Official HMRC figures show that the amount of private wealth being passed on to themselves is growing a lot faster than the amount being passed to loved ones. This is almost certainly due to lack of planning rather than a sudden change amongst the moderately wealthy to contribute extra taxes to the Exchequer over and above those they paid throughout their lifetime.
This apparently startling example of philanthropy might be very welcome to the government but is unlikely to please relatives who might have otherwise benefitted. It is almost certainly not deliberate. But it is avoidable.
Inheritance Tax (IHT) has often been described as a voluntary tax. Despite recent efforts by HMRC to tighten up the rules, it remains quite easy to avoid with relatively simple planning but there are traps which will catch the unwary or ill advised.
UK expats, even those who have lived abroad for many years, often remain UK domiciled so need to plan accordingly. This article focuses on planning opportunities for them and UK residents of all nationalities.
The rate of tax might be considered penal. It is 40 per cent on the total value of the estate of a deceased person after the exemption.
All taxation is a form of social engineering. Originally, inheritance tax and its forerunners were introduced into the UK primarily aimed at old money. Historically, massive proportions of wealth, and land in particular, had been accumulated by the very few. Often large estates were given out by the King in return for military assistance with various wars. It was thus seen as fair and reasonable, particularly by left leaning political parties, to break up these “unearned” estates and redistribute the wealth. Estate duties were the tool of choice. However, this has proved innefective. Instead, middle-class families are bearing the burden of the tax, in part at least, because the family home has risen so much in value that the whole estate is brought into the IHT charge. The vast estates are not getting broken up by the need to pay IHT as in most cases all value was transferred into trust many years ago and therefore escapes IHT. Witness the reported lack of IHT paid on the death of the Duke of Westminster. He was the custodian of the Grosvenor estate which includes large swathes of Mayfair and Belgravia property worth an estimated £12 billion. The IHT bill is likely to have been miniscule to zero as the estate was, and still is, owned by the trustees, not the Duke, so the death of the Duke was non event for tax purposes.
How To Reduce IHT
There are obvious ways to avoid IHT. One is to spend everything. That is fine as long as you know when you are going to die and can spread your spending accordingly. Indeed, the UK disincentivises saving by making it difficult to rely on state-funded care if the “client” has assets of their own. Fair enough, perhaps. Why should the state pay for the care of those who can afford to pay for themselves? We are all living longer and need more money for our latter years so it seems sensible to be cautious on spending and giving and keep substantial reserves.
There is no charge on transfers between spouses either during lifetime or on death provided the donee spouse is domiciled in the UK. Such gifts also do not attract Capital Gains Tax (CGT) provided the spouses live together (TCGA 1992 Section 58). This makes sense. Without that exemption, the surviving spouse may be unable to look after themselves and could need to resort to state funds. This exemption only delays the IHT as on the death of the surviving spouse the tax would bite when, presumably, the assets would then be left to the children or other persons so HMRC get their 40 per cent then.
Outright gifts obviously reduce the value of the estate and can be made tax free to other individuals providing the donor survives for another seven complete calendar (not tax) years. This is the Potentially Exempt Transfer regime (PET).
Trusts used to be a very effective way of eliminating IHT. They still avoid the 40 per cent charge on death but if an UK domiciled person transfers assets to a trust there is an immediate lifetime IHT charge of 20 per cent of the value of the capital transferred. Additionally, the trust would be subject to a 10 yearly periodic IHT charge equal to approximately 6 per cent of the then capital value of the trust assets. For older persons this might still be preferable to waiting and losing 40 per cent as long as they can pay the 20 per cent tax payment when they set up the trust. And, of course, the trust can have many additional advantages – dynastic planning, asset protection, avoidance of the substantial costs and delays of probate etc. If the settlor survives the settlement by 30 years it is cheaper to pay 40 per cent on death than the immediate 20 per cent and three lots of the 6 per cent 10 year charge.
For non-UK domiciled persons trusts remain extremely effective for IHT planning. This is particularly relevant to many wealthy foreign domiciled persons who have been in the UK for a considerable time and are about to be considered as domiciled. Under those rules, anybody who has been in the UK for 15 out of the last 20 years will now pay UK IHT at 40 per cent on their worldwide estate – the same as a UK domiciled person. This has caused some panic amongst the very wealthy “foreigners” living in London and many have left. It is not necessary to do that. Non UK assets can be transferred into trust prior to becoming deemed domiciled and this will be an Excluded Property Trust (EPT). Those assets remain outside the UK IHT. UK assets can be transferred to overseas companies and the shares of those companies can be settled into the EPT. The exception is UK residential property. That is subject to UK IHT on the death of the owner/settlor of the trust irrespective of how it is held.
UK registered pension schemes now benefit from a specific exemption from UK IHT (IHTA 1984 s151(1)). The exemption extends to certain types of overseas pension schemes known as Qualifying Non UK Pension Schemes (QNUPS). QNUPS can be set up in Malta or Guernsey.
If the member dies aged 75 or over, benefits will be subject to income tax but income can now be payable to any nominated beneficiaries who can each utilise their £11,000 personal allowance.
If the member dies under the age of 75, benefits paid out within two years of death can be paid entirely free of UK income tax.
Family Investment Companies
Increasingly, wealthy individuals are setting up Family Investment Companies (FICs). This is a relatively simple technique. Assets are transferred to an offshore or UK company. The rights and obligations attaching to the shares of that company are divided between shares which carry votes only, shares which carry the right to income (dividends) only, and shares which carry the right to the underlying assets (capital). In simple terms, the transferor retains the voting shares and therefore controls the assets and the affairs of the company. He/she may also retain some or all of the income shares so dividends can be received during their lifetime. The capital shares are immediately or progressively given away to family members. The gift of the capital shares would be a PET so would be tax free as long as the donor survives the gift by seven years.
There are quite a few other exemptions to the IHT regime. Every UK person gets a nil rate ban of £325,000 so can give that amount away tax free during their lifetime. In fact, this is another misnomer as the bar resets every seven years so on the seventh anniversary any one gift of £325,000 can be made. Gifts of £3,000 per annum can be made to as many people as you like tax free. If the allowance is unused one year, it can be rolled over and added to the allowance for the following year so a tax free gift of £6,000 can be made. There is an additional exemption for the family home which is currently an extra £175,000 so a family home worth up to £1 million can be passed on to the children tax free. Terms and conditions apply.
Business Property Relief
There are also other forms of property which are given Business Property Relief (BPR) (IHTA 1984 s.105). If a taxpayer holds assets which qualify for BPR, on death those assets will either benefit from 100 per cent relief from IHT or 50 per cent relief, depending on the type of asset that is held. 100 per cent relief applies to shares in unlisted trading companies. Assets which only attract the 50 per cent relief tend to be buildings which are used in a business but owned by the taxpayer (and typically let out to the business) and not owned by the business itself. Again, terms and conditions apply.
There are shares that qualify for BPR listed on the Alternative Investment Market (AIM) exchange. Once they have been held for 2 years they can generally be passed on free of IHT.
All planning which reduces tax could be subject to the rules on Pre-Owned Assets Tax (POAT) and, in particular, the Gift with Reservation of Benefit (GROB) rules. These are complicated and can easily catch out the unwary.
GROB is often an issue for those transferring assets during their lifetime. Simple examples include parents giving away their house whilst continuing to live in it without paying rent. Or gifts of artworks which remain on the walls of the donor who continues to enjoy that work.
And then there is the possibility that the General Anti-Avoidance Rule (GAAR) could apply to any type of fancy or complicated planning. The danger of GAAR can generally be eliminated by receiving opinion on that particular point.
A succession of Chancellors have announced that they will be looking at all these methods of reducing IHT, presumably to eliminate their effectiveness. Others are calling for the abolition of IHT. They see it as fundamentally unfair to charge tax on tax paid assets. Abolition is highly unlikely. The UK government want and need the money now more than ever. The best advice for anybody with a global wealth of over £1 million is to plan early whilst opportunities remain. After all, you can still leave the money in your will to HMRC if you think they should have some more of it!
There is never a convenient time to start this planning and, clearly, many people never get round to it. The results are obvious from the headline at the start of this article. The message is: Get on with it or lose it.
Howard Bilton is Chairman and founder of The Sovereign Group – one of the world’s largest privately-owned consultancies specialising in the provision of offshore trusts and companies and associated international tax advice. Howard currently lives and works in Hong Kong. Howard holds a joint honours degree in classics and law from the University of Keele and is qualified as a Barrister and called to the Bars of England/Wales and Gibraltar. As a visiting non-resident Professor at Texas A and M University, he assists with their LLM and Master’s degrees in International Tax and Offshore Centres. He is a regular contributor of articles to numerous newspapers and technical news wires.