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Plan of attack

Last week, I looked at the use of a discretionary trust as a tax-efficient means of passing on a half share of a property when the first of a married couple dies.

Having identified the possibility of the Inland Revenue cracking down on such schemes where de facto exclusive occupation takes place by the survivor, I then looked at the use of a debt/charge scheme for inheritance tax planning. This works by the first to die leaving his or her entire interest in the property to the survivor but effectively depressing the value of that share.

There has been some indication that the prevalence of these schemes is causing Inland Revenue Capital Taxes to consider a possible attack. The grounds (surprise, surprise) would seem to be based on a con-

tention that the trust that holds the charge (for the primary benefit of the non-spouse beneficiaries) is not valid. It seems to be focused on trusts under which, subsequent to establishment, the trustees have taken no action whatsoever. In the view of Inland Revenue Capital Taxes, the role of a trustee should be an active one if it is to be real. A substance over form approach appears to be favoured.

When the property held in the discretionary trust is other than real property, it may be easier for the trustees to be active. It is thought that a charge rather than a debt being held in such a trust may carry less risk since, with a debt, it might be considered reasonable for the trustees to meet regularly to assess the risk inherent in the debt/charge and possibly determine the amount of interest payable, if any. When the asset is a charge, documented meetings at least at reasonably regular intervals will help sustain a defence against a contention that the trust is not valid.

Aside from ensuring that the trust used to hold the debt or charge is seen to be valid, there is the issue of stamp duty land tax to consider. The amount payable depends on the value of the property.

For transfers of up to £60,000, the charge is nil.

For transfers valued at between £60,001 and £250,000, the charge is 1 per cent.

For transfers valued at between £250,001 and £500,000, the charge is 3 per cent.

For more than £500,000, the charge is 4 per cent.

Stamp duty land tax was a serious consideration to those contemplating the lifetime double trust or IOU scheme, whose success was a significant reason for the introduction of the pre-owned assets tax. If SDLT was payable, it added significantly to the effective cost of the scheme. It was payable during the lifetime of the taxpayer ahead of the time when the benefit of the IHT saving was secured.

For the debt/charge scheme taking effect through the will of a deceased person, this will be less of a problem as, if SDLT is payable in respect of the debt/charge, it will be payable when it becomes effective, that is, at the time the IHT saving is secured. At its maximum rate, it is still 10 per cent of the tax saved, so ensuring it is not paid, if possible, will be worthwhile.

The key to chargeability in connection with will-based debt/charge schemes appears to be whether the trustees have the right to enforce payment of the debt/charge against the owner of the property, typically, a surviving spouse. If they cannot, there is no chargeable consideration and no charge.

In this respect, the Inland Revenue has stated: “Where the personal representatives charge land with the payment of the pecuniary legacy. The personal representatives and NRB trustees also agree that the trustees have no right to enforce payment of the amount of the legacy personally against the owner of the land for the time being . The NRB trustees accept this charge in satisfaction of the legacy. The property is transferred to the surviving spouse subject to the charge. There is no chargeable consideration for stamp duty land tax purposes provided there is no change in the rights or liabilities of any person in relation to the debt secured by the charge.”

However, it would seem that where an IOU/debt (that is then held in trust for the deceased’s children or on discretionary terms) is given by the surviving spouse (who becomes the owner of the property) this will not be excluded from the SDLT charge. This is clearly an area where professional advice is needed before action is taken.

So much for SDLT. How about the IHT-effectiveness of the scheme? Inland Revenue Capital Taxes is known to be interested in schemes that operate to reduce or avoid IHT, particularly where the asset is a property. Where trusts are involved (as they usually are in the charge scheme) the validity of the trust to which the charge is subject may be questioned. What the trustees actually do will be important in this. Remaining passive would seem to be courting possible challenge. The message is to take the role of trustee seriously and to document trustee meetings to create as much defence as possible against attacks on these grounds. To date,we have no record of any attack on the charge scheme although it would seem to be on the radar.

So, the will-based charge scheme seems to work in using the nil-rate band of the first of a couple to die. However, there is the spectre of Inland Revenue action. This is not to say any such action will be successful but we have the recent experience of the pre-owned assets tax and an obvious lack of official concern over applying a tax charge to transactions that may have taken place in the past.

Accordingly, some may take the view that a more certain and less complex course of action should be concluded. Such a course might be the effecting of a life policy (last survivor for couples) held in trust for the beneficiaries. This will provide cash in the right hands at the right time to meet the IHT liability. To rely on some other form of property-based planning runs the risk that if whatever strategy is adopted is prevented from working, it may not be so easy to secure life cover.

It may be appropriate for those who will benefit to pay the premiums. Insurable interest needs to be proved at outset, of course. However, once the policy has been set up, the beneficiaries (who will usually be adult) could take over premium payments under the policy which, typically, would be issued in trust for them anyway.

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