SPECIALIST INHERITANCE TAX PLANNING (IHT)

This most famous words about Inheritance Tax...

"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, Commons debate, 1986

While the above certainly holds true, planning your estate to reduce IHT cannot be left to the layman nor the inexperienced...

As there are so many rules that govern Inheritance Tax, knowing what to implement, when and how requires not just professional advice, but a specialist who has bit of creative flare too, because any solution must be effective as well as fit in with your circumstances and needs. In this section, we'll have brief look at the factors which have deterred people from planning, and then we'll consider some of the tools available to overcome them. Further planning ideas also feature in the articles and links section of this website.

What is inheritance tax?

Inheritance Tax is a tax charged on a deceased's estate whose value exceeds their available nil rate band at the time of death. Inheritance tax is charged at 40%. For married couples, on first death, no inheritance tax is charged if everything is left to their spouse and on second death two nil rate bands will be available.

For tax purposes, the value of an estate includes not just the assets, but any gifts made in the 7 years prior to death (these gifts use up the nil rate band first), life assurance policies or pension plans not held in trust, as well as any loans still owing to you, for example a director's loan. Outstanding loans, such as a mortgage obviously reduce the estate for IHT purposes.

Some Factors affecting Inheritance Tax Planning

Normally when you make a gift, you have to survive seven years for it to fully escape inheritance tax at 40 per cent. The rules dictate that you can’t use the asset once gifted, otherwise it is a “gift with reservation of benefit” and caught for inheritance tax. This is the first hurdle. Many clients cannot afford to lose access to an asset. One answer may be to gift and then pay a market rent for the use of the asset, for example gifting away your home to your children, and then paying them a full market rent to continue living there - this will avoid the IHT, but in practice most won't have adequate income to fund a market rent.
If you are able to gift away an asset, then doing so immediately triggers Capital Gains Tax (CGT), as if you had sold the asset at FULL market value. Faced with the prospect of a large tax bill on an asset which you havn't sold, few ever go down this route.

Initial points to consider

As mentioned above one can gift away their home to a family member, and providing you can afford to pay a full market rent, IHT will be avoided providing you survive seven years.
Another method, little advertised is where an adult child is still living at home with their parents. In such a case the property can gifted to the child, and providing the child remains living there and the parent(s) survive seven years IHT will be avoided without the need for rent to be paid.
Under the Business Property Relief (BPR) rules, owning shares in a trading company, for example a family business, is IHT exempt providing they've been held for two years. Unfortunately property companies do not fall under the definition of a trading business, and consequently are liable for IHT.

Tools available to the specialist financial advisor

The Discounted Gift Trust

A sophisticated vehicle which reduces the value of an estate immediately for Inheritance Tax purposes. Assets are placed into a Trust, which provides a tax efficient income to the donor for life. This is not affected by the 'gift with reservation' rules, including those under the Pre-Owned Assets Finance Act 2004. A proportion of the fund is removed from the estate immediately for IHT purposes, with the remainder falling outside the estate after 7 years. As this vehicle in practical terms is a legitimate 'gift with reservation of benefit' which does not fall foul of the rules, we have devised, in conjunction with estate planning lawyers and Tax Counsel, specialist applications of this Trust which, in certain circumstances, can be used to mitigate IHT on property or other assets, and particularly so where adult children have wealth in their own right. An added benefit of the structure can also achieve an efficient extraction of capital from a family business or limited company without having to take a dividend.

This Trust is also available under a Bare or Discretionary Trust.

Business Property Relief (BPR) Products - IHT exemption in just 2 years

Invest in a qualifying portfolio of Alternative Investment Market (AIM) shares

As mentioned above owning shares in a trading company is IHT exempt after 2 years. However, if you don't have a trading business to invest in you could:

Invest in a qualifying portfolio of AIM shares - For clients who understand accept the investment risk
Invest in lower risk BPR products - These achieve the same IHT relief in 2 years, but without the risk of wild movements in the investment. One reputable fund manager is offering an excellent fixed rate of return.

Again, with appropriate advice, in certain cases these vehicles can be used to mitigate IHT on property or other assets.

For further advice, please contact Arnold Aaron.

Other mechanisms

Other mechanisms are available to address IHT, particularly through the use of other types of Trusts. Usually these can be set up through a lawyer specialising in private client tax. We can recommend such professionals to you where appropriate. Please contact us for more information.

For further advice, please contact us.