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Elastic bands

This tax year, 2007-08, has been a vintage year for inheritance tax aficionados.

Inheritance tax is not going away. It becomes more significant each year. The take for the first nine months of the 2007-08 tax year was £2.949bn, a 10 per cent increase over the equivalent period in 2006-07.

On April 6, the inheritance tax nil-rate band will rise to £312,000, an increase of 4 per cent on the current year but this is not the biggest change to affect IHT this coming year.

In his pre-Budget report, the Chancellor said that, with effect from October 9, 2007, it would be possible for spouses and civil partners to transfer their unused inheritance tax nil-rate band to a surviving spouse or civil partner for use on their death. This is not, as was claimed in some quarters, a “doubling of the nil-rate band” but the proposals have been generally welcomed.

A transferable nil-rate band arises when one party to a marriage or civil partnership dies and the portion of his or her estate chargeable to inheritance tax (after exemptions and reliefs) is less than the nil-rate band at time of death.In other words, part of the nil-rate band is “unused”.

Assuming the current proposals become law, this unused portion can now be transferred to the surviving spouse or civil partner and used in calculating the inheritance tax liability on the second death.

The transfer works by looking at the proportion of the nil-rate band unused on the first death (not the absolute amount unused) and applying that proportion to the nil-rate band available at the time of the second death.

The opportunity to avail of a transferable nil-rate band will apply where the surviving spouse or civil partner died on or after October 9, 2007. It will not matter how long before that date the first death occurred, although there will be some minor computational complications where the first death occurred during the estate duty regime (that is,before March 21, 1972).

It should be appreciated that the transferred nil-rate band is only available on a death. It cannot be used on the occasion of lifetime chargeable transfer by the survivor.

The advantage of the transferable nil-rate band is only available once. Where the survivor has remarried, the transferable nil-rate band is restricted in value to that available on the survivor’s death.

The executors of the survivor have to make a formal claim for the transfer. Such a claim must be made within two years from the end of the month in which the survivor dies.

There may be a practical problem in computing the available nil-rate band on the first death, particularly where that death has already occurred. Records of lifetime transfers may not have been retained and the reconstruction of a transfer history could be timeconsuming and involve significant expenditure on professional assistance.

It goes, almost without saying, that the proposals will only help those couples who are married or in civil partnerships. Those in less formal relationships will be unaffected by the changes.

The proposals will not excite the Misses Burden currently seeking a declaration from the Grand Chamber of the European Court of Human Rights that the UK inheritance tax code, and in particular the availability of unlimited spouse exemption, discriminates against single people and is consequently a breach of the European Convention on Human Rights.

If the sisters win, it is possible that significant chunks of the UK inheritance tax code, including provi-sions enacted to permit transferable nil-rate bands, will be affected.

It may be still be desirable to use nil-rate band will trusts and forego the advantages of transferable nil-rate bands. This might be appropriate where:

  • Capital appreciation in the trust is anticipated to outstrip future increases in the nil-rate band;

  • It is desired for non-tax reasons (for example, potential family disputes, financially unsophisticated beneficiaries) to adopt a flexible trust structure;

  • There is a wish to protect the family home from future liability for care fees.

    Action required nowMany of these changes are going to come in to force in the future but there are some changes that need to be taken into account now.

    Trustees of interest in possession trusts and accumulation & maintenance settlements which were already in existence on March 22, 2006, have until April 5, 2008 to reorganise the trusts while retaining the benefits of the benevolent pre-March 22, 2006 IHT rules.

    Interest in possession trustsIIP trusts in existence on March 21, 2006 will generally continue to enjoy the tax treatment offered by the old regime so long as the interest in possession beneficiary(ies) remain unchanged. If however, the interests are varied, then the trust will fall within the relevant property regime.

    However, where interests in possession are varied before April 6,2008, the old regime will continue. The “disappointed” beneficiary must be excluded from all benefit under the trust (otherwise there will be a gift with reservation).

    A&Ms in existence on March 21, 2006 will fall into the relevant property regime on April 6, 2008 unless the trust is amended to provide that beneficiaries become absolutely entitled to capital on attaining age 18.

    An alternative is to change the terms of the trust so that a young person’s trust is established. Under the terms of a young person’s trust, the beneficiaries become absolutely entitled to capital after attaining age 18, but before attaining age 25.

    YPTs will suffer an IHT charge – similar to the charge on a relevant property trust – on a beneficiary becoming absolutely entitled.

    As the maximum life of a YPT is seven years, the maximum IHT charge will be (7/10) x 6 per cent = 4.2 per cent. This charge will be proportionately reduced should a beneficiary become absolutely entitled before that age.

    Reorganisation may not be necessary where the amounts involved are not expected to exceed available nil-rate bands or where maintenance of the existing structure is desired for non-tax reasons – but specialist advice should be taken before any decision is executed.


    David died on December 1, 2007. He left £150,000 in total to his three children equally and the remainder of his estate to his wife Amanda. Amanda died on November 30, 2008 leaving an estate of £1mm.

    At the time of David’s death, the nil-rate band was £300,000. Half of it was absorbed by his non-exempt transfers, leaving half unused.

    On Amanda’s death, her executors can avail of her nilrate band, £312,000 together with half a 2008-09 nil rate band transferred from David (£312,000 / 2 = £156,000)

    The liability on Amanda’s death is thus:

    Estate £1,000,000

    Amanda’s nil-rate band £312,000

    Transferred nil-rate band£156,000£468,000

    Chargeable to tax at 40%£532,000

    Tax £212,800


    Arthur established a flexible interest in possession trust on September 9, 1998 with a gift of £350,000. The interest in possession beneficiary was his daughter Olivia.

    Arthur’s gift was a Pet – now exempt as seven years have passed.

    Olivia is a tax barrister and has amassed considerable personal wealth. She does not want the trust fund to be included in her estate for IHT purposes.

    She asks the trustees to exercise their power of appointment in such a way as to give the interest in possession to her daughter Jan. The trustees are amenable to this.

    The trustees’ power is exercised on March 1, 2008 and not only is the interest in possession given to Jan but Olivia is excluded from any possible benefit from the trust.

    The trust fund was valued at £700,000 on 1 March 2008.

    Olivia has made a Pet of £700,000 and the trust fund is treated as being in Jan’s estate.

    The trust does not fall within the relevant property regime.



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