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Time to re-evaluate the IHT situation?

Kleinwort Bensons Graeme Stenson provides an update on the current tools for IHT mitigation.

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The introduction of this facility has certainly simplified the planning in this area. Prior to Alistair Darling’s announcement in the 2008 Pre Budget Report, it was possible for spouses and civil partnerships to achieve a similar result to the transferable NRB by leaving sufficient assets on the first death to a beneficiary other than the  surviving spouse.

However, this strategy assumed that there existed suitable assets that could be specified in the will and clearly this did not include the principal private residence, even if held as tenants in common whereby each party held a specific share, rather than joint ownership which is more common and where the joint owners do not own a clearly identified fraction.

This is particularly relevant as in the majority of situations that concerned ‘Middle England’ it was the value of the house that was creating the IHT liability and any planning involving the family home has always been fraught with complication. Up until the announcement in October 2007 it had been predicted that the IHT take would increase considerably as a result mainly of rising house prices and prosperity generally.

Reduced tax take

In fact, the tax take has reduced considerably in recent years. According to the latest statistics IHT raised approximately £3.83bn in 2007/8 and approximately £2.72bn in 2010-11. This reduction is to a large extent due to the introduction of the transferable nil rate band and possibly a reduction in house prices across much of the UK.

It is also possible that the reduction in the tax take is due to an increase in IHT planning due to greater awareness of the tax as a result of the publicity in 2007 and the promotion of IHT structures by advisers to a wider audience.

Two new developments are the introduction of the Disclosure of Tax Avoidance Scheme (DOTAS) rules for IHT with effect from 6 April 2011 and the proposal (for deaths occurring after 6 April 2012) for a reduced rate of IHT of 36% for those leaving 10% or more of their estate to charity.

As regards the former, one of the aims is to restrict disclosure to those schemes which are new or innovative and this is achieved by exempting from disclosure those schemes which are the same or substantially the same as arrangements made before 6 April 2011 (known as ‘grandfathering’ provisions). Some of the more popular planning and structures that are exempted are:-

  • The purchase of business or agricultural assets or with a view to transferring the assets into a relevant property trust after two years.
  • Discounted Gift Trusts – a structure normally offered by an Insurance company whereby an investment is made in a single premium insurance policy with the settlor electing to take fixed annual withdrawals from the policy. A value is placed on the retained right to receive the withdrawals and this reduces the value of the gift for IHT purposes leading to an immediate IHT reduction. The value of the remainder or the gifted right will fall outside of the settlor’s estate after seven years.
  • Changes in the distribution of deceased’s estates – a variation or disclaimer
  • Transfers of the Nil Rate Band every seven years
  • Loan into trust
  • Insurance policy trusts
  • Pension death benefits

Therefore the more popular strategies will remain intact and doubtless their attraction will increase as individuals seek advice and become averse to using a new structure, particularly if it has been disclosed to HM Revenue & Customs, and has to be mentioned specifically on their tax return. It is arguable that one or more of the following strategies will appeal in varying degrees dependent on the individual’s attitude to risk:-

  • Qualifying AIM shares
  • Structured investments qualifying for Business Property relief after the two year holding period
  • Life Assurance either to cover the seven year period following a gift or to provide a lump sum to beneficiaries on death
  • Discounted Gift Trusts and Loan Trusts depending on need for income and capital
  • Normal expenditure out of income
  • Transfer of the Nil Rate Band every seven years into a relevant property trust
  • Ensuring that unvested pension death benefits pass into a relevant property trust or direct to a beneficiary.
  • Loan against the security of relevant chargeable assets.
  • Gifts to charity

The latter development is the proposal announced in the March budget that, as part of a package of measures designed to encourage charitable giving, there should be a reduced rate of IHT of 36% where 10% or more of a deceased’s net estate is left to charity. This relief is due to apply to deaths occurring from 6 April 2012 and will undoubtedly encourage charitable gifts but the extent is difficult to forecast.

The existing Gift Aid and other charitable donations reliefs are also valuable in that they can provide higher rate Income Tax reliefs for lifetime gifts but do not yield the same reduction in IHT. Depending on the final shape of the relief it may lead to a policy of advisers suggesting the option of making charitable gifts and for this question to be asked by those drafting wills.

The recent reports by learned bodies suggest that IHT needs to be reformed and repeated reference is made to a tax based on the donee rather than the donor. However, there appears to be no political will for change during the current parliament and therefore planning must be based on the current IHT regime and the pre DOTAS structures.

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