Inheritance Tax Planning
Inheritance tax and lifetime planning
The broad aim of lifetime planning from an inheritance tax (IHT) perspective is to organise a person’s assets during their lifetime in such a way as to minimise the future IHT charge on death. This may be achieved in a number of different ways and a major part of lifetime IHT planning is lifetime giving so as to reduce the value of the estate owned on death.
Lifetime IHT planning can also involve making or reviewing a person’s Will. Where the planning involves a combination of lifetime gifts and structuring a Will, the two aspects should not be considered in isolation.
Lifetime planning involves:
- consideration of the full extent of your assets, previous gift-making history and family circumstances
- deciding on your needs and objectives and consider the best way in which these can be met
- ensuring the planning remains suitable in the light of changes to your circumstances and changes in taxation
The main IHT exemptions for lifetime giving are:
- the annual exemption
- small gifts exemption of up to £250 per individual donee
- exemption for lifetime gifts out of surplus income, ie the ‘normal expenditure out of income’ exemption
- gifts made in contemplation of marriage or civil partnership
IHT exemptions and reliefs on death
There are many IHT exemptions and reliefs which apply on death.
Assets left by Will or on intestacy to the deceased’s spouse or civil partner qualify for the spouse exemption from IHT, although this may be limited where the surviving spouse or civil partner is not UK domiciled and has not elected to be treated as UK domiciled.
Assets left by Will to a charity or other exempt body may qualify for exemption from IHT.
There is also an IHT exemption for estates where the deceased died on active service. This exemption applies to individuals who die on active military service, as well as emergency services personnel and humanitarian aid workers.
The IHT reliefs available on death include:
- agricultural property relief (APR)
- business property relief (BPR)
- woodlands relief
Once the available exemptions and reliefs have been applied, any available nil rate band (NRB), transferrable NRB (TNRB) and residence NRB (RNRB) may be applied to reduce the value of the estate chargeable to IHT.
Wills and tax planning
A key element of any individual’s tax planning is a Will. Without a Will, the scope for mitigating tax that would otherwise arise on death, is reduced. While it is possible to alter the provisions of a Will or intestacy and thereby improve tax efficiency following death.
Foreign assets and domicile
An individual’s domicile can offer tax planning opportunities. In particular, where an individual is not UK-domiciled or deemed domiciled, effective lifetime planning may secure exemption of certain assets from IHT.
A ‘pilot trust’ is a lifetime trust set up with a nominal amount (typically a small sum of cash such as £10), which does not become active until further funds are added subsequently. It is very common to establish a trust in this way. The initial sum gets the trust started so that it is ready to accept the main assets at a later date.
Historically, setting up a series of pilot trusts was a popular IHT planning technique to divide assets between several settlements which each have their own nil rate band. This planning sought to minimise future IHT charges on the trust assets on ten-year anniversaries and when assets leave the trusts.
However, such planning is no longer effective following the enactment of Finance (No 2) Act 2015, which introduced new legislation in IHTA 1984, ss 62A–62C. The effect of these new provisions is that individuals will no longer have the advantage of multiple nil-rate bands by creating multiple trusts, but they will be able to settle property up to the value of the nil-rate band into a trust every seven years. The change to the tax treatment of pilot trusts is part of the increasingly wide-ranging anti-avoidance rules (see below).
The new provisions apply to all charges arising on or after 18 November 2015 in respect of relevant property trusts created on, or after, 10 December 2014. To prevent forestalling, they also apply to relevant property trusts created before 10 December 2014 where additions are made to more than one trust on the same day.
Where the testator dies before 6 April 2017, the rule about additions to existing trusts does not apply to a Will executed before 10 December 2014, or where such terms have been carried forward to a later Will. This allowed taxpayers sufficient time to change their Will without being caught out by the new provisions.
When undertaking any form of tax planning, practitioners and taxpayers need to be aware of the growing raft of anti-avoidance provisions.
A gift with reservation of benefit (GROB) occurs when an individual disposes of property but the recipient does not take possession of the property or does not enjoy the property to the exclusion of the donor. A classic example of this would be a parent passing the family home to their adult child, but continuing to live alone and rent-free in the property. Such a gift would be a GROB, and the value of the home would remain in the parent’s estate for IHT purposes. There are a number of exceptions to the GROB rules (such as where the donor pays a full market rent for any enjoyment of the property or where the pre-owned assets tax or POAT applies).
There are a number of other anti-avoidance measures in the legislation relating to IHT or which affect how other taxes interact with IHT, including restricting CGT hold-over relief on gifts to certain types of trust, applying POAT (which is an income tax) or the IHT excluded property rules. The disclosure of tax avoidance schemes (DOTAS) and general anti-abuse rule (GAAR) must also be considered in the context of IHT planning.