The Latest Position

In October 2007 the government announced changes to the way Inheritance Tax would be calculated. Although the changes help married couples, widows, widowers and civil partners the changes in my opinion, only help those people who have not already been proactive in trying to reduce this tax. It does not mean that retirees will pay no tax in the future. And for those people who have taken steps previously it only adds further emphasis on the constant need to review what is in place.

The Facts

The importance of IHT to the government

The annual amount paid to the government over the last 10 years has risen from £1.558 million to £3.545 million - a rise of 127%. *

From April 1997 to April 2007 the average UK house price rose from just over £54,000 to £180,314 – a rise of around 214%* *

The nil rate band allowance (2007/8 - £300,000) has, in comparison risen by about 40% in the last 10 years.

* Source HMRC.gov.uk as at April 2007

** Source Nationwide.co.uk/hpi – April 2007

How it is calculated

The value of all the assets that are left behind on a persons estate are added up (these can include bank accounts, the family home any assets given away but where there is a retained benefit), the annual nil rate band allowance, £300,000 (2007/08) is deduced from this amount and then the balance is taxed at 40% unless any exemptions or potential exemptions apply.

Any IHT has to be paid within 6 months of the end of the month in which the death occurred. Interest is charged on any tax not paid by that date. Probate will not be granted until any IHT bill has been paid. This means that the legal personal representatives are not allowed to distribute assets until probate has been granted.

Wills

If you die without making a will, called dieing in testate, certain fixed rights of inheritance apply. This means the law decides who gets what, and the property and other assets might not end up in the hands of the people who should have received them. In some cases it can even go to the crown. Therefore, the very first piece of action to be taken is to have yours wills set up in a tax efficient manner to make use of the tax allowances given to you by the government. Where wills have not been set up in the most tax efficient manner it is still possible to change the rules after death and up to two years by means of what is called a deed of verification.

Enduring (EPA) / Lasting Powers of Attorney (LPA)

In October 2007 LPAs took over from EPAs. EPAs were set up to allow a relative, friend or solicitor to conduct their financial affairs should they become mentally incapable of acting for themselves.

EPAs need to be registered with the Court of Protection when the individual loses or has lost mental capacity.

EPAs set up before October 2007 will be unaffected by LPAs and will continue to operate in parallel with them.

The main difference between LPAs and EPAs is that LPAs now have the right to decide on personal welfare matter whereas previously EPAs only covered property and financial affairs.

Exemptions & Reliefs

Exempt Lifetime gifts

 The following gifts are exempt from IHT – no matter how long your individual survives after making them:

• Gifts to spouse of civil partner
• Gifts to charity
• Gifts to a political party
• Annual Gifts of up to £3,000
• Unlimited small gifts of up to £250
• Gifts on marriage

• £5,000 for a child
• £2,500 for a grandchild
• £1,000 for any other person getting married

• Gifts out of normal expenditure
• Armed forces exemption

Potentially Exempt Transfers (PET) and Taper Relief

If a person survives seven years from the date of giving the gift then no IHT is payable.

Where the person dies within seven years IHT may be payable.

In this respect Taper Relief will reduce the amount of IHT payable as follows:-

(Assuming a gift of £100,000)

Business Assets

Business Property Relief (BPR)

If your client owned a property for two years before transferring it could qualify for BPR with some exemptions.

The types of property which could benefit from 100% relief are business, unquoted shares or those traded on the Alternative Investment Market.

These are other rules allowing for 50% BPR.

Agricultural property Relief

Here again property must have been occupied for at least two years or owned it for seven years.

Agricultural property must be in the UK, Channel Islands or Isle of Man can include land pasture and any farmhouses, cottages and buildings which are appropriate to the property.

Woodlands Relief

 The executors can have the value of the timber (but not the land) excluded from the client’s estate.

Using Life Assurance to pay the tax

If after using all the allowances and exemptions, or where the individual wants to retain benefit assets then a simple way of covering the IHT bill is by means of life assurance.

To be effective it must be written within a Trust which means the proceeds fall outside the estate.

Where there is a couple the policy would be written on a join life second death basis (there is no IHT liability when the first spouse dies) the sum assured would therefore only be paid out after the death of the second spouse or partner.

Back to Back plans are arrangements created by linking whole of life policies with lifetime annuities. A lump sum payment is split into two contracts: part pays the premium of a whole of life policy while the balance buys an annuity. The annuity cost reduces the estate immediately – the life policy proceeds pay for the remaining IHT liability.

Using Trusts

 A trust is a legal way of giving assets to others. These could be buildings, investments or cash.

Trusts are often considered to be complicated but they can be a very effective means of reducing or avoiding an IHT liability.

They also have the additional benefit of clearly defining who will receive the asset, they offer the flexibility and some control and they allow timely distribution of assets. Since the review of trusts brought about in the Finance Act in 2006 there are now basically three types of trust

• Absolute or Bare Trust
• Discretionary Trust
• Interest in Possession Trust

Which trust is you choose depends entirely on how and when the donor wants the assets to be distributed, there can also be different tax implications depending on the amount put into the trust and the type of trust used.

There are then choices of trust available which would match each donor’s individual circumstances.

• Loan Trust
• Gift Trust
• Discounted Trust
• Discretionary Trust

Alternative Schemes through Specialist providers

A number of specialist investment companies and stockbrokers offer higher risk schemes where IHT liabilities fall 100% out of the estate after two years.

Close Brothers offer investment in residential property development schemes, which also offers a life policy to cover death before the end of two years if aged under 77 at inception even if they are in poor health.

Investments in the London Stock Exchange Alternative Investment Market (AIM) again put 100% of the liability out of the estate after two years. The AIM market was launched in 1995 and consists of smaller growing companies. There are now over 600 companies trading on AIM with over 80 moving to the main market.

Enterprize Investment Schemes give unlimited CGT deferral on realised gains whilst qualifying on business assets so that they can offer 100% IHT relief through Business Property Relief.

The Family Home

The increase in property prices has brought IHT into the realms of people who might not be high network couples.

The Gift With Preservation at pre owned Assets Tax rules make it almost impossible for individuals to gift away their property effectively unless a full market rental is paid to the donee or they have a joint occupation with the donee.

Equity Release schemes allow a debt to be raised against the value of the estate. The proceeds can then be put in trust to get the money out of the estate.

Ownership – joint tenants or tenants in common

Most couples own their own property as joint tenants. This effectively means that when the first of them dies the survivor will automatically own the whole property and nothing passes under the will.

For tax purposes joint tenants are treated as owning half of the property each. For IHT purposes, on first death, a transfer will be made according to the will. This means that 50% of the value of the property can be put outside the value of the estate immediately, thus utilising one of the nil band allowances. Legal advice should be taken as to the best ways of utilizing the nil rate band as there are a number of ways of doing so.