arrangements are such that main benefit/one of benefits is the obtaining of identified advantage

Question 33

What are the 2 conditions that must be satisfied for the IHT hallmark to apply?

Answer 33

1. Main purpose/one of main purposes of arrangement is one or more **specific advantages** re IHT 2. The arrangements involve one or more **contrived/abnormal steps** without which there would be no unfair tax advantage

Question 34

What are the specific advantages?

Answer 34

* Avoidance/reduction of charges arising under GROB rules (unless it gives rise to POAC instead) * Reduction in value of individual's estate which does not give rise to a chargeable transfer or PET ## Footnote Examples: * Creation of a reversionary lease to lessor's children that starts so far in future that lessor would not still be expected to be alive * Creation of employee benefit trust to benefit settlor's children * Settlement of shares qualifying for BPR with an arrangement to sell them back to settlor

Question 35

What will **not** be notifiable?

Answer 35

* Ordinary outright gifts (even where exempt) * Executing a will which gives rise to an IHT exemption * Acquisition of property which qualifies for a statutory relief | I.e. ordinary IHT planning

Question 36

What are the goals of tax planning?

Answer 36

1. Minimise IHT (reduce size of taxable estate in advance) 2. Retain sufficient assets to maintain financial security during own lifetime 3. Provide adequately for family after death

Question 37

How should the annual exemption be used in tax planning?

Answer 37

* Use AE each year to make gifts (consistent giving over several years) * Use **after** any other available exemption/relief applied

Question 38

When is the normal expenditure out of **income** useful?

Answer 38

For clients who have a large income where significant amount is unused each month | Not for 'asset rich cash poor' elderly clients ## Footnote Can make monthly premiums on life policy into trust and will not treated as PETs (because no upper limit)

Question 39

How should the spouse exemption be used in tax planning?

Answer 39

Richer spouse should transfer to poorer spouse - can make more exempt transfers than if one party held all assets | Can also be used for CGT - gains not accrued until donee disposes

Question 40

How can the charity exemption be used in tax planning?

Answer 40

If a person leaves 10% or more of net estate to charity, **will be taxed at reduced rate of 36%** ## Footnote Net estate = succession estate assets + additional items (inc pass by sship)

Question 41

How should BPR and APR be used in tax planning?

Answer 41

Clients could choose to invest in assets that qualify for BPR/APR; turning non-exempt cash into exempt assets | More efficient to give away to non-exempt B

Question 42

How can assets not subject to IHT be used in tax planning?

Answer 42

* Take out life insurance and/or pay into a pension and write benefit of these in trust * Should take steps to ensure death benefits have been nominated for a third party (if not already) ## Footnote Recall - discretionary lump sum payments/life policies written in trust are excluded from taxable estate

Question 43

What happens when a life policy is written in trust after it has been set up?

Answer 43

There is a deemed PET of redemption value of policy at that date | Usually small amount

Question 44

How can transfers of value be used in tax planning?

Answer 44

Giving away valuable asset/large cash lump sum = smaller estate after transfer and less IHT due

Question 45

How can the risk of not surviving 7 years after making PET be mitigated?

Answer 45

Taking out fixed term life assurance specifically to cover cost of IHT | Could be written in trust to ensure lump sum paid out not taxed

Question 46

What should be considered when making PETs for tax planning?

Answer 46

* Give away assets that increase in value over time (chargeable value of PET will be value at time it was made not date of death) * Make gift of assets over 2 separate tax years to use 2 CGT annual exemptions (or just transfer cash as exempt from CGT)

Question 47

What is the parental settlement rule?

Answer 47

Where the income arising from property transferred to unmarried minor child is taxed as if it still belongs to parent

Question 48

How can LCTs be used in tax planning?

Answer 48

* If LCT for amount equal/less than NRB there is no IHT due at that time and if survives 7 years then no IHT due at all * Can make LCTs of up to NRB every 7 years (effectively 'resets')

Question 49

**When** will spouse and charity exemption offer a tax saving?

Answer 49

If **IHT would otherwise have been payable**

Question 50

Can a testator increase the amount of a charitable gift without reducing the amount the non-exempt B receives after tax paid?

Answer 50

Yes - increase in legacy amount is **offset by tax saving made by the lower rate** (36%) | Cost of legacy born by HMRC not estate Bs

Question 51

What should a client be reminded of when BPR/APR is available?

Answer 51

* Must own qualifying assets at date of death (not will) * Should not make changes that would mean assets become outside of qualifying criteria * Should not sell assets before death

Question 52

Who should the client **not** make specific gifts of qualifying assets to?

Answer 52

Exempt Bs - both exemptions will apply re same gift and BPR/APR is wasted

Question 53

Where a testator wants their spouse to benefit from BPR/APR, what can they do?

Answer 53

Make specific gift of qualifying assets to a discretionary trust (non-exempt B) and claim BPR/APR * If spouse named as one of trust Bs they can benefit from asset despite not inheriting directly * Will also remain outside of survivor's taxable estate

Question 54

What happens when qualifying assets are not specifically given away and fall ito the residuary estate?

Answer 54

APR/BPR do not **attach to the assets**, instead the benefit of relief is **apportioned** generally between taxable and non-taxable Bs ## Footnote So wasted where apportionment allocates some/all relief to exempt B e.g. residuary passes to exempt B

Question 55

How do statutory rules apply to ensure an exempt B is not taxed on their gift?

Answer 55

IHT will be taxed from **elsewhere** subject to 'subject to/free of tax' ## Footnote E.g. Specific gift to chargeable beneficiary (£100,000 to daughter subject to tax) and residue to chargeable and exempt beneficiaries (residue equally between spouse and son): * Spouse’s share of residue is exempt. * IHT due is apportioned between the legacy and son’s half of residue. * Daughter gets legacy with IHT deducted (i.e. less than £100k) * Son gets share of residue with tax deducted (i.e. less than spouse)

Question 56

What happens where a specific gift (over NRB) is to a chargeable B (free of tax) with residue to exempt B?

Answer 56

Reduced balance passes to exempt B; IHT was due and residue was only part of estate from which it could be taken

Question 57

How will 'subject to tax' and 'free from tax' affect how IHT is paid?

Answer 57

* £400,000 to son **subject to tax**, residue to spouse = only part of estate subject to IHT is specific gift; IHT paid from legacy and spouse inherits residue with no deduction for IHT * £350,000 to son **free of tax**, residue to spouse = £350,000 paid to son and IHT paid from residue

Question 58

When is double grossing up required?

Answer 58

Where: * specific gifts to chargeabkle Bs and a gift of part of residue to an exempt B * specific gifts to chargeable B where some but not all are 'free of tax'

Question 59

When is 'fixing NRB' relevant?

Answer 59

Where a client does not want to use their NRB, because if it goes up in the future the combined value of the two NRBs can be larger than if the first was used ## Footnote E.g. First spouse dies NRB is £325,000, when second spouse dies it has increased to £400,000 Will 1 gives away £NRB to chidlren = first spouse dies uses £325,000 NRB, second spouse dies uses £400,000 NRB = £725,000 total NRB Will 2 gives everything to spouse = first spouse did not use NRB, second spouse can use both NRBs = £800,000 total NRB

Question 60

What is bunching?

Answer 60

When the surviving partner (of unmarried couple) ends up with own assets plus inherited (which were already taxed because no spouse exemption); value of inherited assets can be re-taxed before passing to children

Question 61

How can a couple limit the amount survivor inherits (and avoid surviving spouse's estate becoming too large)?

Answer 61

1. Make gifts to children/other family members on first death rather than leaving everything to each other 2. Leave amount to discretionary trust instead of survivor directly

Question 62

How would this discretionary trust work? What is the benefit when the survivor (B of DT) dies?

Answer 62

* Survivor and children/grandchildren named as Bs they can benefit from assets (but not have complete control over them) * When survivor dies = taxable estate does not include assets held in trust ## Footnote Tax saving can outweigh the administrative costs and the downside that Bs do not have unrestricted/certain access to the trust

Question 63

What should be done in scenario where one party has an estate worth less than the NRB, and poorer of unmarried couple dies first meaning NRB cannot be used in full and unused part is wasted?

Answer 63

The richer of the two should make transfers during lifetime to equalise the value of the two estates and then each person making wills that benefits the other

Question 64

What should a party consider when they want to use their RNRB?

Answer 64

1. If specific gift of property being made to Bs or property is part of general residue of estate 2. If property is passing directly to descendants If shared between non-lineal descendants, B is under age, or property left in certain types of trust = **more complicated and RNRB may not apply**

Question 65

Why should a client who wants to give away the NRB to a non-exempt B not draft the gift of a **fixed sum** (i.e. give the sum of £325,000 to...)?

Answer 65

1. **May not have a full NRB available when they die** (so part of gift may become taxable) 2. **Amount of NRB can change over time** (so missed opportunity) ## Footnote Should be: “I give as much of my nil rate band as is available to my daughter” + certainty re TNRB or TRNRB

Question 66

As trust does not have separate legal personality, what does a gift into trust take effect as?

Answer 66

A transfer to the Ts (legal owners of the asset) - so normal IHT applies | Bs have equitable and beneficial interests

Question 67

What is a will trust?

Answer 67

A trust created on death by testator's will * Will is trust deed * Testator is settlor

Question 68

When does a will trust come into existence?

Answer 68

On the date of testator's death when provisions of the will become operative | Not when executed

Question 69

What is a discretionary will trust?

Answer 69

A trust for the benefit of a group of Bs, none of whom have a fixed right to trust assets | Ts have absolute discretion over capital and income ## Footnote Will be drafted as discretionary trust of residue (whole or part of residuary estate passes) **or** legacy to a discretionary trust (fixed sum equal to NRB passes)

Question 70

What is a life interest will trust?

Answer 70

A trust for the benefit of a life tenant (entitled to income during lifetime) and the remainderman (entitled to capital when life interest ends; usually on death) | Ts do not have complete discretion over distributions

Question 71

If settlor creates a discretionary will trust, is there an immediate tax saving for the testator/estate?

Answer 71

No ## Footnote No difference in this sense cf discretionary trust v outright gift in will

Question 72

Can spouse exemption apply to discretionary will trusts?

Answer 72

No - even if named as one of the trust Bs

Question 73

As there is no immediate tax saving, why is the use of a discretionary trust considered 'tax planning'?

Answer 73

If testator makes gift to DT, the Bs can benefit from trust assets without accumulation of wealth into any of them individually - so **when B dies their taxable estate does not include the trust assets at the time**

Question 74

Can the residence NRB apply if deceased's residential interest passes to a DT?

Answer 74

No! Children are not inheriting **directly**

Question 75

What are the non-tax purposes for setting up a DT instead of leaving gifts to individuals?

Answer 75

* Not required to know in advance how estate should be distributed * Changing needs of B can be accomodated * Letter of wishes can still be used to exercise some discretion (but not binding) * Assets are protected from claims by B's creditors or spouse

Question 76

Are there IHT charges to the discretionary will trust?

Answer 76

Not for the estate of any individual B, but HMRC apply charges to the trust paid by trust fund | Significantly smaller than IHT that would be payable if owned outright

Question 77

What is the purpose/effect of a 2 year discretionary will trust? ## Footnote Drafted with intention they only last for period of 2 years from testator's death

Answer 77

Distributions of capital from a DT made by Ts within first 2 years of testator's death are deemed to have taken place under deceased's will for IHT purposes and not by the Ts (so relevant exemptions/relief can apply) - **see example** | Ts can decide who among Bs should inherit and what they should receive ## Footnote Only used where trustee is trusted to make appropriate decisions i.e. will often be surviving spouse as one of trustees

Question 78

Example of 2 year DT

Answer 78

Shows how exemptions/reliefs can apply

Question 79

Can spouse exemption be claimed on amount passing to a life interest trust?

Answer 79

Provided testator's spouse if life tenant | No relief if remainder B

Question 80

Is the IHT position the same whether a testator leaves entire estate to spouse absolutely or leaves entire estate to life interest trust and names spouse as life tenant?

Answer 80

Yes! But in life interest can benefit from practical advantages of trust while maintaining benefit of IHT exemptions

Question 81

What are the key practical advatages of life interest trust compared to outright gift?

Answer 81

Testator can 1. Control the ultimate destination of their estate 2. Specify who benefits as the life tenant while preserving capital of their estate for other Bs ## Footnote Can address concerns where settlor has children from previous marriage or thinks spouse will remarry: **obtains tax advantage of spouse exemption but also ability to preserve assets for other family members after spouse dies**

Question 82

Is the life tenant entitled to trust capital and income?

Answer 82

Only income | May not be sufficient

Question 83

What if life tenant's needs are likely to exceed resources plus trust income?

Answer 83

Either make trust fund larger so more income generated or ensure Ts have power to advance capital/make loans to life tenant if needed