Homer says ‘Doh’ to DOTAS

The recent announcement that IHT mitigation via transfers into trust is likely, in future, to be included in the DOTAS (Disclosure of Tax Avoidance Schemes) regime was received with some trepidation by advisers accustomed to assisting their clients with IHT mitigation.  In reality this proposal by the Treasury and HMRC is nothing more than was expected following the blocking in the Finance Act 2010 of two specific trust schemes which dramatically (and arguably artificially) reduced the value of assets gifted into trust.

Now that the coalition has nailed its IHT colours to the mast by freezing the Nil Rate Band (NRB) for 5 years it is backing this, much harsher than heralded, approach with supporting legislation to plug as many leaks as possible.  The consultation document introducing the DOTAS requirement does not seem unreasonable in the circumstances and certainly does not impact on most conventional IHT mitigation work using the various trust schemes which are widely available.  What is being suggested as far as disclosure is concerned?

The new rules will not require any existing schemes well known to HMRC (such as flexible and discounted gift schemes) to register because they are being ‘grandfathered’ in to acceptability.  Looking forward it will only be new trust schemes which (a) involve chargeable transfers beyond the donor’s current allowances, including any unused NRB – in other words where property becomes ‘relevant property’ – AND, (b) which involve an ‘advantage’ in relation to the IHT entry charge – an advantage being defined as the avoidance, reduction or deferral of a charge – which have to be registered.

This avoids any requirement to disclose straightforward situations where an individual simply transfers property into trust and relief or exemption is available in the same way it would have been had the property been gifted directly to another individual.  This is generally the case with most of the current crop of trust-based mitigation arrangements.  The proposals are only at the consultation phase so it is too early to be unequivocal about the requirements for plans launched in the future.  However the grandfathering facility will ensure that all existing plans of which HMRC are aware – and future plans which adopt the same principles as existing plans – will be quite safe.  In fact this is the nearest we have ever come to having a blanket approval from HMRC of all existing plans.

What does this mean for tax planners and their clients going forwards?  Well we should start by considering the position of taxpayers who have been relying on either the indexation of the NRB or, more recently, the Tory commitment to a transferrable £1m NRB, to lift them out of potential liability.  I think this is bad news for such optimists.  It is clear that a Lib-Con coalition government has a rather less generous approach to inherited wealth than that promised by the Tories.  Freezing the NRB for 5 years when the knock-on impact of ‘quantitative easing’ (printing money) is likely to be rampant inflation down the line is really quite serious.  I think most readers will agree that inflation is already rearing its ugly head no matter what interest rates are doing.  Looking further ahead there has been plenty of speculation that the coalition might well continue through until another term of government – especially if next year’s referendum delivers backing for the Alternative Vote electoral model.  This will mean a continuation of a cautious approach to raising IHT allowances.

The following chart shows the value of the NRB compared with assets starting at the same value rising with inflation.

This means that taxpayers currently on the cusp of a potential IHT liability will be severely disadvantaged by the freezing of the NRB – assuming inflation of 4% over the next 2 years followed by 8% for 3 years.  Readers may doubt such a scenario but not if they are German historians!  In the situation shown, a potential liability of nil at the beginning would become a liability of some 40% of £117,814 (tax of £47k+) after 5 years, simply resulting from inflation.

This brings me on to a favourite phrase of my IHT planning friend, Nick Chadwick, who constantly reminds taxpayers to ‘hope for the best but plan for the worst’.  This has served him well over several decades of capital tax planning and, I suspect, he will be proven right yet again!

So the message here is that all those advisers and their clients who, since 2008 when they were given false hope by the posturing of Alistair Darling and George Osborne, have put off their IHT mitigation planning, have no time to lose.  Since many of these people are relying on multiple use of the NRB, every day is important in clocking up those 7 year inter vivos periods.  Remember – hope for the best but plan for the worst – start your IHT mitigation planning today.

Paul Wilcox,
Chairman & Technical Director, WAY Group
9th August 2010

Posted on 9th August, 2010 | Tags: HMRC, IHT Mitigation, Nil Rate Band |
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As the smoke clears we begin to see the flames

So the phony campaign is now over. After four weeks of argument as to whether £6bn or £10bn of cuts now or next year would be the right way to deal with a £163bn deficit, the election delivers a government and a collection of policies that nobody voted for. Whilst the election seemed to take place in a surreal parallel universe, we now have a real, if unexpected, government and we are beginning to see the truth behind the false debates. A painful fiscal pinch is beginning, as taxes are hiked and public spending cut.

One of the first casualties of the re-emergence of the real world is the Conservative party’s manifesto commitment to increase the IHT nil rate band to £1m. The Tories had clung on to this pledge despite the best efforts of Ken Clarke, in their own ranks, and the wider weight of common sense, that said the policy was not a good or affordable priority. Mr Cameron hinted in the final leader’s debate that the increase would not be top of the agenda in the event of an outright Conservative victory. In any case, events have now moved on and the policy has been kicked firmly into the long grass. The nil rate band is £325,000 and we will either stay frozen as per the outgoing government’s plans or at best might enjoy some annual indexation.

The killing off of this policy is in many ways a good thing for financial planners. The move restores a good amount of certainty to the market: We know IHT is here to stay and we know at what level it bites. Some planners will have agreed a “wait and see” approach with clients who would be taken out of the IHT net by a £1m nil rate band. The difficulty facing clients in such a position was how long would they have to wait until they knew that the nil rate band was to be raised high enough? Well, we haven’t had to wait long and now we have seen. It is therefore time to revisit those clients and to get on with the business of planning for IHT mitigation.

Whilst the position for IHT is much clearer, we have a little longer to wait to know what changes the new government will make to lifetime taxes. We know the news will not be good, and we also know that we only have to wait until the next Budget is delivered by new Chancellor Osborne on 22nd June. The outgoing Labour government had already brought in a new 50% rate of Income Tax and we know from the coalition agreement that the new government is to make CGT bite harder upon non-business assets. At present details are scant regarding the level of the rate, the exemptions and the date of introduction, so we will have to hold our breath for a few weeks more until Budget 2010.2.

Frequent changes to the tax regimes are of course very unwelcome for long-term investors and their advisers. The current flat rate CGT regime only dates back to 2008 and the previous (taper relief) regime only survived about 10 years. Such upheaval becomes a great hindrance for individuals who are trying to put in place a long-term investment strategy. The current changes to taxation will of course mean that advisers will have to, once again, review the provisions in place. In the current climate it may be hard to find a safe haven from a demanding Treasury however. So what strategies are available to advisers upon reviewing their clients’ portfolio options?

The first thing to keep in mind is that whilst there may be choppy waters ahead, in the longer-term we may find that we just have to get through a difficult but short period where taxation rates are unusually high. One would hope that in a few years time healthy growth will have returned to the economy and the deficits will be under better control. The first option may therefore be to just ride out the storm, keep investments in place and wait until a more favourable environment allows profits to be taken with less penalty. This will suit many long-term investors who do not rely on encashment of investments to meet income needs or shorter-term objectives.

Whilst the ultimate drawing of profits may be able to be delayed, most investors will want their portfolios to be actively managed and for their portfolio asset allocations to be adjusted from time to time. It is clearly unhelpful if considerations of the tax chargeable events that would be generated have to interfere with such activity. The answer, of course, is to ensure that such activity takes place within a suitable investment wrapper. Fund of Fund portfolios will therefore be very useful where it suits the client to be ultimately exposed to CGT on the realised profits, as they deliver cost effective active management within a Unit Trust or OEIC wrapper. Where an Income Tax environment is preferred a life insurance bond will provide similar shelter.

Investors with funds in trust, such as WAY Inheritor Plan holders, will now have the forthcoming changes to the CGT regime to absorb on top of the recent Income Tax changes. Holders of the classic Unit Trust versions of the plans already benefit from the inherent tax efficiency of the nil-yielding WAY Global Portfolio funds of funds. As the choice between the CGT and Income Tax environment becomes more critical it will also be good to know that WAY, uniquely, offer access to their funds within the Inheritor Plans both as direct Unit Trust/OEIC investments and within offshore bond wrappers.

The most flexible variants of the plan such as The WAY Flexible Inheritor Plan, The WAY Gifts from Income Inheritor Plan and the WAY Duo Inheritor Plan can also perform a key role in adapting a client’s overall investment strategy to the new tax regimes. As well as the choice of tax environments identified above, these plans also allow the trustees to determine whether or not the flexible reversions take place. Thus the adviser can recommend that more or less (or none) of the client’s income needs are provided for by the Inheritor Plan and balance the reversions with drawings (or not) from other sources. This judgement can of course be made year by year and respond to changing tax regimes and client needs – an option that is not available where a typical discounted gift scheme is used.

In summary then we can present our manifesto for a new government:

• Now is the time to revisit IHT planning that was put on hold
• Review tax wrappers but don’t chase the tax tail – it may be better to ride out the storm
• Make sure investments have the best income / growth profile for the client
• Shelter active management within a suitable wrapper
• Maximise flexibility – only choose plans that can adapt to client needs as the winds change

Welcome back to the all too real world!

Yours sincerely,
Mark Benson TEP CertPFS
Technical Manager, WAY Investment Services Limited
28th May 2010.

References:
1. Preliminary Budget Report, Data & Statistics – ‘Budget 2010, UK Stationery Office, HC 451, 24th March 2010′
2. Labour, Conservative & Liberal Democrat pre-Election Manifestos – May 2010

Posted on 28th May, 2010 | Tags: Coalition Government, IHT Mitigation |
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Don’t sit on the fence – you’ll only get splinters!

With at least one budget and at least one election in prospect for 2010, WAY Investment Services Ltd’s Technical Manager Mark Benson says that there is no time to delay before putting in place IHT mitigation plans for your clients. Given the average gestation period of an IHT case from agreement to settlement and with the (first) budget possibly a month away, the time to start is really today.

A recent IFA enquiry caused me to open the file of a WAY Inheritor Plan settled in February 2004 with an investment of £1,100,000. A number of thoughts sprung to mind such as how growth of over £300,000 in the investment value since then is safely out of the estate of the settlor and thus not subject to IHT on their death, and how in a year’s time the whole trust fund should also fall out of the estate at the end of the 7 year inter-vivos period. The overriding thought that came to mind however was “£1.1m transferred into a flexible trust – those were the days!” Whilst cases of such a size are unfortunately rather rare, it is interesting to reflect on how easily planning could be put in place for such amounts prior to the surprise change to the IHT rules in the 2006 Budget, which shut the door on PET based transfers to discretionary or interest in possession settlements. Nowadays unfortunately our settlor could not put much more than the amount of growth they have enjoyed into trust without breaching the nil rate band and generating a lifetime IHT charge of 20%.

There is a cautionary tale here as 2010 promises to be something of a white knuckle ride for tax planning as the political parties try to balance the challenge of dealing with the financial crisis with the desire to be generous in their manifesto promises ahead of the election. What is certain is that we must have one budget and one election this year. However, whilst May 6th remains a solid favourite for the date of the election – in particular since local elections are already scheduled for that day and cash-strapped local authorities could do without paying for two polls within a few weeks – the odds on the Conservatives as favourites to win that election have lengthened somewhat as the opinion polling shows a narrowing of their lead. With the likelihood of a change of government and the possibility of a hung parliament we cannot discount the possibility of at least one more budget and perhaps one more election this year.

When considering the dismal state of the nation’s finances and the unconvincing emergence from recession, it would seem that there is one thing we can be certain about: The forthcoming budget(s) will make the tax code more hostile to our clients’ income and capital. It is possible that the availability of trust based IHT planning might be attacked itself, akin to the changes introduced in 2006. Moreover there is also the strong possibility that an unfavourable change to the rate of income tax, CGT or IHT would dilute the savings on offer. Some may argue that the Conservatives have pledged to increase the IHT nil rate band to £1m in the first term of a prospective government, however we feel that given the fiscal challenges that lie ahead this might be a policy that remains an aspiration only. Any prospect of a first term introduction surely lies nearer the last year of the parliament.

The prospect for the next few years is that IHT will remain a challenge to succession planning, and if another aggressive attack on the use of trusts is made we might in time look back on the present as another golden opportunity that has passed. Where clients are hesitant to put plans in place due to the uncertain future, their minds can be put at ease by the recommendation of flexible arrangements such as the WAY Inheritor Plans. Our plans can adapt to the client’s changing circumstances by granting flexible powers to the trustees and also to changes to the rates of lifetime taxes by (uniquely in the market) offering access to collective investments and offshore bond wrappers. Furthermore, since clients are limited to investments within the nil rate band it is necessary to start at a younger age and (hopefully) make repeated use of the nil rate band over the years to come.

At some point in 2010 a government will face up to the reality of our financial crisis and present the bill for the remedy to taxpayers.  Those still sitting on the fence at that time will suddenly feel the splinters!

Mark Benson, TEP CertPFS,
Technichal Manager, WAY Investment Services Limited.
19th February 2010.

Posted on 19th February, 2010 | Tags: IHT Mitigation |
Comments: One Comment

IHT – avoid but don’t evade

It has been a frenetic few years for IHT mitigation.  Pre-owned assets tax (POAT) in 2004, the taxation of trusts in 2006, false promises by the Tories in 2007 and a major fall in asset values in 2008, have all kept taxpayers and financial planners well and truly on their proverbial toes.

Now Alastair Darling’s pre-budget report (PBR) has thrown yet another cat amongst the pigeons.  The double whammy this time is the removal of a previously legislated increase in the Nil Rate Band/NRB (under the Finance Act 2007, the personal nil rate band was due to rise to £350,000 in April 2010, but it will now stay at £325,000) and an attack on some specific strategies which have been using legislative loopholes relating to trusts.

Some commentators have speculated as to whether Darling’s comments in the PBR, about future legislation regarding trusts, spell the end for IHT mitigation as we currently know it.  In fact HMRC has no desire to upset conventional IHT planning using long-accepted trust-based solutions – all of which were brought into the taxable ‘relevant property’ regime in the Finance Act 2006.

HMRC and the Treasury remain fair and even-handed in their approach to collecting IHT.  All absolute gifts, at any level, remain potentially exempt transfers (PETs), whilst chargeable gifts to the full extent of the taxpayer’s NRB can be made every 7 years without any tax being incurred.  Furthermore regular gifts of any amount, from surplus after tax income, are immediately exempt.  All of these facilities remain, as do the various long-established trust schemes that have been available over the last decade and more.  It is flagrant abuse and the exploitation of inadvertent loopholes which is being attacked in forthcoming legislation.

As Nick Chadwick (well-renowned architect of some of the signature IHT mitigation schemes of the last two decades) recently explained to me “the acceptable spirit of tax avoidance has to reside within the house of fair play as secured in case law. Thereby evolving rules, where the law is inevitably silent on many issues, offer no protection from retrospective legislation at worst and swift blocking at best. HMRC will give confirmation of schemes that fall within the acceptable spirit of IHT avoidance. Failure to obtain this will be fatal for some providers, sooner or later”.

There are many conventional trust arrangements available, now and for the foreseeable future, which permit taxpayers to efficiently remove assets from their chargeable estates, whilst maintaining suitable ongoing flexibility for both themselves and their beneficiaries. There is therefore little need to seek out schemes which operate outside the confines of acceptable tax mitigation.

By far the bigger problem is the inertia suffered by many potential IHT payers who still seem to think this tax will somehow either mysteriously disappear or their estate values will be overtaken by the Tories enhanced NRB.  It should be clear to everyone at this point that for the foreseeable future there will be no appetite for either reducing or eliminating the impact of what is still seen as a wealth tax.  Not only does the ongoing budget deficit make it a non-runner but current public ambivalence toward MPs, bankers and others perceived as wealthy and privileged makes the easing of Inheritance Tax politically unthinkable.

George Osborne recently admitted on the Andrew Marr show that the Tory ambition to substantially raise the NRB was now pencilled in for later in their term of office.  But if New Labour can reverse actual enacted IHT legislation after only 2 years we surely know what expediency to expect from the Tories during their own turn in government.

With asset values likely to continue their recovery over the next year or two the business of carefully planned and executed IHT mitigation (particularly taking full advantage of somewhat depressed current values) is likely to blossom once more.  But be warned; HMRC will take an increasingly dim view of those attempting to exploit schemes operating on principles which rely on “reading between the lines” of existing tax legislation and are against the spirit of the law.

The two recently closed loopholes related to the purchase of (exempt) interests in excluded property trusts and the absolute gift (and therefore potentially exempt transfer) of retained reversionary interests within trusts. 

The first of these permitted a purchaser to buy (exchange taxable cash for) an exempt family interest in an exempt trust, thereby removing any future potential IHT charge from that value.  The second loophole involved the immediate and absolute gift of a retained reversionary interest which had already benefited from a discount to its value.  In this arrangement the taxpayer used a two step process to convert an otherwise chargeable gift into a combination of an initial small chargeable gift swiftly followed by a larger potentially exempt transfer.

In conclusion then, with the Tories recently announcing, that based on their analysis of ONS statistics in the newly published ‘Wealth in Britain’ report, some 4 million taxpayers are still likely to incur an average IHT bill of £60,000 (Guardian newspaper 29 December 2009) there is no time to lose.  Help your clients avoid this heinous tax by engaging in good down-to-earth IHT planning including, where necessary, the use of one or more of various highly-effective but conventional trust-based mitigation arrangements which remain available.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 22nd January, 2010 | Tags: IHT Mitigation |
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Darling incentivises the wrong investors

Margaret Coles is a fit and healthy 73 year old widow.  Her late husband used his Inheritance Tax Nil Rate Band by leaving a holiday property to his children. She remains fairly well off with a house, various investments including an ISA portfolio, a healthy sum on deposit and two pensions.  Her son, Raymond, helps his mother to manage her financial affairs and has suggested she take immediate advantage of the new ISA limit for older persons announced in Alastair Darling’s recent Budget. He thinks there will be a stockmarket recovery within the next few months and believes she should capture the maximum benefit by adding to her substantial ISA portfolio by investing her 2009/10 ISA allowance now.

The primary benefit of placing investments within an ISA ‘wrapper’ is that they are then permanently exempt from Capital Gains Tax (CGT) and from higher rate Income Tax. But how beneficial are these concessions in general and, in particular, to Mrs Coles? Anecdotal evidence from advisors indicate that a high proportion of ISA holders could easily hold and manage their investments perfectly well and effectively tax-free by utilising their existing annual CGT allowances. Most ISA investors, such as Mrs Coles, are not higher rate Income Tax payers and so will not suffer any further tax on dividends/distributions. So, are they needlessly investing in ISAs?

The only real beneficiaries of these tax-exempt investments are either:

•  (a)those taxpayers who invest in cash or fixed interest investments (not equities or mixed funds) and who benefit from exemption from standard rate Income Tax on those specific investments, or
•  (b)higher rate taxpayers who are already utilising their annual CGT allowances.

For these two groups the continuing concessions are very good news. In particular young, dynamic, higher-rate taxpayers saving on a monthly basis into high growth funds for school fees and other medium term commitments, and doing so with the added benefit of pound cost averaging, are likely to benefit most. Whilst Mrs Coles is interested in boosting her flagging income, which has fallen with interest rates over the last year or so, she is certainly not in the second group. Even in her search for income the benefits of Income Tax relief on currently miniscule yields are not great.

In reality the Treasury is actually misleading naïve investors into thinking there are substantial tax benefits in retaining ISA portfolios into one’s dotage, while simply ensuring that it can continue to collect large amounts of IHT from the unwitting and unprepared elderly investor. Arguably investors from their mid-sixties onwards who believe they will have an IHT liability should no longer be holding ISAs and certainly should not be buying more. What so many of them do not realise is that they will suffer a punitive IHT sting at death, whereby at the top end they and their families potentially lose a colossal 40% of their hard-earned savings. This loss completely dwarfs the often marginal annual tax benefits resulting from the ISA wrapper.

So what can Mrs Coles do to avoid IHT on her accumulated savings? The answer is simple, she should encash her ‘tax-free’ ISA and supplement the proceeds to a total of £325,000 by selling a portion of her stockmarket investments and then make a gift of the total sum to her chosen beneficiaries via a flexible reversionary trust. Although gifts into such trusts constitute an IHT taxable transfer there will be no tax so long as the gift is within the current Nil Rate Band for IHT – £325,000 per person.

Such gifts then fall out of account after 7 years and so there is an opportunity for each taxpayer to make gifts up to this level every 7 years. Mrs Coles has a life expectancy of some 13+ years and so should easily survive the first 7 year inter vivos period and might even survive a second. Even should she not survive to see her gift fall out of account, any growth (recovery) enjoyed by the gifted assets will occur outside her chargeable estate.

A good flexible IHT gift trust will offer Mrs Cole’s trustees extraordinary ongoing flexibility over the trust whereby she can be supported with regular or occasional ‘reversions’ to top up her conventional income. In her case she will certainly need to replace income from her surrendered ISAs (Capital Gains Tax exempt) and part of her share portfolio (which she was able to dispose of within her annual CGT allowance and without incurring Capital Gains Tax).  Since the assets will have been placed within a gift trust then it is proper that drawings or reversions from the trust should be made available to replace that sacrificed income. The trust wording is sufficiently flexible to also allow the trustees to continue to look after the needs of her children and grandchildren in exactly the same kind of way as before the gift.

Assuming she does live those 7 years then she will have dramatically reduced the potential IHT liability on her death.   Moreover her ‘income’ is maintained and, via her trustees, she retains tremendous flexibility over the future return of funds from the flexible trust.  The table shows that at current levels her family is likely to benefit from a tax saving of some £130,000 which completely dwarfs any conventional’ benefit she is likely to receive from her ISAs.

 

Paul Wilcox
Chairman & Technical Director, WAY Group.

Posted on 24th April, 2009 | Tags: Budget 2009, IHT, IHT Mitigation, Inheritance Tax Nil Rate Band, ISAs |
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A tale of IHT mitigation

John and Frances Greening are facing a major dilemma regarding the death of Frances’ widowed mother in January 2008. Frances is the sole beneficiary of her mother’s Will and she was left a substantial inheritance which has unfortunately fallen in value very dramatically in the intervening period. John and Frances have been working their way through the probate process and suddenly realise that they are caught out by the credit crunch from settling the estate in the most effective manner. They are having difficulty raising funds to pay the Inheritance Tax in order to achieve the very probate which will allow them to sell assets to pay the tax. The assets in question have fallen so much in value that the effective rate of tax they could finish up having to pay is much higher than the 40% normally payable upon death. Frances’ father died nine years ago and utilised the whole of his Nil Rate Band.

There are three different problems here which combined are putting this couple in a very difficult position indeed. The challenges are:

• Mum lived in the suburbs of London in a house valued (at the date of death) at about £1.3 million. In addition she had other, financial, assets totalling a further £0.4 million. Based on a Nil Rate Band of £300,000 (as at January 2008) this would incur IHT of £560,000. So they have to find a lot of cash to pay the IHT in order to be able obtain probate to sell any assets.
• The value of the house has probably fallen by some 30% since her death and the value of the share portfolio (which was weighted towards banks with a generous exposure to builders and mining stocks) has fallen by nearer 50%. The theoretical values are therefore now £910,000 for the house and £200,000 for the shares. The house is unlikely to be saleable since similar properties in her area are just not moving. The IHT based on these lower values would be £324,000 – a huge £236,000 less than on the death values.
• There is an HMRC concession whereby falling asset prices can be re-based for probate purposes but only if they are sold by the executors within a specified period after death – 48 months for property and a challenging 12 months for other assets. To sell, the executors must have obtained probate. This is only achievable if the full tax is paid in advance and a re-base claim then made later when the assets are sold at lower prices.

The Greening’s have less than 2 months to sell the shares to establish a lower re-base value. If they manage to achieve this they will probably be well advised to re-invest any proceeds in Frances’ name straight away, to make sure they do not miss any subsequent recovery. But this assumes that they achieve probate and to do so they must pay any tax due. With Capital Gains Tax now at 18% it is better for any recovery to happen in Frances’ name rather than with the executors where any recovery will fix the IHT on the gain at 40%.

Fortunately, there is also the property instalments concession which they can use to avoid paying the full tax on Mum’s house immediately. They will have to pay 10% of any tax due to achieve probate and can then pay the remainder in another nine annual instalments with interest. This means that they can take their time selling the property and to claim any re-basing (if the house does not climb back above January’s value) so long as they sell by January 2012.

So what does this now all look like in terms of what they must do before January to achieve the optimum results – remembering that probate can take some time even once the application is in and the tax is paid? They will have to pay the full tax on the ‘other assets’ and the first instalment of tax on the property (plus a little bit of interest which becomes payable from 6 months after the date of death) before they can have access to the shares to sell them before the 12 months is up. They must work very fast to get the probate application in to make sure they get probate in time.

The calculation looks something like this:
Total Assets (£1.7m) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (the £560,000 mentioned above). This gives a marginal rate of IHT of 32.94%. This rate is applied to the separate assets, so they will have to pay £131,765 on the ‘other assets’ (32.94% of £0.4m) and £428,235 on the house (32.94% on the £1.3m) but need only pay 10% of this immediately. So to obtain probate they must submit the necessary forms and make a payment of tax on account of £174,588 (£131,765 plus £42,823).
They have to find this cash from somewhere and in the present climate that will not necessarily be easy because there are no assets available to charge to a bank (until after probate). Assuming they can raise this cash, obtain probate in time and sell the shares before the first anniversary of Mum’s death, then they can ask for the share valuations to be re-based onto an actual basis. They will then be able to obtain a partial refund from HMRC following a new calculation, as well as being able to repay the bridging finance from the share proceeds.

The new calculations will then look like this:
Total Assets (£1.5m now that the share values have been re-based) less the Nil Rate Band (£0.3m) at 40% gives the total tax payable (£480,000). This now gives a marginal rate of IHT of 32%. This rate is applied to the separate assets, so they should have paid £64,000 on the ‘other assets’ (32% of £0.2m) and £416,000 on the house (32% on the £1.3m) of which only 10% was payable immediately. So their initial tax bill should have been £105,600 and not the £174,588 they actually had to pay on account. So they should receive a refund of almost £69,000 at that point.

These potential calculations are repeated all over again if and when Mum’s house is sold for less than the original probate value. Again, there is some sense in pursuing this because John and Frances will receive an IHT refund at 40% on any reduction whilst only suffering CGT at 18% were they to reinvest and enjoy an increase in property prices.

This whole scenario simply underlines the benefit of removing assets from one’s chargeable estate early enough to avoid all of these probate challenges, quite apart from the general benefits of avoiding as much of this heinous tax as possible.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: IHT Mitigation |
Comments: One Comment

IHT and the Glenrothes effect

Labour’s surprise victory in the Glenrothes by-election (7th November 2008) has rekindled that party’s hopes of achieving re-election sometime in 2010. The reasons for the unexpected vote of confidence in Labour probably include Gordon Brown’s new reputation as financial crisis Superman as well as the apparent policy vacuum from Cameron and his front bench colleagues in relation to the current banking and economic chaos.

There has recently been some question about the future of Inheritance Tax (IHT) planning for Mr and Mrs Average. For a brief interlude the combination of falling house prices, falling stockmarket values and the promise of a couple’s £2 million Nil Rate Band from the Tories seemed to make IHT planning for all but the very wealthy somewhat less urgent.

This view is completely misplaced and has to be challenged because taxpayers need very little encouragement to be completely complacent about a tax which they will never suffer but which brings great difficulty to the next generation. An interesting and extremely difficult by-product of the recent fall in asset values, particularly house prices, is that many taxpayers that have died over the last year or two left taxable assets which have subsequently fallen dramatically in value before they were able to be sold to pay the tax.

Imagine someone having died early this year with a sizeable share portfolio focused on banks, builders and mining companies. They may be required to pay 40% tax on assets which have subsequently fallen in value by 90%. To put that into context the tax on an investment portfolio of, say, £300,000 might be £120,000 (at the full 40% assuming their Nil Rate Band was exhausted elsewhere) and yet the related portfolio may have fallen to only £30,000 in value after the dramatic market falls of the last few months. How can you realise £120,000 of tax from a portfolio worth only £30,000 – what a horrendous side effect of the recent market debacle.

This has been exacerbated for tax on properties where beneficiaries are faced with a market which has not only tumbled but in many cases has become completely static so that properties cannot be sold at all. In both of these cases there is an HMRC concession to re-base the value but it requires a sale of the assets in question by the executors within a set time period (12 months for shares) and only after the full tax has been paid to facilitate probate – so a major cash flow challenge especially in the current banking climate.

This whole new scenario is an added incentive to make sure that assets are transferred outside a taxpayer’s estate more than seven years before their demise to remove the relevance of pre and post death values. If the whole value is beyond the reach of the taxman then no tax will have to be found and therefore there will be no forced sale of assets.

So what chance is there that IHT is a thing of the past for most of us? Shadow Chancellor George Osborne was recently compromised into a confirmation of the impact of Alistair Darling’s moves on transferability of Nil Rate Bands between spouses and civil partners. Transferability combined with the Tories’ Autumn 2007.

Paul Wilcox,
Chairman & Technical Director, WAY Group.

Posted on 2nd February, 2009 | Tags: Glenrothes by-election, IHT Mitigation |
Comments: One Comment