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Inheritance Tax Notes These notes are intended as a brief introduction to some of the issues involved. If you need any further information please contact one of Ashcourt Investment Advisers’ personnel detailed below. These notes only apply to UK resident and UK domiciled individuals. It should be highlighted that the rules and practice relating to inheritance tax are changing almost continuously. Basis of Inheritance Tax (IHT) IHT is a direct tax levied on transfers of capital (including gifts). Tax is charged at a rate on death of 40% on transfers above a nil rate band ("NRB"). The NRB is £263,000 for 2004/05 tax year. Almost all assets are included in this calculation, however there are a number of exemptions and allowances to IHT including all transfers between spouses during life and on death. In addition, certain business assets are exempted (see ‘Exempted Assets’ below). Most transfers made during the lifetime of a donor are "potentially exempt transfers" (PETs). Usually this means that if the donor survives for 7 years after the transfer (or up to 14 years where discretionary trusts are involved) no IHT will be payable. Certain lifetime transfers (gifts in to certain types of trust) are immediately chargeable at a reduced lifetime rate which increases to the full rate if death subsequently occurs within 7 years. Nil rate band planning Should the first to die of a married couple leave everything to their spouse, the use of the NRB is lost. Instead, assets up to the value of the NRB could be given away directly to other beneficiaries such as children or, if the surviving spouse needs access to the funds, the creation of a discretionary trust may be more suitable. The beneficiaries of such a trust can be the spouse and, for instance, their children or other people. Such a trust can give the spouse access to the money in their lifetime but avoid IHT on their death. To make full use of the NRB exemption the assets should be reasonably equally divided between the spouses if at all possible. Various arrangements exist to maximise the benefit of the NRB and in many cases much can be achieved in this way. Giving money away The amount of any gift for IHT purposes is the reduction in the estate caused by the gift, not the value of the assets passed. Usually the two are the same, but not always. It is important that the donor retains no interest in, or derives any benefit from a gift they make otherwise the gift may be ineffective for IHT saving. For instance, there is considerable difficulty in giving away a house in which the donor wishes to live, and the Inland Revenue is looking further to close existing loopholes in this regard. Careful use of gifts into trusts can be useful although caution must be exercised should the donor (or their spouse) retain the right to benefit from the trust. It is vital that a person does not give away too much and leave themselves short of money. The solution to one problem may give rise to larger problems in future. Gifts out of Capital There are many allowances and exemptions to IHT beyond the scope of these notes but the most popular ways of giving money away so that it is immediately outside the estate for IHT liability are:
Gifts out of Income Gifts which are made from normal income expenditure and which do not reduce the donor’s standard of living can also be claimed as an exemption. The gift should, if possible, involve a regular pattern of expenditure. If amounts in excess of the allowances and exemptions are gifted during the lifetime, the effect of the tax due on the gift reduces over the seven year period (or up to 14 years where discretionary trusts are involved). This only has an impact where the total value of the estate (including previous gifts) exceeds the NRB. Life Assurance Where a person wants to protect the value of their assets from IHT, but wishes to retain the use of them, life assurance can be of benefit. This can provide a lump sum to pay the tax bill when it is due. The policy is usually written under trust to keep the proceeds outside the estate. The premiums on such policies are gifts and subject to the provisions above. If the client has insufficient income to pay for the premium they may like to consider using capital instead, on the principle of using some of their capital to protect the remainder. It is not usually possible to match precisely the IHT due, but the principle is to provide a reasonable approximation. The cost of life cover increases rapidly with age and depends on the health of the potential policyholder. Temporary policies, covering death in a fixed time-frame, can be a cost effective way of protecting tax due on gifts or to provide a breathing space to rearrange assets. Exempted Assets Several assets are currently exempt from IHT, of which one of the most useful is often a business asset. These include unquoted private company shares (which also include some AIM and OFEX companies) and the assets of a client’s business. Not all companies qualify and so caution must be exercised when using this relief. For instance investment, financial and property based companies are not covered. To qualify for relief the assets must have been held for two years. If a business asset is given away before death the recipient must continue to hold the same asset when the donor dies, or the donor must live for seven years after the asset is sold. Schemes exist to enable people to make use of this relief, such as the Ashcourt AIM & OFEX portfolio service and property development schemes. Conclusion IHT has been called a voluntary tax in that if you give everything away seven years before death no tax would be payable. However, for most people this is impractical and so compromises are necessary. An important point to note is that a client does not themselves have an IHT problem with their own assets, but the amount of the estate to be distributed to the beneficiaries is affected by the tax. As a result, planning should only be done where it fits in with the needs and wishes of the client. It is often not worth making the client poorer, or their affairs more complex, in order to make their children richer. John Taylor, David Bowman or David Horder London Office 020 7618 1000 Ian Mereweather Winchester Office 01962 852520 Colin Bannister Kings Hill Office 01732 520780 Sir Robert Hutchison Ipswich Office 01473 225055 Important Notes and Risk Warnings This document has been prepared by Ashcourt Investment Advisers Limited for the general interest and benefit of readers. This document is not intended to be a definitive analysis of legislative rules and it does not recommend any particular course of action. Any levels of taxation or limits referred to depend on the individual circumstances of the investor and the law and these may change in the future. Ashcourt Investment Advisers does not and does not purport to offer taxation expertise in respect of investment advice or its impact upon the taxation position of the investments or the Client arising from any decision or step taken by Ashcourt Investment Advisers on behalf of the Client, except that incidental tax matters may be considered with the Client as part of the overall advice given. Ashcourt Investment Advisers shall not be responsible for advising the Client in relation to taxation of whatsoever nature, or for seeking to minimise any taxation liability of the Client in relation to the investments, and shall be under no liability whatsoever in relation to any depreciation in the value of the investments or any adverse tax consequences which may arise as a result of any advice given in respect of the management or variation of the investments. Whilst proper care and attention is taken with respect to the general effect of taxation matters incidental to any recommendations made or advice given, the Client should seek specialist tax advice to confirm the specific tax consequences for the Client which may follow from acting upon any such recommendation or advice. In this regard, the Client must note that Ashcourt Investment Advisers will not be liable and excludes all liability for any charges to taxation the Client may incur as a result of any action taken on the Client’s behalf by Ashcourt Investment Advisers. | ||
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