Inheritance Tax (IHT) is a notoriously unpopular tax and that has been the case for many years. It is often perceived as an unfair tax not least because the event which triggers a liability to IHT is death itself! In addition, it is regarded as being a tax levied on assets which have already essentially had tax paid on them. Such is the unpopularity of IHT that it has been recently reported that the Government is considering abolishing it. It is thought that this could be a vote-winner.
Of course, the availability of certain allowances and reliefs does help to limit the impact of IHT but the headline rate of 40% is particularly eye-watering, especially for overseas individuals who are based in the UK temporarily or happen to have assets here.
With the Government actively looking for ways in which to increase its tax take, many do have a growing anxiety to ensure that assets are protected from IHT and that family members will not have a large tax bill to worry about on the death of a loved one. A common concern relates to the family home and the desire that it should not necessarily have to be sold in order to settle IHT.
It has always been difficult for effective IHT planning to be put into place in relation to the family home, mostly because of the strict gift with reservation of benefit rules which apply when an individual gifts away an asset but then continues to benefit from it. In those instances, HMRC will deem the asset still to belong to the donor and the hoped-for IHT benefit of having transferred the asset outside the scope of IHT will not be obtained.
All of that being said, there are still options for planning regarding the family home. These can include having a specific trust structure in the property owner’s Will which seeks to fragment ownership of the property so as to save up to 6% IHT on death. In addition, the gift with reservation of benefit rules can be managed by a donor paying market rent for use of a gifted asset. Furthermore, there is a specific exemption from the rules which can be utilised in certain circumstances where the donor and the donee both own and occupy the property. This does allow for a particularly interesting planning opportunity as the term “occupation” is not clearly defined.
Aside from the family home, many people are aware of the fact that they have assets which they do not necessarily need and, consequently, the option of transferring some of those assets outright on to the next generation can be appealing from an IHT planning point of view. At present, it is necessary for the donor to survive seven years for there to be no IHT implications for him/her, his/her estate or the recipient. In some cases, it will be possible for the donor to take out life insurance in order to protect against the possibility that he/she may not survive the requisite seven years. Furthermore, life insurance can be used to protect his/her estate from the potential loss of the donor’s IHT nil rate band allowance which, if not protected, would be detrimental to his or her residuary beneficiaries).
Outright lifetime gifting may be appropriate in some cases but, often, there is a legitimate concern about asset protection and, in particular, a desire to avoid the risk posed to assets through a divorce or bankruptcy scenario. Pre-nuptial and cohabitation agreements are prevalent tools for addressing a divorce scenario and, of course, trusts are a classic asset protection vehicle generally. Although they do still have a role to play in certain circumstances, it is important to remember that their tax treatment can make them unattractive. There is therefore renewed interest in alternative vehicles such as family investment companies and, in particular, family limited partnerships. Whilst complicated to establish and somewhat unwieldly and costly to operate, the tax treatment is currently less prohibitive than that which applies to trusts and they are often worth considering.
It is important not to overlook available reliefs and exemptions from IHT. Business Relief at 100% can apply to qualifying assets which have been owned by the deceased for at least two years by the time of death. It is increasingly common for individuals to invest in portfolios which are specifically designed to attract this sort of relief from IHT. This can be a very sensible planning tool, especially for elderly individuals who perhaps do not have a realistic prospect of surviving the seven-year period if they were to make a lifetime gift. Of course, Business Relief may not always be available and there is always the possibility that it could be restricted or abolished completely in the future. If it can be taken advantage of now, it makes sense to do so.
The option of making regular gifts out of surplus income is well worth considering as, if set up correctly, the current exemption from IHT means that there will be no IHT implications of the gifts at all.
For overseas individuals who are not UK domiciled, it is always sensible to ensure that the range and value of assets which they retain in the UK is kept as limited as possible.
Of course, it is worth emphasising that it is only the net value of assets which is potentially subject to IHT. Consequently, borrowing or the use of loans can be a legitimate and effective way of mitigating an IHT liability. That is certainly the case in relation to the acquisition of residential property with a standard commercial mortgage. However, it can also be effective when an equity release arrangement is put in place in respect of a property, even many years after its acquisition. That said, it is easy to fall foul of the strict rules which curtail the deductibility of certain loans for IHT purposes
Overall, there is a palpable sense that IHT is an unfair tax which also hinders the next generation and a growing feeling that families need to be proactive about their financial planning. Of course, IHT mitigation should never be an end in itself and it is important not to over-divest oneself of assets. In many ways, spending money and having a comfortable lifestyle is the most effective and enjoyable IHT planning strategy!
