Topic 5 - Inheritance Taxation Strategies

Question 1

IHT Background

What is the history of IHT?

What are some statistics of IHT?

Answer 1

Collection of estate & legacy duties started 1796.

Estate Duty replaced in 1975 by Capital Transfer Tax

Renamed Inheritance Tax in 1986

Dependent on Domicile

Paper Inheritance Tax Statistics 2015 to 2016 - 24,500 estates liable to IHT in that tax year or 4.2% of deaths with average bill of £179,000 (HMRC, 2018)

£5.2bn tax receipts in 2017/18, increase of 8% from 2016/17.

Prudential and Unbiased research in 2016, UK Taxpayers expected to waste £595 in needless INHT payments in 2016.

inheritance tax payments in 2016

Question 2

Social and Ethical Considerations

Give an argument for and against IHT?

What was the ‘voluntary tax’ quote regarding IHT?

Answer 2

Against

Can be seen as double taxation since income and growth to get wealth has already been taxed in life.

IHT must be assessed before probatae so the state stakes claim as preferential beneficiary in everyone’s estates.

As must liability must be settled before paid out, can create burden for heirs if asset not liquid.

For

Not paid by taxpayer but by heirs who have opportunity to create wealth. Therefore state creates environment where it can redistribute some wealth rather than allow concentrated wealth to accumulate in some areas of society.

Quote

‘Inheritance Tax is, broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue!’ (Roy Jenkins MP, 1986, in a Commons debate about IHT, cited in Brooks Green, no date).

Rising house prices and frequent changes in IHT law mean that unless people plan, a large part of a family’s inheritance could be swallowed up by unnecessary tax.

Domicile is a significant factor in an individual’s overall tax position, and is particularly important in relation to IHT. We will consider the main points now

Question 3

Double Taxation Agreements

What happens if UK has no DTA with other country?

How does the tax credit work and calculated?

Answer 3

Arrangements to provide relief if similar taxes apply. Country asset is located has primary right to charge tax and resident/domiciled country provides tax credit on own tax.

Tax Credit - Death tax charged in other country is credited (deducted) from the UK IHT liability.

• Establish UK IHT liability including asset
• Find porportion of tax liability from overseas asset - Asset value divided by estate value x IHT liability
• Credit is lower of overseas tax or UK IHT liability

Unilateral Relief

May be applied if no DTA in place for IHT or similar tax, heirs can apply to HMRC for relief. HMRC must be satisfied the overseas tax is:

• Paid by person liable to pay it
• Similar to IHT or payable on death
• Attributable to the value of the asset

Examples

Brian was UK domiciled but living in South Africa when he died. His estate on death was £700,000, including a South African apartment valued at the equivalent of £100,000. Brian was single with no children, and left the bulk of his estate to his niece and nephew. His property abroad was subject to local death tax of £10,000.

The calculation would be:

IHT: £700,000 – £325,000 = £375,000 taxed at 40% = £150,000.

Proportion of IHT represented by the overseas property: £100,000 / £700,000 x £150,000 = £21,428.

Tax credit is £10,000 – the overseas tax, which is lower than the IHT liability on the property.

Glenda was UK domiciled and her estate on death was £400,000, including a property in Derby and an overseas apartment valued at £125,000. She was single with no children, and left the bulk of her estate to her brother and sister.

Her property abroad was subject to local death tax of £15,000. The calculation would be:

Her IHT estate: £400,000 – £325,000 = £75,000. IHT at 40% = £30,000

Proportion of IHT represented by the overseas property: £125,000/400,000 x £30,000 = £9,375.

As the IHT apportioned to the property was lower than the overseas charge, IHT credit would be limited to £9,375

Question 4

Non Domiciled for IHT

What is the treatment of IHT on non domiciled individuals?

How does the inter-spouse exemption work?

Answer 4

Non domiciled in UK - IHT only on UK assets,

Treated as UK assets if derive value from UK resi property or been used as security for loan to buy or improve UK resi property.

.

The inter-spouse exemption

Non UK domicile can leave entire estate to UK domiciled spouse and free from IHT paying IHT on survivors death.

If UK domiciled spouses leave estate then can only leave assets up to nil rate band to be exempt. Can have full exemption if elect to be treated as UK domicile for IHT but would then incur charge on worldwide assets on survivors death.

Question 5

Excluded Property Trusts

What are the criteria for an setting up an excluded property trust?

What are the main benefits of an excluded property trust?

Answer 5

Non domiciled can also use trusts to avoid IHT if:

• set up while the settlor was non-domiciled;
• established outside the UK.

Status when setting up trust that matters. So no IHT benefits until settlor later becomes deemed domiciled in the UK which on deaath remains outside UK estate for IHT.

Benefits

Can be any type - most are discretionary for the flexibility

Settlor can also be beneficiary without the ‘gift’ being regarded as a gift with reservation as settlor was no UK domiciled

• The trust can be any type, although most are discretionary trusts due to the flexibility provided.
• The settlor can also be a beneficiary without the gift with reservation rule applying
• No periodic IHT reporting is required and periodic and exit charges to do not apply whilst excluded property.

Recent changes to income and CGT of setlor interested excluded property trust may make them less effective for non domiciled individuals.

Question 6

Nil Rate Band

What is the Nil Rate Band, how much is it, what is it’s history and how can it be transferred?

Answer 6

£325,000 and will remain until 6 April 2021.

From 9 Oct 2007 can transfer unused % of NRB to spouse/civil partner.

Transfer claim must be within 24 months of 2nd death

Not correct to say entitled to two NRBs as can only be used on death of deceased survivor, not for lifetime gifts into trust.

Estate Duty - Before 13 March 1975. Tiered rates starting at 0% and a spouse exemption of £15,000 introduced in March 1972.

Capital Transfer Tax - November 1974 - March 1986, full spouse exemption applied.

Transferrable NRB example

George died in January 2007, leaving £100,000 to his son Gary and the balance of his estate to his wife, Joan. When she died in 2018, Joan left her entire estate of £900,000 to Gary.

The NRB in 2006/7 was £285,000. Even though George died before the introduction of the transferrable NRB, Joan was entitled to his unused NRB. When George died, he used 35% of his NRB (£100,000 of the £285,000 NRB) available in 2006/7, and 65% can be transferred to Joan on her death. Increasing Joan’s NRB of £325,000 by 65% would give her estate an increased NRB of £536,250.

More than one marriage example

If a widowed spouse remarries and the second spouse predeceases them, the unused NRBs of both deceased spouses can be transferred, up to a total of one current NRB.

Example 1

Diane’s first husband died, using 40% of his NRB for bequests to his children and the rest of his estate to Diane, who later remarried. Five years later, her second husband died leaving 50% of his estate to his children and the rest to Diane.

Diane would be entitled to claim for the transfer of the 60% of her first husband’s unused NRB and 40% of her second husband’s NRB, giving her an additional 100% of the NRB.

Example 2

David’s first wife died, using 80% of her NRB for bequests to their children and the rest of her estate to David. He remarried and seven years later his second wife died, leaving 30% of her estate to her children and the rest to David.

David would be entitled to claim for the transfer of the unused 20% of his first wife’s NRB and the unused 70% of his second wife’s NRB, giving him an additional 90% of the NRB

Question 7

Residence Nil Rate Band

What are the RNRB exemptions?

Who can the RNRB be passed to?

What are the tranfser rules?

Can it be used in trusts? If so which ones?

Answer 7

6 April 2017

Residence passed to lineal descendeant - children, stepchildren, adopted or foster children. Also the spouse/civil partner of the decendant.

Rates

The RNRB will be:

• £100,000 (2017/18);
• £125,000 (2018/19);
• £150,000 (2019/20);
• £175,000 (2020/21).

Both the NRB and the RNRB will increase in line with the Consumer Prices Index (CPI) from 6 April 2021.

Rules

Transferable to spouse/civil partner even if first death was before April 2017.

Even if downsizes or sells home after 7 July 2015 and assets of equivalent value are left to direct descendants.

Tapered withdrawal of RNRB for esates above £2m. £1 for every £2 above £2m.

Residence nil-rate band and trusts

Can also be used in following trust environments:

• bare (absolute)
• immediate post-death interest trusts - interest in possesion trust
• disabled person’s trust
• 18-to-25 trust or bereaved minor’s trust - can only be established by parents.

Must clearly define beneficiaries so cant be used in relevant property trusts such as discretionary trusts and cannot be applied to trusts set up through lifetime gifts.

Question 8

What are the 5 IHT exempt beneficiaries?

Answer 8

1. Husband or wife (since 2005 civil partner if UK domiciled)
2. Non UK Domiciled spouse limited to £325,000.
3. A ‘qualifying’ charity established in the EU or another specified country;
4. Some national institutions, such as museums, universities and the National Trust;
5. Any UK political party with
   
   • At least 2 members elected to House of Commons or
   • One elected member but party received at least 150k votes

Question 9

What IHT exempt gifts can be made?

Answer 9

1. Annual Exemption

£3,000 per year. Unsued can be carried forward to following year only. Applies to gifts during lifetime only.

2. Wedding Gifts

• Parents - £5,000 each.
• Great / Grandparents - £2,500 each
• Anyone else - £1,000

Gifts must be made or promised on or shortly after wedding.

3. Small gifts

Gifts up to £250

Given to as many individuals as required

If more than £250 is given to an individual the exemption is lost altogether.

Cannot be used with other exemption.

4. Regular gifts or payments part of normal expenditure

Regular gifts from net income. NOT CAPITAL.

Must have sufficient income left to maintain their normal lifestyle.

Regular capital receipts do not count as income, which means that 5% withdrawals from an investment bond will not be regarded as income.

Examples:

monthly or other regular payments to someone;

regular gifts for Christmas and birthdays, or wedding/civil partnership anniversaries;

regular premiums on a life insurance policy.

The key is that the payments must be ‘normal’ for donor. This may include

• frequency and amount
• the nature of the gifts
• the identity of the recipients
• reasons for the gifts

Maintenence payments can also be made to:

• spouse/civil partner
• former spouse/civil partner
• relative dependant due to old age/infirmity
• children/step children//fostered and adopted under 18 and in full time education.

No need to prove normal lifestyle has not been affected if total gifts made does not exceed £3,000.

Question 10

What are the rules around Potentially Exempt Transfers?

Answer 10

Gifts made will be exempt if donor survives 7 years.

Must forgo all interest in gift.

Death within 7 years will mean failed PET. Gfits will be deducted from NRB, and if over then beneficiary of most recent gift liable for IHT that took it over NRB.

Taper relief is available if death between 3-7 years after making gift.

Question 11

Gift with reservation

What date was the Gifts with Reservation rules apply?

What are the rules around Gifts with Reservation?

Answer 11

Most lifetieme gifts to non-exempt beneficiaries are PETS so only chargeable if donor dies within 7 years. Death after seven years becomes Exempt Transfer.

Gift with Reservation

Gift where donor continues to benefit from asset without payment.

Applies to gift made on or after 18 March 1986 that are not exempt transfers.

Once stops being subject to reservation becomes PET

Question 12

Pre Owned Asset Tax

When was it introduced?

What is it for?

What are the main rules?

Answer 12

Asset disposal on or after 18 March 1986 where continued benefit to donor but not classed as gift with reservation.

Introduced in 2005 to prevent activities designed to avoid reservation rules while still allowing the donor to benefit.

Annual value of benefit recieved (less payment made for it) subject to income tax at highest rate.

Question 13

Chargeable Lifetime Transfers

When and how does a gift become a CGT?

What are the IHT implications?

Answer 13

When gifts placed in many types of trust, IHT usually due if total of chargeable transfers in last 7 years more than NRB.

Full IHT due unless paid by the trustees at 20%.

Question 14

What certain types of reliefs are available to reduce IHT?

Answer 14

Some property can be discounted for IHT during lifetiem or in will. These are:

• Agricultural Relief
• Woodlands Relief
• National Heritage Relief

Question 15

Agricultural relief

What relief is avaialble and how is it determined?

What are the length of ownership rules for relief to apply?

What are the property criteria?

What does it not apply to?

Answer 15

Agricultural relief

UK, Channel Islands, Isle of Man or EEA - 50% or 100%

Relief given on agricultural value.

Relief given at 100% if owner:

• farmed the land themselves
• let the land on a short term grazing licence
• let land on tenancy that began on or after 1 Sep 1995.
  
  • If between 10 March 1981 and this date - relief at 50%
  • Before 10 march 1981 then 100%

Property must have been owned and occupied before transfer for:

• 2 years if occupied by owner or company they control
• 7 years if occupied by someone else

Property Criteria:

• Land used to grow crops or rear animals intensively.
• Stud farms for breeding/rearing horses and grazing.
• Trees planted and harvested at least every 10 years (short-rotation coppice).
• Some unfarmed land under Countryside Stewardship Scheme, or under a crop rotation scheme.
• The value of milk quota associated with the land.
• Certain agricultural shares and securities.
• Farm buildings of type & size appropriate to business
• Farm cottages and farmhouses occupied by someone working in farming, a retired farm worker their widow granted tenancy under former employment contract.

Does not apply to:

• farm equipment and machinery;
• derelict buildings;
• harvested crops;
• livestock;
• property subject to a binding contract for sale.

Question 16

What is Woodlands relief?

Answer 16

Value of timber but not the land can be excluded frome state. May have to pay IHT when subsequently sold.

May also qualify for agricultural relief which takes priority or business relief.

Question 17

Describe how relief can be used for National Heritage property?

Answer 17

IHT and CGT can be defferred indefinitely on gifts of heritage property

Must be of pre-eminent national, scientific, historic or artistic interest, or land is of outstanding or architectural interest

Transferee is prepared to maintain and preserve asset and make it available to the public.

Question 18

What are the IHT rules and calculation for charitable giving?

Answer 18

Since 6 April 2012, if 10% of net estate (after nil rate band) is left to charity, tax due is 36% not 40%.

Example

Joan is single and dies, leaving an estate of £500,000. Her net estate is £500,000 – £325,000 NRB = £175,000. IHT is £70,000 (after 40% tax).

However, if Joan left 10% of her net estate (£17,500) to charity, her taxable estate is £157,500 taxable at 36% = £56,700.

Question 19

Business Property Relief

What is BPR?

What is 100% relief available on?

What is 50% relief available on?

What are some problems with BPR?

What sort of business is relief not avialble on?

Answer 19

BRP gives IHT relief for certain businesses or business assets transferred on death at 50% or 100% depending on nature of assets transferred.

Introduction of 100% relief in 1992 to encourage businesses to be passed onto family members. Instead, keeps control and ownership as asset is free of tax on death.

Not conditional. Can be inherited and sold the next day without clawback.

Likely to be better for partnership to own land, buildings and machinery rather than by partners personally. As assets will be counted as pat of the businesstransferred and subject to 100% relief. If owned by partners then only 50% would apply.

100% relief is available on:

• The transfer of the whole of a business owned by a sole trader.
• The transfer of an interest in a partnership including land and equipment owned by the business.
• Unquoted securities giving control of an unlisted company.
• Unquoted shares, including those listed on the Alternative Investment Market (AIM).

50% relief is available on:

• Quoted shares giving control of a company.
• Land, buildings, machinery or plant owned by the deceased and used wholly or mainly for the business of their partnership or a company over which they had control – this relief does not apply to land and buildings used by a sole trader in their business, unless they are the life tenant of a trust.
• Land, buildings, machinery or plant owned by a trust and used wholly or mainly for a business carried out by a life tenant of the trust.

Not avaialble for business or shares where business:

• Does not recieve profit
• is being wound up or is subject to a contract for sale
• Generates investment income - property letting, serviced office provision. (Let farms are exempt due to the extent of agricultural value).
• Mainly involved in dealing in securities, stocks, shares, land, builidings

Question 20

Use of Trusts

How can trusts be used to mitigate IHT?

Answer 20

Bare (absolute) trust - Named individual gets legal right to trust at age 18.

A discretionary trust - Greater flexibility and allows trustees discretion to apportion trust fund. Involves higher admin, with greater risk trustees will be taxed on income or capital gains.

IHT may be due on the assets in trust when:

• they are transferred out of a trust (exit charges);
• a ten-year anniversary occurs.

Not when in a:

• bare trust
• in an ‘interest-in-possession’ before 22 March 2006;
• subject to a ‘transitional serial interest’ made between 22 March 2006 and 5 October 2008;
• placed in interest-in-possession trust by a will or the rules of intestacy;
• set aside for a disabled person;
• set aside for a bereaved minor

Question 21

What are the three ways of mitigating IHT?

Answer 21

1. Gifts - Give up ownership of assets
2. Reliefs -Maximise reliefs
3. Insurance and products - Put plans in place to pay liability when it falls due.

Question 22

How can you meet IHT liabilities as they fall due?

Answer 22

Life Assurance:

Four reasons for life assurance:

• provide cash/income to pay everyday bills;
• pay debt;
• pay tax;
• leave a legacy.

Roman soldiers are said to have contributed to a pooled fund before battle to pay for remains to be returns home for family to bury (Webster, 1969, p267, p280)

Gift Inter Vivos Insurance

Decreasing-term insurance can meet liability from failed PET

Whole of Life, second-death protection

Lump sum to pay known liability. If not in trust will be added to estate increasing overall IHT bill.

So write in trust to keep out of estate and allow payment before probate is granted so heirs can pay tax bill asap.

HMRC treats premiums paid to insurance policy as a lifetime gift if paid by the insured, but normally covered by annual £3k exemption or gifts out of normal income.

Simple method but cost may be high.

Question 23

Business Relief Schemes

How can these schemes help provide unlimited IHT exemption for investors?

Answer 23

Some schemes offer funds that invest in unlisted AIM companies that qualify for Business Relief.

Unlimited exemption provided investor has held shares in qualifying company for at least 2 years.

After two years not considered as part of estate for IHT.

If death within two year, shares treated in same way as quoted stock exchange shares.

Surviving spouse who inherited the shares would only have to survive the balance of the two years.

AIM is relatively risky market due to the smaller companies listed on it.

Question 24

What are some ways to reduce the value of an estate?

Answer 24

Equity Release

One common issue for IHT payers is they are asset rich. Can convert estate to cash value in life using equity release but must survive 7 years.

On death value of estate will be reduced by debt.

Interest is rolled up and debt can quickly grow. For example a £50k mortgage with 7% a year will be £98,358 within 10 years. So can end up owing more than would have been paid in IHT.

Long Term Care

Individual may go into long term care. Must fund own care until assets are reduced to £23,250.

Question 25

Deed of Disclaimer

What is a deed of disclaimer?

What are the rules around using one?

Answer 25

Can refuse to accept capital or income by employing deed of disclaimer as long as they have not recieved any benefit from gift.

Must disclaim full gift, not just part. But can separate gifts and claim some but not all.

The deed of disclaimer is not classed as a transfer of value.

Disclaimed property passes back into estate and will be distributed in line with will or intestacy.

Disclaimee has no right to influence who ends up getting gift.

Question 26

Deed of Variation

What is a deed of variation?

What is it’s main advantage?

Why is it used?

What 6 rules must be followed to be effective for IHT?

Answer 26

Can redirect a bequest by executing deed of variation to change terms of a will - effectivel rewriting it.

Can be used to rearrange the estate for IHT.

Has advantage over dislciamer that person giving up bequest has conrol over who recieves redirected benefit.

All beneficiaries negatively affected must be at least 18, sound mind and agree with changes by signing deed.

To be effective for IHT the deed must:

1. Be in writing
2. Signed by person giving up their entitlement
3. Made within 2 years of settlor’s death
4. Clear on what is being redirected and to whom
5. Effective for IHT and CGT purposes
6. Done without any consideration in return (payment)

Question 27

Define what would be included in the calculation of inheritance tax on an individual’s estate?

Answer 27

The calculation will include:

• everything owned in their name;
• the share of anything they own jointly;
• gifts made, from which they kept back some benefit, such as a house lived in and maintained, even though it was given away (gift with reservation);
• the value of gifts made in the last seven years (and potentially a further seven years prior to that) which were not covered by exemptions, and potentially subject to taper relief

Question 28

Discuss the reliefs available to an individual either during their lifetime or via their will on death?

Answer 28

The reliefs available during an individual’s life or via their will are:

Business relief

Relief is given at either 50 or 100%, depending on the type of asset.

For people who died after 6 April 1996, 100% relief is available for a business or interest in a business, or a holding of shares in an unlisted company.

The 50% relief rate is available for:

shares controlling more than 50% of the voting rights in a listed company;

land, buildings, plant or machinery used in a business that an individual is a partner in or controls at the time of their death;

land, buildings, plant or machinery held in a trust where an individual has the right to benefit from the trust and use the assets in the trust in their business.

Agricultural relief

Relief is usually given at 100%; any outstanding mortgage(s) on the property is deducted before calculating the relief.

Agricultural property including agricultural land or pasture, farmhouses, cottages or buildings that are used for agricultural purposes and are proportionate in size to the nature and size of the farming activity, and woodland and buildings used for intensive rearing of livestock or fish.

Woodlands relief

Beneficiaries of woodland can ask that the value of the timber – but not the land – be excluded from the estate.

When the timber is subsequently sold, the beneficiaries may have to pay IHT on the value of the sale unless it also qualifies for relief.

Relief for National Heritage assets

Some assets may qualify for relief from IHT under certain very strict and exceptional conditions including an agreement to maintain and preserve the asset and make it available to the general public. Examples of assets that may qualify include:

buildings of outstanding historic or architectural interest;

objects which have national scientific, historic or artistic interest.

Question 29

Jeanette is single and has an estate valued at £800,000. Apart from a legacy to charity, she intends to leave her estate to her niece. Calculate how much IHT would be payable if she died during the 2019/20 tax year, and in her will left £55,000 to charity

Answer 29

Step 1 – deduct the £55,000 charitable donation from £800,000. This leaves a figure of £745,000.

Step 2 – deduct £325,000 (IHT NRB) from £745,000. This leaves a figure of £420,000.

Step 3 – add £55,000 (the value charitable donation) back to £420,000. This gives a figure of £475,000 – the ‘baseline amount’.

10% of the estate of £475,000 is £47,500. This estate qualifies for the reduced rate of IHT because the charitable donation of £55,000 is more than 10% of the ‘baseline amount’.

The IHT payable £420,000 x 36% = £151,200.

Question 30

Explain how a ‘discounted gift trust’ works, and the advantages and drawbacks of using a bare trust or a discretionary trust when setting it up?

Answer 30

A discounted gift trust is usually set up in connection with an investment in either an onshore or offshore investment bond.

The trust allows the gifting of a lump sum into a trust whilst retaining a lifelong ‘income’ from that money, with the overarching aim of reducing the eventual IHT bill on death.

The name ‘discounted gift trust’ was coined by the life insurance industry. In strict legal terms, it is a type of carve out trust.

Provided the settlor is in reasonable health, a calculation is made of the likely total amount of ‘income’ that will be paid back to them by the trustees.

These rights, known as the ‘discount’, are deemed to be retained by the client.

The remainder will be treated like any other gift into trust.

There is a chargeable transfer in the case of a discretionary trust.

There is a potentially exempt transfer (PET) for a bare trust.

In the event of the settlor dying within seven years, this retained ‘bag of rights’ should in theory be returned to their personal representatives. However, the accepted IHT treatment, as has been tested many times and accepted by HMRC, is that this right to an income for life has no value once the settlor has died, and therefore no money has to be returned.

The effect is that the discount is deemed to leave their estate on day one of settlement of monies into the trust – the remainder will be treated like any other gift into trust and brought back into calculations if death occurs within seven (in some cases 14) years. In effect, there is an immediate IHT reduction upon creation of a discounted gift trust.

Question 31

In 2006, the European Commissioner challenged the UK tax regime that allows tax relief for gifts to charities only if they are established in the UK. This resulted in the exemption being extended to the EU. On what basis did the European Commissioner mount this challenge?

Answer 31

The European Commission challenged the UK’s tax regime which allows tax relief for gifts to charities only if they are established in the UK. The Commissioners argued that the difference in treatment between gifts to charities in the UK and gifts to charities in other member states:

• constitutes potentially an obstacle to the free movement of capital and therefore breaches Articles 56-60 of the EC Treaty;
• is contrary to the free movement of workers since workers and self-employed individuals moving to the UK might wish to make gifts to charities established in the member state where they came from (Articles 39-42 of the EC Treaty);
• is contrary to freedom of establishment (Articles 43-48 of the EC Treaty), ie the right of an EU national to exercise economic activity to establish an undertaking in another member state, since foreign charities are forced to set up branches in the UK in order to benefit from the favourable tax treatment.