Guide to inheritance tax
July 2019
CUT THROUGH THE CONFUSION
CLI answers advisers’ top three questions on inheritance tax
OMI on why skilled estate planners are more vital than ever
NAVIGATING COMPLEXITY
OVERVIEW
Plan ahead to avoid getting caught in the IHT net
IA editor Kirsten Hastings introduces the guide
CONTENTS
Passing wealth on to future generations is a key driver for people seeking financial advice. The question is how best to do it? The language around inheritance tax planning is dense, complicated and – frankly – a little terrifying. Have all of the assets been accounted for and properly valued? How much can a they give away as gifts before they die? Has a will been written? Are there any assets overseas? The list of questions is long and, without financial advice, the risk of veering off course is high. In this guide, Old Mutual International’s David Denton breaks down domicile, IHT and the expat investor; while Canada Life International’s Kim Jarvis answers advisers’ top three questions on IHT.
First word
Kirsten Hastings, editor, International Adviser
Contents
Cherry Reynard on planning ahead to avoid getting caught in the IHT net
International Adviser editor Kirsten Hastings introduces the guide
Planning ahead to avoid getting caught in the IHT net
1
2
CLI answers advisers’ questions on IHT
CUTTING THROUGH THE CONFUSION
3
Guide to inheritance tax, July 2019
THE ESTATE WE’RE IN
As more and more people are getting caught out by IHT, which is no longer the ‘optional’ tax it once was, planning ahead is crucial
The way forward
‘Rising house prices mean people have been caught in the IHT net’
Lord Jenkins once labelled inheritance tax (IHT) “a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. This view of IHT as optional could change should the next election usher in a more left-wing government that has its sights on IHT loopholes. IHT receipts have been gradually rising, reaching £5.2bn in the 2018 calendar year, doubling in less than a decade. This is in spite of the introduction of the residential nil-rate band, which exempts a portion of the family home. Rising house prices mean more people have been caught in the IHT net. The Labour Party would like to raise receipts even further. It has proposed that IHT be changed to a tax on the recipient. Each person would get £125,000 tax-free and then pay income tax on the rest. This would be a huge change, according to Kay Ingram, LEBC director of public policy. She says: “The very wealthy will be able to get round it but it could really hurt middle England. People who have saved hard and structured their finances in a straightforward way, their assets are visible and they are the ones that will be penalised.”
Ingram argues for a more careful look at IHT, saying the greatest problem is that people tend to put it off, keeping their head in the sand until it is too late to do anything about it. No matter how stringent the IHT regime or how many loopholes are closed, HMRC can only tax what is in the estate. That means forward planning, the earlier the better, becomes even more important. As it stands, the four main options to reduce IHT are via spending, gifting, insurance or investment. Spending is the easiest (and most fun) but many retirees find it difficult to change the spending habits of a lifetime. Equally, for many their wealth is tied up in their home and therefore difficult to spend. Downsizing is an option, but recent research from Hargreaves Lansdown shows young people in the UK are four times more likely to be planning to downsize than those over the age of 55. A stagnant housing market and rising stamp duty has made it a more difficult option.
Gifting is an alternative. A lot of over-55s recognise their good fortune in having participated in a rising housing market and been eligible for final salary pension schemes. Equally, increasing longevity means that while those in their 50s might have expected to receive an inheritance by now, this is being pushed out further and further. Some older people feel honour-bound to give away more of their wealth while they still can. Ingram says gifting takes many forms. Some of her clients are using equity release to give capital to their children and grandchildren, most often for a deposit on a home or to pay educational fees. This can be tax-efficient. It takes money out of the estate for IHT purposes, either as a gift or a transfer, and also reduces the estate for assessment of carehome fees. The problem with giving gifts is that control is lost. Discretionary trusts may be an option but could be targeted by a left-leaning government. As it stands, they are subject to a chargeable lifetime transfer of 20% and then periodic – 10-year – charges of 6%. Discounted gift trusts are another option but may also be subject to scrutiny under a change of government.
Gift drift
IHT receipts have doubled in less than a decade, reaching £5.2bn in the 2018 calendar year
Source: HMRC
£5.2bn
‘The proposed changes to IHT could really hurt middle England’
Kay Ingram, director of public policy, LEBC
Using life insurance to cover some or all of an IHT bill is an option. Life insurance policies will count as part of the estate unless they are written in trust, which can be done relatively easily when the policy is taken out. There are several different types of protection but it is expensive and remains a ‘Marmite’ solution. Some clients like getting rid of the liability for their heirs, while others don’t see why they should take out expensive insurance in their lifetime to protect the next generation. Some investments will also remove part of the estate from IHT but this is not a solution for those with wealth tied up in their home. Providers increasingly offer ready-made Aim portfolios designed to mitigate IHT. To attract business relief the investment must have been held for at least two years, so planning ahead is crucial. IHT may be about to lose its reputation as an optional tax paid by those who would rather the tax man had it than their errant children. Pre-planning to make use of allowances today is becoming vitally important.
‘Marmite’ solutions
The four main options to reduce IHT:
Spending
Gifting
Insurance
Investment
4
Scroll
Inheritance tax (IHT) divides opinion, because it creates the potential for a person’s wealth to be taxed twice; firstly as it accumulates through income and/or capital gains taxes, then again on death. Although the overall IHT collected by the UK Exchequer is low compared to other personal taxes, the percentage growth in recent years has been marked, given significant asset price inflation and the nil-rate band (NRB) remaining static. A 2015 report by the Office of Tax Simplification (OTS) reviewed and ranked 107 areas of taxation and identified IHT as the third-most complex in terms of ‘underlying complexity’ and 38th in terms of the ‘impact of complexity’. The subsequent introduction of the virtually impenetrable residence NRB in 2017 increased the number of reliefs and exemptions to 95, one more than was identified by the same report. This would all suggest that IHT is an easy tax to plan for, but unfortunately this isn’t the case, given the need to understand both the domicile of the expat client and the rules where they have become resident, the location and type of their wealth. It’s too early to say whether the OTS’s most recent and ongoing review of the administrative and technical aspects of IHT (instigated by the chancellor, Philip Hammond, in 2018) will help the planner and their client, or indeed the Treasury.
Defining the problem
‘Out of over 100 areas of taxation, IHT was ranked third in terms of underlying complexity’
SPONSORED CONTENT
navigating complexity
Confusing rules surrounding inheritance tax means skilled estate planners are more vital than ever, says Old Mutual International’s David Denton
In association with:
The estate of a UK domicile is liable to UK IHT at 40% on all their assets worldwide (with an exemption of £325,000 – the NRB – and any other available reliefs) regardless of where they are resident. If they become non-UK domiciled they are only liable to UK IHT on their UK situs assets, subject to most of the same reliefs and exemptions. Whereas residency looks at where an individual is actually living, domicile is broadly based on where their permanent or habitual home is and where they intend to live indefinitely. This may or may not be the country in which they are currently resident. In some cases, a person’s domicile may be a country which they have never visited but from which their family originates (their ‘domicile of origin’).
Unfortunately, domicile is not defined in UK tax legislation and, unlike residency, there is no statutory test. So those overseas who hope to leave behind the shackles of UK taxation must be mindful of Her Majesty’s Revenue & Customs’ (HMRC’s) apparently subjective approach. Until 2009 it was possible to seek a provisional ruling from HMRC asking them to confirm whether enough had been done to satisfy a change in an individual’s domicile at the time of request. However, this reassurance is no longer possible and the burden of proving a change of domicile sits with the party asserting the change, normally posthumously. The extensive RDRM23000 series of HMRC manuals outline the burden and standard of proof required, as well as the information and documents required from the deceased’s executors. Specifically, RDRM23030 states: ‘A change of domicile is never to be lightly inferred, particularly a change from a domicile of origin to a domicile of choice, which is regarded by the courts as a serious step requiring clear and unequivocal evidence. The standard of proof in this area is the civil one, on the balance of probabilities, but discharging it requires suitably cogent and convincing evidence.’
The UK has double tax treaties with more than two-thirds of the world’s 195 sovereign states, many of which follow the Organisation for Economic Co-operation and Development (OECD) model. Unfortunately, but perhaps not surprisingly, IHT does not feature in this model. The UK has just six double tax treaties for IHT, with Ireland, South Africa, the USA, the Netherlands, Sweden and Switzerland. Treaties with France, Italy, India and Pakistan were in place before 1975 during the Estate Duty era and have different rules to eliminate double taxation, with other implications for UK arrivers and deemed domiciles. If a transfer upon death is liable to IHT and another tax is imposed by another country with which the UK does not have an agreement, unilateral relief may be available, although this requires the taxes to be similar and may require careful negotiation. For example, though the UK system is based on the wealth of the deceased, many other countries have systems which are recipient-based, so for example, a liability could depend upon the value received by your client, where they live, the bloodline between recipient and donor, and the taxpayer’s pre-existing wealth (which some readers may recognise as the system known as ISD applying in Spain). Also, the calculations used for unilateral relief do not always reduce the liability as efficiently as one might expect (click here to see government guidance). Even someone who has successfully acquired a domicile of choice overseas where IHT or estate duties do not apply can still be liable to tax upon death in the UK and beyond, if wealth is owned in a country where estate duty applies. Most notoriously, citizens of the US, courtesy of Donald Trump’s 2017 Tax Cuts and Jobs Act, have a generous exemption of $11.4m upon their demise. However, non-citizens with US assets (even where held on platforms outside the US) are limited to a derisory exemption of just $60,000.
The complexity of the IHT legislation, numerous reliefs and exemptions, and the need to bring into consideration every aspect of the estate, often in multiple jurisdictions, means that estate-planning skills and knowledge are highly valued, no more so than in the cross-border arena. To find out more, including how Old Mutual International’s trust based solutions can help plan for IHT, click here to visit our Technical Centre.
Determining domicile
Double trouble
Flexible solutions
If a child’s parents were married when they were born, the father’s domicile will apply.
How does this work?
If a child’s parents were unmarried, or their (married) father has died before the child’s birth, the mother’s domicile will apply.
If a child’s parents marry following their birth, the child’s domicile of origin will not change as legitimacy does not apply retrospectively.
‘The complexity of IHT legislation, numerous reliefs and exemptions, means estate-planning skills are highly valued, no more so than in the cross-border arena’
As more and more people are getting caught out by IHT, planning ahead is crucial
The answer depends on the type of trust. Calculating the value of a trust is relatively straightforward if you are dealing with a discretionary gift trust, however it is a little more complicated for gift and loan trusts and discounted gift trusts. Under a gift and loan trust, any outstanding loan due back to the settlor needs to be deducted from the value of the trust. For a discounted gift trust, if the settlor is still alive, the trustees have an obligation to provide regular payments to them and the actuarial value of this commitment should be deducted from the value of the trust. When looking at what distributions need to be factored into the periodic charge calculation, these refer to distributions to beneficiaries. If the trust allows reversions back to the settlor and these are correctly carved out in the trust at outset, they will not be treated as distributions. Likewise, neither will any loan repayments made to a settlor under a gift and loan trust be treated as a distribution. Trustees will need to be aware of previous transfers made by the settlor and that these gifts can have an impact for the lifetime of the trust. As more and more discretionary trusts are approaching their 10th anniversary, questions around how the periodic charge is calculated have increased.
People have heard of the 14-year shadow, which relates to gift trust exemptions, but are unsure when it becomes relevant. The 14-year shadow is only an issue if, on death, the total of the Chargeable Lifetime Transfers (CLTs) and Potentially Exempt Transfers (PETs) made in the previous seven years exceeds the available NRB, meaning that tax is payable. For those considering making a PET and a CLT at or around the same time, it is logical to make the CLT before the PET as this can impact the periodic charges. However, when making a PET the donor should also be wary of any CLTs made in the previous seven years, and this is where professional advice is paramount. When looking at the tax on a failed PET we also have to go back seven years from the date of the PET. If a CLT had been made within this seven-year period, this needs to be taken into account when calculating the tax on the failed PET – and casts a potential shadow of 14 years on the overall IHT.
Inheritance tax (IHT) is a hot topic for advisers of late, no doubt fuelled by last year’s review from the Office of Tax Simplification. However, the review may also have added to the confusion around a couple of key issues concerning IHT. With IHT frequently topping the list of advisers’ concerns, we’ve analysed the most common questions we receive to give you our top three IHT queries.
‘People have heard of the 14-year shadow but are unsure when it becomes relevant’
Cut through the confusion
Kim Jarvis, technical manager at Canada Life International, answers advisers’ top three questions on IHT
Question 02 What needs to be included when valuing a trust?
Question 03 When does the 14-year shadow take effect on CLTs and PETs?
Unfortunately, the answer is no, as any available transferable nil-rate band (TNRB) can only be used against the IHT arising on the death of the surviving spouse - it cannot be used by the surviving spouse/civil partner for lifetime gifting. There is also a lot of confusion around transferring the residence nil-rate band (RNRB), which was introduced in April 2017. The RNRB is transferable between spouses/civil partners on death, much like the standard nil-rate band (NRB). It is the unused percentage of the RNRB from the estate of the first to die, which can be claimed on the second death. If the first death occurred before April 2017, on the survivor’s death there will be a 100% RNRB available irrespective of whether the first death owned residential property. However, if the first death’s estate was greater than £2m, then the RNRB would be tapered. It is also important to remember here that NRBs transfer as percentages not amounts, ensuring the NRB at the time of the second death is increased by the proportion of the NRB unused on the first death.
01
03
Question 01 If, on first death, everything is left to the surviving spouse/civil partner, does the survivor now have a lifetime gift threshold of £650,000?
‘As discretionary trusts approach their 10th anniversary, questions around periodic charges have increased’
02
‘Any transferable nil-rate band can only be used against the IHT arising on the death of the surviving spouse’
Confusing rules on IHT means skilled estate planners are more vital than ever
Guide to IHT, July 2019
