Over the last year, since the 2006 Budget, much of the inheritance tax talk has been, understandably, about capital investment (largely, single-premium bonds) based IHT planning in the form of loan trusts and discounted gift trusts. Of course, the major points for debate have centred on the extension of the IHT discretionary trust regime to all trusts other than bare trusts and trusts for the disabled.
It is only very recently that we have had clarity on the HMRC view as to whether a bare trust for a minor beneficiary can be other than a settlement for IHT purposes.
Thankfully (although many feel that it should never have been in doubt), HMRC has stated that a bare trust for a minor can be a bare trust and thus outside the IHT discretionary trust regime.
Both loan plans and discounted gift trusts require the investor to accept a constraint on their access to their invested capital.
This is hardly surprising, given the main reason for the investor doing other than merely holding the investment for his or her own benefit is to mitigate inheritance tax. Loan trust investors make no gift but retain access to the original capital but not any growth. Discounted gift trust investors have no flexible access to capital, only a flow of regular payments. However, the investor does make an initial (discounted) gift which a loan trust investor does not.
Estate planners who are married or in a registered civil partnership and who have capital to invest have, however, always had another choice when it comes to estate planning, especially when they need to retain access to all capital and income from the investment during lifetime.
The choice to which I refer is, of course, to carry out no lifetime planning but confine IHT planning to the use of the nil-rate band on the first death. Where the couple want such a firstdeath gift to other than a surviving spouse to be other than outright and for the survivor to have continuing access to the funds settled via the trustees, a nil-rate band discretionary trust in each of their wills will achieve these objectives. Such a trust will come into effect on the death of the first of the couple to die and means that:
– the deceased can use his/her nil-rate band which will save inheritance tax because the assets are then not part of the taxable estate of the survivor and
– through the exercise of the trustees’ discretion the deceased’s widow/widower/ civil partner will have potential access to the assets in the discretionary will trust by virtue of him/her being a beneficiary under the trust. The surviving spouse could even be one of the trustees.
This type of planning has been used successfully in the past by many couples and, where investments are held in the trust, the IHT benefits can be enhanced by paying any amounts out of the trust to the surviving spouse in the form of interest-free (or interest-bearing) loans repayable on demand.
If the assets subject to trust are stocks and shares or collectives the trustees could raise cash to make the loan, without any tax liability at that time, by using their annual CGT exemption to release capital or by using the 5 per cent tax-deferred withdrawal facility if the trust asset is a singlepremium bond.
It is also worth remembering that, on the testator’s death, any accrued capital gains in the assets left subject to the will trust will have effectively been wiped out through the rebasing of capital value that takes place on death – regardless of the destination of the assets. This rebasing does not take place in respect of gains in a continuing (typically, multi-life last survivor) investment bond.
With the necessary powers vested in them by the trust, the trustees could make an interest-free loan repayable on demand to the surviving spouse.
Provided that he or she spends the money and does not bring into existence assets of an equivalent value, his/her taxable estate will not increase and, on the survivor’s death, the loan (assuming it is still outstanding) would be repayable to the trust which would mean that the deceased’s estate would be reduced and so the resulting IHT liability would also reduce.
The reduction in the surviving spouse’s taxable estate is subject to a caveat. Section 103(1) Finance Act 1986 provides that:”(1) Subject to subsection (2) below, if, in determining the value of a person’s estate immediately before his death, account would be taken, apart from this subsection, of a liability consisting of a debt incurred by him or an incumbrance created by a disposition made by him, that liability shall be subject to abatement to an extent proportionate to the value of any of the consideration given for the debt or incumbrance which consisted of:
(a) property derived from the deceased; or …..”
Section 103(3) gives a very wide definition of “property derived from the deceased”.
Basically this means that if property is transferred by a person (“A”) to the deceased (“B”) whilst alive and, at a later date, this property (or property derived from it) is lent back to A, that loan is not deductible for IHT purposes on A’s death.
This section was the subject of the recent Special Commissioner’s decision in the Phizackerley case. This case reminds us that it is sometimes worth going back to first principles when considering the viability of and any risks associated with tax planning arrangements.
This is especially so when the planning strategy has become well used and in some cases even “commoditised”.
I will look at the Phizackerley case in detail in next week’s article.