Since the Labour Party came to power in 1997, perhaps one of the biggest tax surprises has been the lack of significant change to the inheritance tax rules. But inactivity in this area is set to change as the Government announced in its pre-Budget report that it intends to introduce legislation to charge income tax on any benefit enjoyed by the donor of a major capital asset.
This provision will affect people who make gifts of such assets – such as a home or chattels – and then continue to enjoy those assets without payment and hopefully without being caught by the gift-with-reservation rules. From 2005/06, it is proposed that such people will suffer an income tax charge based on the benefit they enjoy under an arrangement or scheme which they do not pay for.
However, the following planning points remain to be taken into consideration by anyone concerned about a potential IHT liability.
One of the simplest methods of IHT planning is to make full use of this year's annual exemption if £3,000 and any unused exemption from the previous year. It is important to remember that it is necessary to use the current year's exemption before using any of the previous year's available exemption. The exemption is available to both a husband and wife.
The normal-expenditure-out-of-income exemption can be useful. This relief cannot be carried forward. To use this exemption, gifts must be regular, made out of income and of such a size as to not affect the donor's standard of living. An appropriate life policy held in trust may be a good way of using this exemption.
Anybody contemplating making substantial lifetime gifts to save IHT should do so before the Budget to achieve treatment as a potentially-exempt transfer while it is available. All growth in the gift's value will be free of IHT. Gifts to most trusts (with the notable exception of discretionary trusts) count as Pets. By use of a trust, continuing control can be maintained by the donor acting as trustee. Life insurance can be effected to cover any potential IHT liability on the death of the donor within seven years. Careful consideration needs to be given to the CGT implications of making gifts.
If cash gifts are to be made into trust, capital investment bonds can be tax-attractive trustee investments because they provide a tax shelter. As they are non-income-producing and not subject to CGT in the investor's hands, they reduce trust administration.
Premium payments to a life policy (on a joint-lives, last-survivor basis for a married couple) under trust are an ideal way of providing cash on death that is free of IHT and using the annual and normal-expenditure-out-of-income exemptions. By using a flexible trust, the benefits secured under plans implemented can be adapted to changing family circumstances.