OCTOBER 9th 2007 PRE-BUDGET REPORT

Inheritance Tax Planning and Will-making in context

The situation before October 9th

The basic inheritance tax position for married couples and civil partners before October 2007 was relatively straightforward:

1. If you left everything to each other then, on the first death, there would be no inheritance tax payable. That was the result of the spousal exemption to inheritance tax. But there could be a very large inheritance tax bill on the second death.
2. Everything above the 'nil rate band' of £300,000 (tax year 2007-8) in the estate of the survivor of you both would be subject to tax at 40%. Depending upon timing/tax reliefs this could create large inheritance tax bill for your beneficiaries to pay.

This situation has not changed at all for single people or as much as might be thought for legally well-advised married couples and civil partners.

Has everything changed?

No. There is certainly more to take into account by married couples or civil partnerships since the Chancellor's statement on 9th October but it would be very misleading to suggest as some have:

1. That in all cases the survivor of each married couple will have a double the ordinary nil rate band. They will not.
2. That inheritance tax efficient Will planning is no longer necessary. It is still essential.
3. That inheritance tax efficient Wills drawn up before 9th October should be changed. Normally they should not be changed unless other circumstances have altered.

So what has really changed?

1. For second deaths occurring on or after 9th October 2007 the inheritance tax impact of the 'bunching' of estates at the time of that death can be mitigated by the survivor's 'accountable persons' (usually the executors of their Will) making a 'transfer claim' to the tax office.
2. At first glance this looks as though it might be quite attractive. But you should remember from the outset that making a transfer claim is not strategic forward looking tax planning. It is more like placing a sticking plaster over what might have been achieved with more certainty and far more advantages if the first to die had a suitable Will in place when they died. There are potentially serious down sides to not having a more suitable tax efficient arrangement in your Will. These are explained below.

How will a 'transfer claim' work?

A transfer claim would involve ascertaining the proportion of the unused nil rate band of the first to die and then transferring that to be set against the taxable value of the survivor's estate.

Example One:

• Mr A dies in April 2007 leaving his £400,000 estate to his spouse, Mrs A. This wasted his inheritance tax free 'nil rate band' of £300,000 at the time because instead of making use of it his estate passed tax free under the spouse exemption to his wife.
• Mrs A dies in June 2009 leaving her £600,000 estate to the two children. By then the nil rate band is £325,000. So the amount of inheritance tax payable is £600,000 less the inheritance tax free nil rate band of £325,000 = £275,000 X 40% inheritance tax = an inheritance tax bill of £110,000.
• But Mrs A's executors can now make a claim to the tax office for 100% of Mr A's nil rate band to be added to her own nil rate band. It is the value of the nil rate band at the time of the second death which applies so that means another £325,000 can also be set against the value of Mrs A's inheritance taxable estate.
• Mrs A's estate of £600,000 can now be set against an 'enhanced' nil rate band of £650,000 so no inheritance tax is payable.

• Mr A dies in April 2007 leaving his £400,000 estate as to £200,000 to his spouse, Mrs A and £200,000 to his two children.
• This wasted part of his inheritance tax free 'nil rate band' of £300,000 at the time because whilst he made use of £200,000 of it (67% or so of the total available to him) the rest of his estate passed under the spouse exemption to his wife.
• Mrs A dies in June 2009 leaving her £400,000 estate (£200,000 inherited from her late husband and £200,000 of her own money) to the two children. By then the nil rate band is £325,000. So the amount of inheritance tax payable is £400,000 less the inheritance tax free nil rate band of £325,000 = £75,000 X 40% inheritance tax = an inheritance tax bill of £30,000.
• But Mrs A's executors can now make a claim to the tax office for 33% (in round figures) of Mr A's nil rate band (ie 100% less the 67% of it used already). That can be added to her own nil rate band. It is the value of the nil rate band at the time of the second death which applies so that means 33% of £325,000 or £107,250 can also be set against the value of Mrs A's inheritance taxable estate.
• Mrs A's estate of £400,000 can now be set against an enhanced nil rate band of £325,000 + £107,250 = £432,250 so no inheritance tax is payable.

Why is the transferable nil rate band not as useful as it might at first sound?

Will trust arrangements are still potentially very useful for inheritance tax planning and also for other practical reasons. If instead of using a suitable Will trust arrangement everything is left to the survivor outright then:

1. The survivor can spend all the money and the beneficiaries who the first person wanted to benefit might get nothing.
2. The survivor can give all the money away and the beneficiaries who the first person wanted to benefit might get nothing.
3. The survivor might get into financial difficulty and their creditors might take everything they have. The beneficiaries who the first person wanted to benefit might get nothing.
4. The survivor might remarry and leave their estate to their new spouse. The beneficiaries who the first person wanted to benefit might get nothing.
5. The survivor might enter means-tested long term care. Most of their estate may be paid out in care fees. If another form of Will using a trust arrangement was used this could be mitigated.
6. The survivor might lose the mental or physical capacity to handle their own affairs:

1. This vulnerability could expose them to financial abuse by third parties. A Will trust arrangement could eliminate this risk.
2. Their affairs might need to be taken over by the Court of Protection. This expense and intrusion into family life is avoidable so far as the estate of the first to die is concerned if a suitable Will trust was in place.
3. As people get older having Will trustees in place to help out can be a great comfort.

1. If the first spouse/partner to die has any business or agricultural property which is relieved by inheritance tax business property relief or agricultural property relief then unless those assets are either given away outright to non spousal beneficiaries or into a flexible discretionary trust arrangement then the benefit of that type of valuable relief is lost.
2. If the value of the assets in the estate of the first to die eg a share in the family home or shares/ any investment / interest paying bank account grow at more than the rate of increase in the nil rate band for inheritance tax purposes (which has broadly grown at the 'headline' inflation rate or RPI) as they have in the past (we only need to look at house prices and share prices to see this) then it would be advantageous to make use of the nil rate band of the first to die at the time of the first death. In short the growth in value of the assets is taken out of the value of the equation at the second death. The most appropriate way to do this (without leaving the survivor high and dry) is a suitable Will trust arrangement.

Example:

• Mr A dies and the nil rate band is £300,000. He has an estate of £400,000. His will leaves everything to Mrs A who has perhaps an estate of around £300,000 already (eg half the house and some cash).
• This wastes his nil rate band but Mr A considers that his wife's executors will be able to transfer his unused nil rate band so that's not going to be a problem. Sadly it is.
• Assume that the value of the money (which could have been set aside in a suitable Will trust arrangement by Mr A) grows in Mrs A's hands at a compounding rate of say 8% per year (rather easy for house prices and share prices?) whilst inflation (and the nil rate band) only grows at a compounding rate of 3%. After only 10 years (not an unusual gap at all)when Mrs A then dies the value of the £300,000 will be £665,892 whilst the transferable nil rate band would be only £404,806.
• That means that some £261,000 (£665,892 less £404,806) which could have been taken out of the survivor's inheritance tax picture when they died would instead be subjected to a potential (and unnecessary) 40% inheritance tax liability of £104,434. the situation only gets worse as time goes on.

It should not be assumed that the nil rate band cannot be:

1. Frozen;or
2. reduced; or
3. scrapped.

Making a transfer application will involve ascertaining the unused nil rate band of the first to die:

1. Will suitable records exist? Solicitors files are usually destroyed after 7 years.
2. Records may not include the details of joint property transferred at the time of the first death.
3. Records may not include the details of lifetime gifting which limited the nil rate band at the time of the first death.

This means that applicants will be at risk of either being unable to make their case to the tax office and losing out or possibly being overpaid, spending the tax saved and then having to repay it if an overpayment is discovered later. Thus for the purpose of clarity and administrative efficiency alone ensuring you have a suitable Will with appropriate tax efficient trust arrangements still makes good sense.

Summary.

Clients who have made tax efficient provision in their Wills can be confident that they still work. It is also likely that despite the changes made on October 9th that such Will-planning remains appropriate in most cases where the value of joint estates exceed the basic £300,000 inheritance tax free nil rate band.

Note: How do the transfer rules apply to remarriage situations?

If Mrs A in the example married Mr B after Mr A had died and then Mr B died before her, Mrs A could also claim any unused nil rate band from Mr B's estate. But there is a limit so as to avoid multiple inheritance tax planning marriages. Only a maximum of two times the nil rate band at the time of the second death can apply in total including the relevant deceased.

Disclaimer.

Every care has been taken in the writing and editing of this document to ensure that the material appearing within it is accurate and up to date, but the contents are not intended to constitute legal advice and no responsibility is accepted for any consequences arising therefrom.

No responsibility is taken for any loss, damage, problem or difficulty affecting any person relying on this work (or any precedent produced relating to it) either directly or indirectly through others.

Copyright© David Coldrick October 2007

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