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Heavy petting

Last week, in the wake of the silence on inheritance tax in the Chancellor&#39s pre-Budget speech, I considered the prospects for future change to the now relatively well known

IHT regime.

I considered, in particular, the possibility of an increase in the nil-rate band as a fairly simple but effective proposal.

Current best practice on IHT planning for married couples often incorporates consideration being given to a will trust to use the nil-rate band on the death of the first spouse but retain access to the capital to plan for the surviving spouse.

So, any change to the nil-rate band usually generates a reasonable amount of interest among those involved in this market. Given the possibility of a future change – or even a substantial increase – in the nil-rate band, consideration could be given to ensuring that any will trust planning involving the nil-rate band is founded on a wording that gifts the available nil-rate band at death (taking account of relevant chargeable transfers made) rather than a specified figure equal to the nil-rate band current at the time the will or a codicil is executed.

In this way, if the nil-rate band is increased, savings are maximised and, if it reduces, an unwanted IHT liability on the death of the first spouse will be avoided.

It is important, in drafting such a moving nil-rate band clause, to ensure that only so much of the nil-rate band as is available on death after taking into account other transfers on death or within seven years of death, is used.

It remains to be seen whether Labour will eventually introduce (or, should I say, reintroduce) tiered tax rates that increase as the size of the taxable estate increases but this is definitely a possibility and again acts as a stimulant for early lifetime gifts if they can be afforded. Of course, this should be subject to careful consideration of the capital gains tax consequences of gifting.

Gifts that are potentially-exempt transfers give rise to no IHT at the time they are made and there will be no IHT at all if the donor survives the gift by seven years. Even if the donor&#39s death occurs within seven years, provided the donor survives for at least three years, taper relief may apply to reduce any tax charge.

Control over the asset gifted can be maintained by the donor using a trust under which he or she is a trustee. It is worth remembering that, to be a valid Pet within the definition given in section 3 IHTA 1984, the amount given to a trust must either “become settled property” or “increase the value of the settled property”.

In the latter case, the gift will only be a Pet to the extent that it increases the value of the settled property. This can be particularly important in respect of premiums paid under life policies held subject to trust where the premiums (say, because they are funded from capital) are not eligible for the normal expenditure out of income exemption or because they, together with other gifts in the year, exceed the £3,000 annual exemption and the amount of any unused annual exemption carried forward from the previous year.

In this case, taxpayers would be well advised to have contributions paid to a trustee bank account by the settlor and for the trustees to mandate premiums from that account to the insurer. In that way, the property gifted (that is, the funds to meet the premiums) will have become settled property – if only for a short while – within the meaning of section 3 IHTA 1984.

Labour has expressed in the past that it regards the

Pet as a loophole. Therefore, there is at least a possibility that Labour may wish to remove the Pet regime and, in this case, it could well impose an immediate lifetime charge to IHT for all transfers over the nil-rate band.

In essence, all transfers could then be treated as chargeable transfers for IHT purposes. As mentioned above, it may also be that Labour would consider reintroducing tiered rates of tax for transfers above the nil-rate band, perhaps starting at 30 per cent and rising to, say, 50 per cent or perhaps even 60 per cent.

Subject to carefully considering the capital gains tax consequences of gifting (particularly important for those of advanced years) anybody contemplating making substantial lifetime gifts (that is, in excess of the exemptions) in order to save IHT should do so while Pet treatment is available.

All growth in the value of the gift will be free of IHT and, through the use of an appropriate trust, substantial control over the assets given can be maintained. Gifts to accumulation and maintenance trusts and to power-of-appointment interest-in-possession (flexible) trusts (but not discretionary trusts) qualify as Pets subject to the satisfaction of the conditions explained above.

By using a trust, continuing control can be maintained by the donor acting as trustee and, in the case of the flexible trust (interest in possession or accumulation and maintenance), maximum flexibility can be included over who will be the ultimate beneficiary under the trust.

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