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A consumer&#39s view

The recent landmark decision in the High Court, which found against the Inland Revenue when it tried to block an inheritance tax loophole, throws into sharp relief the urgent need for reform of IHT and the inherent unfairness of this tax.

Perhaps the most disreputable aspect of this case is that there is no doubt that the Revenue has known about the “defeasible life interest settlement” loophole for years. But while it was not widely used – and was not used to shelter the family home from IHT – the Revenue chose not to act.

The Eversden case involved the sheltering of the family home from IHT. Fearing that this loophole, once widely known, would result in a significant erosion of the tax take from IHT, which is largely inescapable if the main or only asset is a property in which you live, the Revenue decided to move.

But why should the tax laws be applied so inequit-ably? The tax take from IHT is now some £2.5bn a year, largely paid by the relatively less well off who have a family home worth more than the £250,000 threshold for IHT but little else in assets.

These people cannot give away the family home and continue living in it, as this is deemed a gift with reservation and does not avoid IHT. The wealthy with free assets and access to sophisticated legal advice pay little or no IHT.

The Revenue has been aware for years of packaged insurance company schemes which take advantage of this loophole. These are marketed by life companies such as Clerical Medical, Norwich Union and Scottish Equitable and involve putting assets into a “defeasible life interest settlement” using the life companies&#39 investment products.

None allows you to put the family home into the trust and continue living in it, so the main source of IHT revenue was not attacked by these packaged schemes.

In essence, a defeasible life interest settlement gets round the gift-with-reservation rule by setting up a discretionary trust and giving the spouse an initial six-month interest in the assets gifted.

The assets are subsequently passed to the children, grandchildren or other beneficiaries but the donor is still entitled to enjoy the income from the assets or, in the Eversden case, continue living in the family home.

The arrangement allows both partners in a marriage to take advantage of the £250,000 nil-rate inheritance tax band while continuing to enjoy income from their assets or remain living in the family home. After seven years, these assets are outside the estate for IHT purposes and they still both have their £250,000 nil-rate band to use on death.

Why the Eversden case is so strong is that the legislation states quite clearly that where the spouse is the initial beneficiary, the gift-with-reservation provisions do not apply. Lawyers believe it is unlikely that the decision will be reversed on appeal, as the law is very clear on this point.

This means there will have to be a change in the law, which could be announced by the Chancellor at any moment, with effect from the date of the announcement. Needless to say, since the Eversden judgment, lawyers and life firms which market these packaged schemes have been inundated with requests to set up similar arrangements for new clients.

It is totally wrong that, effectively, the only individuals to be caught for inheritance tax are those whose main or only asset is the family home while the rich get away with paying nothing. When the Revenue finds itself in the situation that loopholes are effectively written into the legislation, which are tolerated so long as it is only the rich who can exploit them, then it is time for reform.

What is required is a simple piece of legislation which is clear and applies the rules fairly to all – not one rule for the rich and another for the relatively poor. If the sole purpose of an arrangement is to avoid inheritance tax, then the courts ought to be able to look through it and levy the tax as though the arrangement did not exist.

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