IHT on Gifts to Minors in Wills

It makes me weep that I need to discuss this. I genuinely do not believe that the government intended to make this bit as complicated as they did. The old (pre-2006) rules for gifts to minors, called the “A&M Trust” rules, were simple, secure and tax-favourable. So, everybody followed them, leaving gifts in wills “to those of my grandchildren who survive me and attain 21” or suchlike. Very straightforward. Nobody thought of creating “bare trusts” (whatever they are) or leaving their children “intermediate income” (whatever that is), because although those options existed in theory, frankly why would you want to do them, and who needs to think about those things, anyway? Well, now you do.

I think the treasury felt that some very rich people with clever lawyers were taking advantage of the A&M Trust rules, so, using a sledgehammer to crack a nut, they simply abolished them. Then, they realised that they needed at least two new statutory regimes to partially replace them. So now, you need to consider a string of options, and to trade-off simplicity -v- security -v- tax-favourableness. Instead of the one option you had before (where the only choice you really had to make was whether the beneficiaries inherited at 18 or 21 or 25, and where even that decision didn’t affect the tax position) you now have to choose between:

a.            Relevant Property Trust. (Example: “to those of my grandchildren who survive me and attain 21”.) Simple, secure, tax-unfavourable. This is the simple option I mentioned above, the kind that would previously have fallen squarely within the A&M Trust rules. This is still unquestionably the best option for those whose estates aren’t in the tax net anyway – indeed, if you aren’t in the IHT net this is the only option I would seriously discuss with you, if you consulted me about a will. The tax disadvantage, however, is that they are taxed as discretionary trusts, suffering ten-year charges and exit-charges. The maximum rate of any charge is 6%, so what I often find is that people whose estates are taxable nevertheless work their way through the following options with me, but then decide to come back to this one: taking the view that the tax charges may be a reasonable price to pay for the simplicity and security of it.

b.           Bereaved Minor’s Trust. (Example: “to those of my children who survive me and attain 18”.) Simple, insecure, tax-favourable. This is a statutory regime, available only in the wills of the parents of the child concerned, and only where the minor gets their money outright, with no strings attached, at 18. And, really, that’s what I mean by “insecure” in these examples – the minors in question taking absolute control of their inheritance the moment they reach 18, whether or not they are mature enough to handle the amount of money involved. The tax advantage is that there are no ten-year charges or exit-charges.

c.            18 to 25 Trust. (Example: “to those of my children who survive me and attain 21”.) Simple, secure, tax-middling. This is another statutory regime, available only in the wills of the parents of the child concerned, and only where the minor gets their money outright, with no strings attached, at an age between 18 and 25. Gifts of this kind become relevant property trusts upon the minor in question reaching 18. Therefore there cannot be a ten-year charge (because there are less than ten years between someone reaching 18 and the same person reaching 25) and the maximum possible exit charge is 4.2% (because exit charges are calculated by reference to the number of years elapsed before the next ten-year charge would happen: in this case there are seven years between ages 18 and 25, and 7/10ths of the maximum 6% is 4.2%).

d.           Bare Trust. (Example: “to those of my children who survive me absolutely”.) Simple (in theory), insecure, tax-favourable [unless the minor dies]. In this case, the gift to the minor is “absolute”, so he or she owns the money outright, even if he or she is only an infant. This may seem to be the ultimate in insecurity, although in practice trustees do actually have to look after the money and the child cannot demand it from them until attaining majority, at 18. The only reason to consider this is the tax consequence: the money actually belongs to the child, so the trust isn’t truly a trust at all, and isn’t taxed as one. Therefore there can be no ten-year charges and no exit charges.

e.            IPDI. (Example: “to pay the income to those of my children who survive me, from the date of my death, and to pay the capital to each of them when he or she attains 21”.) Complicated, secure as regards capital, tax-favourable [unless the minor dies]. The idea of an IPDI is that if you grant someone a right to income, by a trust in a will, from the date of death, then that trust is taxed in tandem with the beneficiary’s estate (and not as a relevant property trust). The tax upside is that there are no ten-year and exit charges. But the assets are taxed in tandem with the minor’s estate, so if the fund is big enough it suffers 40% tax on the minor’s death.

But just to clarify: although I have described some of these options as “tax-favourable” and “tax-unfavourable” none of them avoids the IHT on the death in question (and the old rules didn’t do that either). Leave money to a child or a grandchild (indeed, actually, to anyone except a spouse, civil partner or charity) and you pay IHT on it. The only question we are discussing in this section is whether there might be yet further IHT on the fund before the minors receive their share.

International Estate Planning - Full Version

Here is the full one-hour version of this talk, in four parts:

Annual Residential Property Tax (ARPT)

There are some serious changes about to come in (April 2013) for UK residential property owned through an offshore company.

The political background to the change is that historically the UK has promoted itself as a tax haven for non-domiciled individuals, and has maintained a tax regime full of rules favourable to “non-doms” and “res-non-doms” when compared with the tax treatment of English residents and domiciliaries.

One common example is the use of a non-resident corporation (often a BVI company) to hold English residential property. One of its main advantages is that the property’s value is outside the scope of inheritance tax. This saving arises because – from one angle – the property is owned by a corporation not by an individual, so its owner cannot die; also – from the other angle – the death of the non-domiciled individual doesn’t lead to any tax because what he owns (i.e. shares in a BVI company) are “excluded” from inheritance tax: being the non-UK-situated assets of a non-UK domiciliary.

In the past, governments have seen planning of this kind as advantageous to the economy and have not challenged it. Foreign individuals can bring their wealth (and their businesses, and their expertise) into the UK with the benefit of tax-neutrality.

However the current coalition government perceives things very differently. In its eyes the need to “balance the country’s books” is paramount: the economy is in poor shape, budgets are being cut, the tax-take needs to be maximised and there needs to be a perception that rich non-domiciliaries are paying their share.

Against that background, we are now faced with a number of punitive taxes, the clear intention of which is not so much to raise tax, as to encourage the break-up of these structures.

Unfortunately, the decision is NOT clear cut in a case like this. There is not one recommendation to make, and overall the decision has to be one for each individual client. There are three options, and they are:

1. No action. Keep the structure as it is.

     ADVANTAGES

     a. no inheritance tax, for the same reason as when the structure was set up

     b. no scope for stamp duty, since nothing is changing

     c. all the non-tax advantages of the trust from a succession, flexibility, confidentiality and asset protection viewpoint which the arrangement previously had

     d. no costs, except the any advice needed to reach this conclusion, since there is nothing to implement

     DISADVANTAGES

     a. the new Annual Residential Property Tax

     b. the property will henceforth be exposed to Capital Gains Tax, re-based to April 2013

     c. the law may change, penalising this option further or negating any of its advantages

2. Collapse the structure completely.

     ADVANTAGES

     a. no new Annual Residential Property Tax

     b. most likely no Capital Gains Tax on general principles (i.e. assuming that the owner will be non-resident)

     DISADVANTAGES

     a. inheritance tax payable at death (This is a crucial point - £15,000 is an unintended and unexpected cost of the structure, but you would have to pay it for over 66 years to match the inheritance tax hit on a £2.5 million property.)

     b. various non-tax issues: for example that there would henceforth be an undervalue transaction in the title to the property.

     d. the law may change, in ways less favourable to non-domiciled property owners than the current laws (you could argue that the subject matter of this email is an example of this already occurring)

3. Tweak/Restructure.

     This would involve retaining some elements of the existing structure but reorganising it in such a way – if possible – that the existing advantages are obtained without giving rise to the new tax charges. This is obviously the most nebulous of the three, and cannot be explained in terms of simple advantages or disadvantages. One obvious disadvantage, however, is that tax law may change further – especially if there is a sense that many non-doms are using a particular tweak – in order to negate or penalise the restructuring. Possibilities include:

     a. letting the property: the new rules don't apply to lettings on a commercial basis, so if it is let out to independent tenants at arm’s-length and at full rent the problems do not apply

     b. removing the company from the structure but keeping the trust in place: superficially this appears to achieve the desired effect (no annual residential property tax, no capital gains tax, possibly no inheritance tax on client’s death), but unfortunately introduces a new complication: the trust would cease to be an “excluded property trust” and would instead fall into the regime called the “relevant property trust regime”. The inheritance tax cost of being in that regime could be somewhere close to the ARPT, so it is hard to recommend it in isolation. However there is an argument to the effect that this further tax can be mitigated by burdening the property with debt.

See also Nina Sampson's article on this topic at Business First Magazine, which is a little more up-to-date than my blog above: http://www.businessfirstmagazine.co.uk/heavy-new-taxes-about-to-hit-foreign-owned-properties/

International Estate Planning - Taster

This is the 3-Minute taster for my full-length International Estate Planning seminar.

Inheritance Tax Strategy 6 - Use Your "Business Property Relief"

Business Property Relief is usually abbreviated to “BPR”.

1.           The basic principles are:

              a.           Sole traders get 100% BPR on their business and its assets. (100% relief means no tax to pay at all, whether on a lifetime gift or at death.)

              b.           Partners get 100% BPR on their share of the business. (Even members of Limited Liability Partnerships get this relief.)

              c.           All shareholdings in unquoted companies get 100% BPR. Shares which are traded on the Alternative Investment Market are unquoted for this purpose, so you’re still OK to claim BPR on them.

              d.           Partners get 50% BPR on assets owned by them personally but used by the partnership. (50% BPR, of course, means you pay tax on half of the value of the assets.)

              e.           Controlling shareholders (only) get 50% BPR on assets owned by them personally but used by the company.

              f.            Controlling shareholders of PLCs get 50% BPR on their shares (although if you control a PLC you are one of a very rare breed).

              g.           Generally there’s no actual need to work for the business, or be actively involved in management. The fact that you are a financial backer (such as a sleeping partner or an inactive shareholder) can be enough to get you BPR.

              h.           Everybody is denied BPR on the investment element of the business, so part of the claim will be rejected if the business holds assets such as lots of cash, stockmarket investments, or properties which are let.

              i.            You generally need to have had the business interest in question for over two years to get any BPR.

             

2.           These rules are very generous compared to taxes we’ve had in the past. There’s a good chance that this won’t last. Tax plan now.

3.           You need to be quite careful to ensure that what your business does really is business, as distinct from letting or investment. A business which is chiefly based on rental income, for example, isn’t a “business” in the “business property relief” sense of the word. 

              Just to emphasise the effect of my points 3 and 1(h):

              i.            if the business is mainly investment or letting then you don’t get any BPR at all, on any of it (even the non-investment/letting part); but

              ii.           even if you do get BPR on the business as a whole, it’s refused on the part of the business’s value that is attributable to investment/lettings.

4.           Gifts of your business assets are likely to have capital gains tax consequences. Make sure that any tax plan takes into account the impact of both taxes.

5.           In the case of a lifetime gift, there is a particular trap to watch out for, in the “clawback” rules. These kick-in if BPR is claimed, but the assets in question stop being eligible for BPR by the time the giver dies. These force you to go back and recalculate inheritance tax as if BPR had never been available in the first place, which of course could be a disaster.

6.           The single most important thing in estate tax planning for people whose assets potentially qualify for BPR, is to ensure the BPR is “used” (not “wasted”). It can be used in two ways: firstly by passing the business directly on to a lower generation (e.g. children/grandchildren) or secondly by putting the business onto a First Death Discretionary Trust. BPR gets “wasted” by leaving the business outright to the surviving spouse. The reason this is a waste is that you have used two reliefs (business property relief and the spouse exemption) against the same assets when either one would have done, in consequence of which the surviving spouse has got richer. Then, the surviving spouse can live on for many years, eventually retiring and selling-out of the business, then dying with a huge wodge of cash to be taxed at 40%.

              So if you only take one message from this posting, then it’s this one, which I will set out in big bold lettering for you:

              DON’T WASTE YOUR “BPR” WHEN YOU DIE!!!

7.           This final point isn’t so much a strategy in its own right - more an important problem to be aware of.

              When you sell a business, you are turning an asset (the business) which potentially qualifies for 100% BPR - making it tax free - into another asset (cash) which is going to be taxed in full at your death. There is action you can take to deal with this problem, so you should be sure to take advice on the point before you start negotiating any sale. 

Rysaffe Planning

NOTE: Since I posted the below (September 2012) the government have consulted on whether Rysaffe arrangements should be allowed to continue. At the time of this note (October 2013) no decision has yet been made. If you have these arrangements they could need review. Entering into them also needs to be considered more carefully. 


One of my more technical postings, dealing with a less-common piece of planning for people with larger inheritance tax problems

Discretionary trusts are a good thing once assets are inside them, for the reason that their assets are not owned by a human being and the trust cannot die, thereby never suffering the 40% “tax whammy” that inheritance tax represents. However such trusts are also a bad thing inheritance-tax-wise for several reasons:

a. There’s no exemption when you leave money to a discretionary trust (as there is, for example, when you leave money to a spouse or charity).

b. Giving money to a discretionary trust (indeed to most types of trust) in your lifetime is not a “potentially exempt transfer” like other gifts are: instead you have to pay half of the death-rate IHT right there-and-then upfront (that’s 20% of the amount you pay in, less the £325,000 “nil-band”) and you do not get this money back even if you survive for seven years. However if you do die within seven years you have to recalculate the tax and may have to stump-up some or all of the remaining 20% to make up the 40% death rate.

c. Discretionary trusts suffer “ten year charges” – inheritance tax on the value of the trust over the nil-band at rates up to 6% every ten years.

d. Discretionary trusts suffer “exit charges” – inheritance tax on the value of funds leaving the trust over the nil-band in between ten-year anniversaries, at rates up to 6%.

So, having found an acceptable way to get money into a discretionary trust, is there anything that can be done about items (c) and (d)? Yes, there is, if you plan in advance and if you consider the tax problem sufficiently serious to justify the costs. What you do is this: you establish, in your lifetime, a number of small discretionary trusts. By “small” I mean that the amount of money in them is small – usually £10 – but in all other respects they are full-blown trusts – you sign-up to trust deeds and appoint trustees who take office. The number of trusts you need is found by dividing the amount you want to settle onto discretionary trusts by the current nil band, rounding up. If you have £2million, for example, you need seven trusts. You create each of these trusts on a different day.

When you die, you make a gift of somewhere less than a nil-band to each trust, in your will. The advantage is that because each trust was established on a different day, it has its own nil-band. And, as I mentioned above, the ten year charges and exit charges are charged on assets over the nil-band. And that is likely to be nothing, or very little, if the trusts each start with less than one nil-band.

Is it Better to be Married?

I would never tell a client whether it is better to be married!

I do think, however, that it is legitimate to ask whether it is better, from an inheritance tax viewpoint, for a couple to be married. The answer seems to be “yes”, but I cannot find a very simple way of explaining it. The best I can do is to set it out arithmetically. Let’s imagine a couple who each own £2,000,000, and let’s start with the worst case scenario, which is that they are unmarried and leave everything to each other:

What has happened here is that the total inheritance tax they have paid, £1,872,000 is extremely bad news, and is actually MORE THAN 40% of their total assets, even though 40% is the tax rate. The reason is that some of this money has been taxed twice, once when he died and again when she died.

(Don’t worry about the detail of these calculations, by the way, just keep an eye on the “total tax” number!)

Being married does protect against some of that tax. For example, a married couple could do this:

The total tax has reduced to £1,340,000: which is still a lot of money, but does at least seem ‘fairer’ than the first example in the sense that the tax comes out at 40% of the taxable portions of the estates. The tax saving is over half a million pounds and, significantly, none of it was paid on the first death – it was all postponed until after both had died.

Can an unmarried couple achieve that same bottom-line figure? Yes, they can: for example by incorporating discretionary trusts in their wills:

This third example has the same bottom-line as the married couple achieved. Notice, though, that there is one significant difference. This time some of the tax, £670,000, was paid on the first death. An unmarried couple cannot shield that until the second death, as a married couple can.