Effective Inheritance Tax Planning is a vital part of planning for your future so you are aware not only of the potential charges you and your loved ones will face, how you can protect certain assets and how you can mitigate the payment of Inheritance Tax.
Here we provide you with a variety of ways we can help you with Inheritance Tax planning.
How is Inheritance Tax payable?
Inheritance Tax (IHT) is chargeable on the value of your estate on the date of your death at a rate of 40%. Chargeable transfers or gifts made during your lifetime are taxed at 20% but most lifetime gifts could potentially be exempt transfers.
Each estate is entitled to a “nil rate band” (a tax free sum) and in the tax year 2018/2019 the current amount is £325,000. You may be entitled to claim Residence Nil Rate Band on your death; further details of which can be found here.
What transfers are available?
Transfers to your surviving spouse and transfers to charities you make are usually free of IHT. Lifetime gifts to individuals which are survived by seven years usually pass free of IHT. In other words, after seven years the cumulative gift clock is “re-set”. In the event of death within seven years, IHT may become payable. The nil rate band is set first against any such gifts, with the oldest being first, before the remaining balance can be set against the death estate.
In the event that you made gifts in excess of the nil rate band in the seven years prior to your death, the tax payable may be reduced where the gift was made more than three years prior to your death, otherwise known as Taper Relief. Any tax due is payable by your estate as the deceased person in this example, or in default, the recipient of your gift.
It is possible to mitigate IHT by a variety of planning means. In broad terms, the only tools available are by making best use of exemptions authorised by legislation or by using intelligently the nil rate band. By way of overview, the more elaborate tax planning schemes have been closed down by legislation over the years with an elaborate framework of rules restricting gifts where there are reservations of benefits and the property falls within the pre-owned assets‘ tax framework. The anti avoidance framework is quite complicated and we can help answer any detailed questions or discuss any specific ideas you may have.
What gifts are free of Inheritance Tax?
The gifts below will be free of IHT from the date you make the gift. There is no need for you to survive the gift by seven years and gifts may be made in cash or in kind. Some caution should be noted in relation to non-cash assets as there may be a Capital Gains Tax liability.
- Annual exempt gifts: You may make annual gifts of £3,000 per year free of IHT and where no such gifts were made in the previous year, a total of £6,000 may be gifted free of tax. Annual exemptions can only be carried forward one tax year.
- Small gifts: You can make gifts to the value of £250 to numerous individuals in each tax year free of IHT – typically Christmas and birthday gifts
- Wedding gifts: When your child marries you may give £5,000 in consideration of marriage entirely free of IHT. Grandparents and great-grandparents can give up to £2,500 free of IHT and other individuals can give up to £1,000 free of IHT
- Regular and habitual gifts out of surplus income
Gifts from surplus income over expenditure
Regular and habitual gifts out of surplus income are Inheritance Tax free. If you receive more net income than you need to live on, you may make arrangements to make regular gifts of any surplus at any level with immediate IHT effectiveness. Provided you make it clear that you intend to make regular gifts in this manner, even if only one payment happens to be made prior to an unexpected death, the payment will qualify. This exemption is often under utilised in Inheritance Tax planning but can be extremely useful.
The key elements of this exemption are as follows:
The gift must be made as part of “normal expenditure”
When considering what normal expenditure is, particular attention is paid to your particular habits rather than a “typical” person, meaning it is subjective rather than objective. Recent cases suggest that such expenditure and gifting must be within a settled pattern, which may be evidenced in a number of ways, including whether there is already be a clear pattern of you making regular gifts out of surplus income over expenditure.
Alternatively, you may have assumed a commitment regarding future expenditure and therefore set about complying with it. This commitment need not be legally binding, however there would need to be evidence of an intention to make regular payments over a period of time. You do not need to make the payments to the same person, nor does the amount need to be fixed as long as a means is adopted by which the payments may be quantified. For example, you could make regular gifts of 10% of earnings to members of your family but not specify an amount to be gifted to any one individual.
Although there is no set time span over which you must show the habit of giving, a reasonable time span would normally be 3 – 4 years.
It must be paid out of annual income (ie not capital)
Income is not defined in legislation but is generally taken to mean your net income after payment of income tax. Payments must be made from surplus income, meaning that sufficient income must be retained to maintain your usual standard of living.
There also needs to be some thought applied to the method evidencing the conditions above. A commitment to make regular gifts could be shown by way of a letter to the recipient. The gift could be in the form of agreeing to meet a financial commitment, for example if you pay school fees or a stakeholder pension on behalf of a grandchild.
If these three factors can be met then the individual can give away surplus income, without any upper limit.
Gifts using Business Property Relief
Investment in private companies can provide relief from Inheritance Tax after only two years of ownership. The business must be a qualifying business and the asset must qualify as relevant business property. In these terms, a business includes a business carried on in the exercise of a profession or vocation.
What is a relevant business property?
A business would not qualify for relief if the business (or the business of the company) consists wholly or mainly in dealing in securities, stock or shares, land or buildings or making or holding investments.
There are six types of relevant business property attracting relief at the following rates:
The definition of ‘unquoted’ has varied over the years since inheritance tax was introduced. The current definition which has applied since March 1992 is “not quoted on a recognised Stock Exchange”. Note however that shares dealt in or on USM and AIM are currently treated as unquoted.
There are also investment products available in the market place to enable investment in a basket of qualifying companies (usually invested on the alternative investment market). Some of these so-called products minimise the risk of capital erosion by way of certain guarantees.
- A business or an interest in the business – 100%
- A controlling shareholding in an unquoted company – 100%
- A minority shareholding in an unquoted company – 100%
- A controlling shareholding in a quoted company – 50%
- Land, buildings, machinery or plant used wholly or mainly in a business carried on by a company controlled by the transferor or by a partnership of which he is a partner – 50%
- Land, buildings, machinery or plant in which the transferor has an interest in possession and which is used for his business:
- Transferred at the same time as the business – 100%
- Not transferred at the same time – 50%
What are the disadvantages of gifts using business property relief?
In a family company, for instance, any sort of contract that requires executors to sell the shares to shareholders on death must be avoided. If such a contract exists, Business Property Relief will not be given and it is better to grant an option on the shares and a carefully drafted Shareholders’ Agreement is essential. As part of the tax strategy review, the Articles of Association should be checked to see whether there are any provisions which would affect the disposal of shares.
Care should also be taken to ensure that the main activity of the business remains that of a trading nature; as the company’s nature changes more to an investment company the Business Property Relief will be lost.
Another risk is if the business is too “cash rich”, then Business Property Relief may be denied. For example, HMRC in one case considered a family company which had £450,000 on the balance sheet and in the end levied an IHT charge on £300,000 of that. HMRC argued that only £150,000 was needed to successfully maintain the company’s future business. It is prudent to ensure that the company board carefully maintains minutes of the investment and trading plans for the company thus justifying its cash holdings.
For more information on how you make appropriate Inheritance Tax plans, contact the team on 01329 222075 or emailing us at firstname.lastname@example.org.