7 - IHT: Tax Planning Flashcards

Question

How are loans made to acquire assets that qualify for Business Property Relief (BPR) treated for inheritance tax (IHT) purposes?

Answer 1

When a loan is made to acquire, maintain, or enhance assets that qualify for BPR (or agricultural/woodlands relief), there are specific restrictions on how the loan is deducted for IHT purposes: **Deduction Requirement**: The cost of the loan must first be set against the value of the qualifying assets, which reduces the value of the assets that attract relief. **Excess Loan Deduction**: If the loan exceeds the value of the relievable assets, any remaining amount can be deducted from the chargeable estate's value. **Illustrative Examples**: - **Loan for BPR Assets**: If the loan was used to acquire BPR-qualifying shares, the loan's cost must be deducted from those shares, thus reducing the available relief. - **Loan for Non-BPR Purpose**: If the loan was used for purposes like home improvements, the loan cost is not restricted to any specific asset. Consequently, BPR can be claimed on the entire value of qualifying shares, lowering the taxable estate’s value.

Answer 2

The impact of loans on the taxable estate can vary depending on the purpose of the loan and whether it is associated with relievable property: **Example 1**: A man dies. His £700,000 estate includes: · A house worth £400,000 · Shares worth £100,000 which qualify for BPR (at 100% relief) · Cash of £200,000 The man’s funeral expenses are £5,000. He has an outstanding debt of £25,000 from a loan used to buy the shares. - Deduct debts / expenses: Shares reduced to £75,000. £5,000 funeral expenses deducted. Estate = £670,000 - Apply reliefs: Deduct £75,000 (BPR) - **Taxable estate**: £595,000 **Example 2:** A man dies. His £700,000 estate includes: · A house worth £400,000 · Shares worth £100,000 which qualify for BPR (at 100% relief) · Cash of £200,000 The man’s funeral expenses are £5,000. He has an outstanding debt of £25,000 from a loan used for home improvements. - Deduct debts / expenses: Total debts £30,000. Estate = £670,000 - Apply reliefs: Deduct £100,000 (BPR) - **Taxable estate**: £570,000

Answer 3

Unpaid loans impact the taxable estate based on whether they are repaid from the estate: **General Rule**: Loans are only deductible from the estate’s value at death if they are actually repaid from the estate. HMRC generally assumes commercial, arm’s length loans will be repaid. **Closer Scrutiny**: HMRC examines debts more closely if they involve: - Family members, related trusts, or companies - Loans linked to tax avoidance arrangements - Only deducted if actually repaid. **Example**: A woman lends £200,000 to her brother, who later dies, leaving: - Estate: £600,000 house and £50,000 cash - £5,000 funeral expenses - If the debt is not enforced, it cannot be deducted, resulting in a taxable estate of £645,000. - If repayable, it would reduce the taxable estate to £445,000.

Answer 4

The Gifts with Reservation of Benefit (GROB) rules, introduced in the Finance Act 1986, aim to prevent inheritance tax (IHT) manipulation by addressing gifts where the donor retains a benefit: - **Purpose**: To stop individuals from giving away assets to reduce IHT liability while still enjoying personal use or benefit from those assets. - **Effect**: Property given away but retained for personal benefit by the donor is treated as part of the donor’s estate for IHT purposes. This ensures the property is taxed upon the donor’s death, unlike genuine gifts, which are only taxed as failed Potentially Exempt Transfers (PETs) if the donor dies within 7 years of making the gift.

Answer 5

The Gifts with Reservation of Benefit (GROB) rules, as set out in s 102 of the Finance Act 1986, apply to **a lifetime gift in two situations**: - **Condition 1**: The donee does not take “bona fide possession” of the property at or before the start of the “relevant period.” - **Condition 2**: During the “relevant period,” the property is not “enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor,” meaning the donor retains some benefit, whether by contract or otherwise. **Relevant Period**: - This is the seven-year period before the donor’s death (or a shorter period if the gift was made less than seven years before death). - Importantly, it is not simply the seven years after the gift is made; a gift may fall under GROB rules even many years later if the donor reacquires an interest in the property. This provision prevents donors from bypassing the GROB rules by temporarily giving up an interest in the property.

Answer 6

For a donee to have bona fide possession of a gifted property under GROB rules: - **Vested Interest**: They must obtain a vested, beneficial interest in the property. - **Actual Enjoyment**: They need to have actual enjoyment of the property, either through physical use (e.g., living in it) or by receiving income from it. - **Timing**: Possession and enjoyment must begin at the start of the relevant period. **Example**: If a donor transfers a home but lives in it rent-free while the donee lives elsewhere, the donee does not have bona fide possession. In contrast, if the donor pays market rent to stay, the donee achieves actual enjoyment.

Answer 7

Under GROB rules, the donor must be entirely or virtually excluded from benefiting from the property: - **Definition of "Virtually":** Though not statutorily defined, HMRC interprets “virtually” as “**to all intents**” or “as good as”. - **De minimis Benefits**: Minor benefits, like occasional social visits or brief overnight stays, may be acceptable without violating exclusion. - **Trusts**: If a gift is made into a trust and the donor is a potential beneficiary, a GROB arises regardless of whether the donor actually benefits. For discretionary trusts, including the donor as a beneficiary will trigger GROB.

Answer 8

The impact of reserving a benefit under GROB rules varies based on the duration of the benefit: - **Benefit at Death**: If the GROB subsists at the donor’s death, the property is treated as part of the donor’s estate for IHT, valued at the donor’s date of death. - **Benefit Ceased Before Death**: If the donor ceases to retain the benefit before death, it is treated as a PET from the date the reservation ended, taxable as a failed PET if the donor dies within seven years. However, this deemed PET doesn’t qualify for the Annual Exemption. **Note**: Potential double taxation can arise if both the original gift and the GROB are chargeable, but relief is available to prevent this.

Answer 9

The CGT consequences of making a GROB are as follows: **Donee's Ownership for CGT:** The property becomes the donee’s for CGT purposes, with the donor potentially paying CGT on any gains since they acquired it. **CGT on Donee’s Sale**: If the donee later sells the property, CGT is calculated on the increase in value from the gift date to sale, even if the donee had limited enjoyment until the GROB ceased or the donor died. **Gift at Death**: If the gift is made at death, no CGT is payable on gains accrued during the donor's life, and the donee inherits the property at its market value at death, benefiting from a CGT-free uplift. This “free CGT uplift” can incentivise holding off on valuable property gifts until death.

Answer 10

In this scenario, a man transfers legal title to his house worth £650,000 to his daughter while continuing to live in it until his death, resulting in a GROB, At the date of death the house is valued at £750,000: **Bona Fide Possession**: The daughter does not have bona fide possession as the donor continues to occupy the property. **Taxable Value at Death**: The house is included in the taxable value of the estate for Inheritance Tax (IHT) purposes at the date of death value of £750,000. **Capital Gains Tax (CGT):** No CGT was payable on the initial gift since it was the donor's main residence. The daughter's acquisition cost for CGT is £650,000. **Gain Accrued**: By the time of the man’s death, the daughter has accrued a gain of £100,000, despite not benefiting from the property. **CGT Uplift:** Had the gift occurred upon the man's death, the daughter would have inherited the property at the £750,000 value, benefiting from a CGT uplift and being able to sell it without CGT liabilities.

Answer 11

In this case, a man transfers legal title to his house worth £650,000 at the date of gift to his daughter but continues living in it until he moves into a care home five years before his death. At this date, the house is worth £700,000. His daughter rents out the house and receives the rental income. The house is worth £750,000 at the man's death. This leads to the following: **GROB Status**: Initially, a GROB exists as the donor retains enjoyment of the property. This status ceases when he moves out, allowing the daughter to benefit from rental income. **Failed PET**: The transfer is treated as a failed Potentially Exempt Transfer (PET) valued at £700,000 at the time he moved out. **No Annual Exemption (AE) is available for this transfer.** **Acquisition Cost**: The daughter’s acquisition cost remains £650,000, and she does not benefit from a CGT uplift. **Rental Income**: Unlike the previous example, the daughter benefits from rental income after the GROB ceases, but this income is subject to income tax. At the time of the donor's death, the property is worth £750,000.

Answer 12

The Pre-Owned Assets Charge (POAC), introduced in the Finance Act 2004 (FA 2004), is an annual income tax charge imposed on individuals who give away certain types of property but later obtain benefits from that property. **Purpose**: The POAC aims to prevent individuals from exploiting loopholes in the GROB rules that allow them to remove the value of their homes from their estates for Inheritance Tax (IHT) while continuing to live in them rent-free. **Application**: The POAC does not apply to property that remains within the individual’s estate for IHT purposes. Therefore, property cannot be taxed under both the GROB rules and the POAC simultaneously. **Election**: Individuals can elect for property to be taxed as a GROB instead of a POAC, depending on their personal circumstances and a comparison of their income tax and IHT positions. **Terminology**: Although sometimes referred to as the ‘pre-owned assets tax’ (POAT), this term is not strictly accurate as it is not a separate tax.

Answer 13

The Pre-Owned Assets Charge (POAC), as set out in s 84 and Sch 15 of the Finance Act 2004, applies to three different types of property: **Land**: The POAC can apply to any real property transferred away while the donor continues to derive a benefit from it. **Chattels**: This includes movable personal property that may be given away but from which the donor retains benefits. **Intangible Property:** Specifically refers to property held in a settlor-interested trust, meaning any property that is not classified as land or chattels. Examples include: - Cash - Bank account credits - Shares The rules governing each type of property are different, and specific circumstances can lead to a transaction being excluded from the POAC. Notably, other exemptions and reliefs exist to prevent individuals from being subject to both Inheritance Tax (IHT) and the POAC. There are also de minimis and territorial exemptions, which prevent the POAC from applying to individuals who are resident or domiciled outside the UK.

Answer 14

For land to be subject to the Pre-Owned Assets Charge (POAC), two conditions must be satisfied: **Occupation Condition**: An individual occupies the land (either individually or with others). This condition is broadly interpreted, and the assessment is based on the specific facts of each case, as there is no statutory definition of "occupation." **Disposal or Contribution Condition**: Either the individual has disposed of the occupied land or has contributed (directly or indirectly) towards its acquisition without obtaining a beneficial interest. If the POAC applies, the benefit received through occupation is treated as income. The individual pays income tax on the equivalent of the market rent they would have had to pay for occupying the land. **Example**: A woman lives in her solely-owned house with her adult daughter. On her daughter’s 40th birthday, the woman transfers legal ownership of the house to her daughter, but they continue living together. In this scenario, both the occupation and disposal conditions are met. The woman must pay the POAC based on the market rent for the property, although she could elect into the GROB regime instead.

Answer 15

For chattels to be subject to the Pre-Owned Assets Charge (POAC), the following conditions must be satisfied: **Possession or Use Condition:** The individual must be in possession of or have use of the property. Similar to land, there is no statutory definition of "possession" or "use," making it a matter of fact for HMRC to determine. **Contribution Condition**: The individual must have contributed (directly or indirectly) to the acquisition of the chattel without obtaining a beneficial interest. If the POAC applies to a chattel, income tax is calculated by taking the market value of the chattel and multiplying it by an official rate of interest. **Example**: A man gifts shares to his sister, who immediately sells them and uses the proceeds to buy a car. The man then uses this car to commute to work daily. In this case, the possession condition is satisfied since the man has use of the car. The contribution condition is also met as the car was indirectly acquired using the gifted shares. Therefore, he must pay the POAC, calculated based on the official rate of interest on the car’s market value. This situation does not allow for electing into the GROB regime.

Answer 16

For the Pre-Owned Assets Charge (POAC) to apply to settlor-interested trusts, the following two conditions must be satisfied: **Settlor-Interested Trust Requirement:** The trust must be settlor-interested, meaning that the trust property is, will, or may become payable to or for the benefit of the settlor. **Examples** include discretionary trusts where the settlor is an object and trusts in which the settlor has a remainder interest. **Intangible Property Requirement:** The trust property must include intangible property that was settled into the trust by the individual at its creation or subsequently added by them. This property includes the invested proceeds of the original settled property and must have been settled or added after 17 March 1986. If the POAC applies, it is calculated by reference to the official interest rate that would be payable on the settled property, with credit for any income tax or CGT paid under other anti-avoidance rules.

Answer 17

The Pre-Owned Assets Charge (POAC) does not apply to 'excluded transactions,' which are generally equivalent to other inheritance tax exemptions and specifically pertain to land and chattels. The exclusions include: **Transfers to Spouse or Civil Partner**: Transfers made to the individual’s spouse or civil partner are exempt from the POAC. **Family Maintenance Dispositions**: Gifts qualifying for family maintenance allowance are exempt from POAC, regardless of whether they meet the disposal or contribution condition. **Annual and Small Gift Exemptions**: Gifts qualifying for annual or small gift exemptions are not subject to the POAC, irrespective of whether they would meet the disposal or contribution condition. **Arm’s Length Sales:** Disposals made at arm’s length to unconnected persons do not satisfy the disposal condition. **Occupation Post Seven Years:** If the contribution condition is satisfied more than seven years before the occupation or possession condition, the POAC does not apply.

Answer 18

The General Anti-Abuse Rule (GAAR) was enacted in the Finance Act 2013 to combat a wide range of **aggressive tax avoidance** across various taxes, not limited to inheritance tax (IHT). The key aspects of GAAR are as follows: **Intent**: It targets arrangements that are contrary to the spirit or policy of tax law, exploit perceived loopholes, or involve artificial arrangements aimed at avoiding tax. **Counteraction Requirement**: When arrangements are caught by the GAAR, the taxpayer who benefits from the tax advantage must counteract the abusive effect of these arrangements by making “just and reasonable” adjustments. **Penalties**: To deter such arrangements further, a penalty of 60% of the counteracted amount is imposed on the taxpayer. **Independent Review**: Decisions made by HMRC regarding the application of the GAAR can be referred to an independent GAAR Advisory Panel for determination, ensuring an external review process of HMRC's decisions.

Answer 19

The General Anti-Abuse Rule (GAAR) applies when the following conditions are satisfied: **Tax Advantage:** There is an arrangement that gives rise to a tax advantage, which can involve a reduction, deferral, or complete avoidance of tax. HMRC compares the result with the tax consequences of a hypothetical transaction that the taxpayer would likely have engaged in without the arrangements. **Applicable Tax**: The tax advantage must relate to a tax to which the GAAR applies, including inheritance tax (IHT). **Main Purpose Test**: The arrangement must satisfy the ‘main purpose’ test, where it is reasonable in all circumstances to conclude that obtaining a tax advantage is the main or one of the main purposes of the arrangement. **Abusive Arrangement**: The arrangement is considered abusive if HMRC can demonstrate that entering into it “cannot reasonably be regarded as a reasonable course of action” concerning the relevant tax provisions, taking all circumstances into account. This is referred to as the ‘double reasonableness test’.

Answer 20

The Disclosure of Tax Avoidance Scheme (DOTAS) was introduced in the Finance Act 2004 as a reporting regime aimed at making HMRC aware of potentially unacceptable tax avoidance arrangements at an early stage. It applies to a range of taxes, including inheritance tax (IHT). The key responsibilities under DOTAS include: **Duties of Promoters**: Primarily, DOTAS places duties on the ‘promoters’ of tax avoidance arrangements to inform HMRC about notifiable arrangements or proposals. This obligation can extend to legal advisers. **Scheme Reference Number**: Once notified, HMRC may allocate a scheme reference number to the arrangements. Promoters (and their clients) are then required to communicate this number to all parties involved in the arrangements. **Client Information:** Promoters must provide HMRC with information regarding any clients to whom they offer services related to the notifiable arrangements. **Obligations of Parties:** All parties involved in notifiable arrangements must also provide information to HMRC. **Investigation Powers**: HMRC has the authority to investigate and enforce compliance under DOTAS. **Penalties for Non-Compliance:** There are penalties for failing to comply with DOTAS, although such non-compliance is not considered a criminal offence.

Answer 21

Under section 306(1) of the Finance Act 2004, arrangements concerning inheritance tax (IHT) are deemed notifiable if any of the following conditions are satisfied: **Prescribed Descriptions**: The arrangements fall within any description that has been prescribed by HM Treasury through regulations. These prescribed descriptions are commonly referred to as ‘hallmarks.’ **Tax Advantage Expectation:** The arrangements might be expected to enable any person to obtain a tax advantage that relates to a relevant hallmark. **Main Benefit of the Arrangement**: The arrangements are structured such that the main benefit, or one of the main benefits, expected to arise from them is the obtaining of the identified tax advantage. It is important to note that the hallmarks differ based on the type of tax involved, with three specific hallmarks applicable to IHT. This module primarily focuses on the specific hallmark relevant to IHT, while acknowledging that there are two more general hallmarks that also apply in practice.

Answer 22

**Two conditions must be satisfied** for the IHT hallmark to apply: **Main Purpose of Arrangements**: The main purpose, or one of the main purposes, of the arrangements is to enable a person to obtain one or more specific advantages concerning IHT. The specific advantages include: - Avoidance or reduction of specified IHT charges relating to trusts and gifts to close companies (which are outside the scope of this module). - Avoidance or reduction of charges arising under the GROB rules, unless the arrangement instead gives rise to the POAC. - Reduction in the value of an individual’s estate that does not give rise to a chargeable transfer or potentially exempt transfer (PET). **Contrived or Abnormal Steps**: The arrangements involve one or more contrived or abnormal steps without which there would be no tax advantage. This indicates that the arrangements are not straightforward or typical.

Answer 23

HMRC guidance specifies that ordinary inheritance tax (IHT) planning will not be notifiable under DOTAS. The following are therefore not notifiable: - Ordinary outright gifts, even if exempt. - Executing a will, deed of variation, or disclaimer that results in an IHT exemption. - Acquisition of property that qualifies for statutory relief or a transfer specifically provided for in IHT legislation. Conversely, certain arrangements may be notifiable under the IHT hallmark, including: - Creation of a reversionary lease to the lessor's children that starts so far in the future that the lessor would not be expected to be alive. - Creation of an employee benefit trust to benefit the settlor's children after the settlor’s death. - Settlement of shares qualifying for Business Property Relief (BPR) with an arrangement to sell them back to the settlor—this may be notifiable depending on specific circumstances.

Answer 24

For IHT purposes, the cottage is treated as part of the woman’s taxable estate and is valued at £500,000. For CGT purposes, the woman disposes of the cottage for £300,000, resulting in a gain of £100,000. Her daughter acquires the cottage at its market value of £300,000. The gift is a GROB which does not cease before the woman’s death so it is treated as part of her taxable estate for IHT purposes. It is also a potentially exempt transfer but it is not reassessed because it was made more than 7 years before the woman’s death, so it is not reassessed when the woman dies. The lifetime gift is treated as a disposal for CGT purposes, meaning the woman has made a gain (which will be chargeable because it’s not her main residence) and her daughter does not benefit from the free CGT uplift.

Answer 25

£690,000 The woman’s assets are worth £800,000. The funeral expenses and loan are deducted to reach a figure of £740,000. As the loan is deducted from the value of the shares (reducing them to £50,000) only £50,000 can be deducted for BPR. This results in a figure of £690,000.

Answer 26

Aggressive tax avoidance is countered by HMRC taking a purposive approach to tax legislation as well as enacting and utilising a range of targeted and general anti-avoidance rules. The following are the key IHT anti-avoidance rules you need to know: - **Restriction on deduction of loans for IHT purposes** – These rules prevent individuals manipulating the rules on deducting debts to artificially reduce their IHT liability. - **Gifts with reservation of benefit (‘GROB’) ** rules –These rules prevent individuals manipulating the PET rules by giving away property but retaining an interest in it. - **Pre-owned assets charge (‘POAC’)** – This is an income tax charge which complements the GROB rules by preventing individuals using assets which they have given away (or contributed towards). - **General anti-abuse rule (‘GAAR’)** – This is an extremely wide measure that penalises aggressive tax avoidance. - **Disclosure of Tax Avoidance Schemes (‘DOTAs’)** – This is a reporting regime that helps HMRC identify and monitor potential tax avoidance at an early stage.

Answer 27

The simple objective of inheritance tax (IHT) planning by will is to minimise the tax liability on a person’s death, ensuring the greatest provision for their surviving family. When drafting a will with this objective, the following considerations are typically taken into account: **Exempt Beneficiaries & Qualifying Assets**: Identifying beneficiaries who are exempt from IHT and assets that qualify for relief or exemption. **Allocation of Exemptions:** Strategically allocating available IHT exemptions to maximise the benefit to beneficiaries. **Nil Rate Band**: Understanding and applying the nil rate band, which is the threshold below which no IHT is charged, to ensure the full advantage is taken. **Trusts**: Considering the use of trusts to manage the distribution of assets, potentially reducing the IHT liability by placing assets outside the individual’s estate.

Answer 28

When a person dies, there are two kinds of beneficiaries who are exempt from Inheritance Tax (IHT) purposes: - **Spouse/Civil Partner of the Deceased**: Transfers to a spouse or civil partner are exempt from IHT, ensuring that any assets passed to them do not incur tax liability. - **Charities**: Gifts to registered charities are also exempt from IHT, which can be advantageous in estate planning. When drafting a will, it is essential for clients to be made aware of the exempt status of these beneficiaries, as it may significantly impact the drafting of their will. Understanding this status helps in structuring the will to minimise tax liabilities effectively. **Note**: All rules that apply to spouses and marriage apply equally to civil partners and civil partnerships.

Answer 29

Gifting assets to a spouse or civil partner is tax efficient, as all gifts to a spouse are exempt from Inheritance Tax (IHT). The key points regarding this exemption include: - **Scope of Relief**: The relief applies to specific gifts as well as the gift of residue, meaning the remaining estate after other gifts have been made. - **Value of Relief**: The amount of the relief is 100% of the value of the items inherited by the surviving spouse. - **Tax Advantage**: While leaving assets to a spouse offers a significant advantage in eliminating IHT charges, this exemption is beneficial only if the client’s estate would otherwise be taxable. **For instance:** In the case of A and B, with A's estate valued at £200,000 and B's at £50,000, neither estate is taxable due to the nil rate band (NRB), so no IHT is saved despite the exemptions available. In contrast, C, with an estate of £340,000, wishes to leave assets to their sister (S), but if done outright, there would be a small IHT liability. Instead, C can leave £325,000 to S and the remainder to their civil partner (D), benefiting from the civil partner exemption, thereby eliminating the IHT charge and simplifying the administration of the estate.

Answer 30

When advising unmarried couples, it is crucial to discuss the benefits of spouse exemption as part of their tax planning strategies. **Tax Planning Advice:** Encouraging the couple to consider marriage may be one of the best tax planning strategies they can adopt, as spouse exemptions for IHT apply only to married couples or civil partners. **Impact of Marital Status**: It is essential for clients to understand that the benefit of spouse exemption on death is forfeited if the client is no longer married at that time. Therefore, marital status can significantly affect IHT liability. **Domicile Considerations**: If either partner in a married couple is domiciled outside the UK, the application of spouse exemption may be more limited. Clients in this situation should receive specific legal advice to understand the implications for their estate planning.

Answer 31

**Tax Efficiency**: Gifts to qualifying charities made by will are exempt from IHT, providing significant tax efficiency for clients. **Scope of Relief**: The relief applies to both specific gifts and the gift of residue, allowing clients to leave 100% of the value of items inherited by the charity free from IHT. **Condition for Relief**: Charity exemption offers tax savings only if IHT would be payable on the estate following the distribution of assets upon death. **Qualifying Charities**: It is essential to verify whether the charity qualifies for relief. Most charities registered with the Charity Commission will meet the criteria, but unregistered charities or those abroad require careful consideration. **Effective Drafting**: Ensuring that the legacy to the charity is effectively drafted is crucial, as poor drafting can result in the gift failing and no IHT relief being claimed

Answer 32

**Full Exemption:** A gift to a charity by will is fully exempt from IHT. **Reduced Rate Benefit**: If a testator leaves 10% or more of their net estate to charity, the chargeable part of the estate may qualify for a reduced IHT rate of 36% instead of the standard 40%. **Definition of Net Estate**: The 'net estate' for this purpose includes the assets in the succession estate as well as additional items, such as assets passing by survivorship. **Practical Implications**: If a testator leaves 8% to charity, the remainder of the estate (above the nil rate band) is taxed at 40%. In contrast, leaving 10% to charity results in the remaining estate being taxed at 36%. **Tax Efficiency Strategy**: Testators can increase the amount of the charitable gift without reducing the amount received by non-exempt beneficiaries after tax. The increase is offset by the tax savings from the lower tax rate, benefiting both the charity and the estate.

Answer 33

Types of Qualifying Assets: **Business Property**: - Must have been owned by the deceased for a minimum of 2 years prior to death. - Business Property Relief (BPR) applies, offering either 100% or 50% relief on the value of the assets. **Agricultural Property**: - Must also have been owned by the deceased for a minimum of 2 years prior to death. - Agricultural Property Relief (APR) provides either 100% or 50% relief on the agricultural value of the assets. **Ownership Requirement:** The client must own qualifying assets at the date of their death (not just at the date of their will) for relief to apply. **Advisory Note:** Clients with qualifying assets should be made aware of the criteria to prevent changes that could render the relief inapplicable, such as selling the assets before death.

Answer 34

Drafting Considerations: - The will should be structured to ensure that the estate is distributed in a tax-efficient manner, assuming it includes qualifying assets at death. - **APR** and **BPR** only provide a tax saving if IHT would otherwise be payable. **Example Illustrations**: Example 1: A’s taxable estate is £300,000 (including agricultural land worth £20,000). Since the estate is within the nil rate band (NRB), APR has no effect. Example 2: B’s taxable estate is £500,000 (including business assets worth £200,000). Without BPR, IHT payable is £70,000. If BPR applies at 100%, no IHT is due as the taxable estate reduces to within the NRB.

Answer 35

**Tax Planning Focus**: Most tax planning regarding the gift of qualifying assets by will occurs when clients wish to leave part of their estate to exempt beneficiaries, such as a spouse or charity. **Complex Interaction**: The interaction between beneficiary exemption and asset relief can be complicated, necessitating careful consideration to maximise the benefits of both. **Different Will Structures**: **Specific Gifts**: A specific gift of qualifying assets to an exempt beneficiary can have different tax implications compared to a gift of residue that includes qualifying assets. **Strategic Considerations**: It is crucial to navigate these complexities to ensure full utilisation of available tax reliefs and exemptions in estate planning.

Answer 36

**Wastage of Relief**: If a specific gift of qualifying assets is made to an exempt beneficiary (e.g., a spouse), both Agricultural Property Relief (APR) and Business Property Relief (BPR) may be wasted. For example, a gift stating, “I give my shares in X Ltd to my spouse” results in the relief attaching to the assets, not applied generally to the estate, leading to lost opportunities for tax-free gifts to non-exempt beneficiaries. **Future Qualification Concerns**: There is no guarantee that the assets qualifying on the testator’s death will still qualify on the death of the surviving spouse, making it preferable to utilise the relief upon the testator's death. **Advisory Note**: Clients should be advised against making specific gifts of qualifying assets to exempt beneficiaries from a tax planning perspective, but there may be practical reasons for doing so.

Answer 37

**Discretionary Trust Solution**: Instead of making a specific gift of qualifying assets directly to an exempt beneficiary, a testator may opt to gift these assets to a discretionary trust, which is considered a non-exempt beneficiary. This allows for the claim of BPR or APR while still addressing the needs of the exempt beneficiary. **Benefits for the Spouse**: By naming the testator's spouse as one of the beneficiaries of the discretionary trust, they can still benefit from the trust assets without inheriting them directly. **Tax Implications**: The value of the trust assets remains outside the taxable estate of the surviving spouse, as they are treated as a discretionary trust beneficiary and not the owner of the trust assets. **Practical Considerations**: This approach provides a balance between tax efficiency and fulfilling the testator’s desire for the spouse to have access to the necessary assets, particularly if there is no appropriate chargeable beneficiary available.

Answer 38

**Residue and Relief Application**: If qualifying assets are not specifically gifted and instead fall into the residuary estate, APR and BPR do not attach to those assets as per section 39A of the Inheritance Tax Act (IHTA). **Apportionment of Relief**: The benefit of the relief is apportioned generally between taxable and non-taxable beneficiaries, which leads to different results depending on the method of inheritance: - **Specific Gift**: Relief may be lost if an exempt beneficiary inherits through a specific gift. - **Gift of Residue**: If an exempt beneficiary inherits through the residuary estate, relief may also be wasted. **Wastage of Relief**: APR and BPR are wasted when apportionment allocates some or all of the relief to an exempt beneficiary. This can occur if: - All or part of the residuary estate containing qualifying assets passes to an exempt beneficiary, typically the testator’s spouse. - The residue contains qualifying assets along with a specific gift of non-qualifying assets (like a cash legacy) to an exempt beneficiary, such as a charity.

Answer 39

All gifts to a spouse or charity are exempt from IHT and are a tax efficient method of giving away assets by will. If a testator gives away 10% or more of their estate to charity, the chargeable part of the estate qualifies for a reduced rate of IHT at 36%. Owning assets which qualify for APR or BPR provide an opportunity for a testator to make tax-free gifts to otherwise taxable beneficiaries. By s 39A IHTA BPR/APR attaches to the qualifying assets where they are given away specifically, but, where the assets form part of residue, the reliefs are apportioned generally between exempt / non-exempt beneficiaries as a whole. APR/BPR are wasted to the extent the relief applies to a gift to an exempt beneficiary. This may occur where a specific gift of qualifying assets is made to an exempt beneficiary, or, as a result of apportioning the relief generally where the qualifying assets form part of the testator’s residuary estate. The relief applies to specific gifts and to the gift of residue The amount of the relief is 100% of the value of the items inherited by the surviving spouse It is clear that there is an advantage to leaving assets to a spouse and many clients may wish to leave assets to their spouse as a method of eliminating the charge to IHT. However, spouse exemption only offers a tax saving if the client’s estate would otherwise be taxable.

Answer 40

**Context of Taxable Estates**: This scenario arises when IHT is payable on the testator’s estate, but some assets are passing to exempt beneficiaries. **Statutory Rules:** - Specific statutory rules ensure that exempt beneficiaries are not taxed on their gifts. - The effect of these rules can vary significantly based on how the will is drafted. **No Issues for Certain Estates**: There are no particular issues if: - No IHT is payable because the estate value is below the Nil Rate Band (NRB) or below the NRB after applying all exemptions and reliefs. - IHT is payable, and all gifts in the will are made to chargeable beneficiaries, as IHT is typically paid from the residue unless the testator specifies otherwise.

Answer 41

**Exempt Beneficiaries**: - Spouse or civil partner of the deceased. - Charities. **Basic Principle**: All gifts to exempt beneficiaries are made free of IHT, meaning they receive their inheritance without any direct IHT cost applied to their gift. **Statutory Rules**: Determine the allocation of exemptions and may influence the testator’s instructions regarding their will. **Impact of Will Wording**: Express wording within the will can significantly affect how IHT is calculated.

Answer 42

Specific Gift to Exempt Beneficiary with Residue to Chargeable Beneficiary: - Example: £100,000 to spouse; residue to child. - Outcome: Only the residue is subject to IHT, paid from residuary funds. - Spouse receives £100,000 tax-free. - Child receives the remaining amount after IHT is deducted from the residue. Specific Gift to Exempt Beneficiary with Residue to Chargeable and Exempt Beneficiaries: - Example: £100,000 to spouse; residue divided equally between charity and children. - Outcome: Only part of the residue is subject to IHT (the charitable gift is disregarded). - IHT is calculated on the children's share, which is paid from this amount. - Spouse receives £100,000 tax-free. - Charity receives half of the residue. - Children receive the other half of the residue after IHT has been deducted.

Answer 43

Specific Gift to Chargeable Beneficiary (Subject to Tax) with Residue to Exempt Beneficiary: - Example: £400,000 to child (subject to tax); residue to spouse. - Outcome: Only the specific gift is subject to IHT; IHT is paid from the legacy amount. - Child inherits £400,000 minus the tax due. - Spouse inherits the residue without any IHT deduction. Specific Gift to Chargeable Beneficiary (Subject to Tax) with Chargeable and Exempt Beneficiaries: - Example: £100,000 to daughter (subject to tax); residue divided equally between spouse and son. - Outcome: Spouse’s share of the residue is exempt from IHT. - IHT due is apportioned between the legacy to the daughter and the son’s share of the residue. - Daughter receives the legacy with IHT deducted (i.e., less than £100,000). - Son receives a share of the residue with tax deducted (i.e., less than the spouse’s share).

Answer 44

Specific Gift to Chargeable Beneficiary (Free of Tax) with Residue to Exempt Beneficiary: **Example**: £350,000 to son specified as “free of tax”; residue to spouse. **Outcome**: - The son receives the full amount of £350,000 without IHT deductions, rather than a smaller sum. - The true value of the gift is £350,000 plus the IHT attributable to the legacy; this requires "grossing-up" for accurate calculation of IHT, which is outside this module's scope. £350,000 is paid directly to the son, while the IHT is covered by other funds. - The residue, which passes to the spouse, will be reduced because IHT is deducted from this part of the estate. - Importantly, drafting gifts as “tax-free” does not reduce overall tax liability; in fact, it can lead to more IHT payable since grossing-up applies and can increase the proportion of the estate subject to tax.

Answer 45

Double Grossing-Up: A calculation method required in certain will scenarios where: - Specific gifts are made to chargeable beneficiaries, along with a gift of part of the residue to an exempt beneficiary. - Specific gifts to chargeable beneficiaries include some that are designated as “free of tax” and some that are not. Key Points: - This process involves complex calculations to ensure accurate IHT liability. - It is advisable to avoid drafting wills that necessitate double grossing-up due to the complexity involved.

Answer 46

All gifts to a spouse or charity are exempt from IHT and are a tax efficient method of giving away assets by will. There are statutory rules that determine how the benefit of the exemption applies where an estate is divided between exempt and non-exempt beneficiaries and IHT is payable. The overall effect of the rules is to ensure that exempt beneficiaries do not suffer the burden of the IHT payable in respect of the assets passing to the non-exempt beneficiaries. Where IHT is payable as a result of specific gifts to non-taxable beneficiaries which are made “free of tax” and the residue passes to an exempt beneficiary, the amount of the specific legacy needs to be grossed-up before the IHT due can be calculated.

Answer 47

Importance of Maximising NRB: - Ensures clients minimise Inheritance Tax (IHT) liabilities on their estates. - Relevant when taking instructions for a will, particularly for clients with taxable estates. Key Considerations: - Assess the extent to which a client ‘uses’ their NRB to optimise their estate planning. - Consider drafting a gift specifically for the NRB amount to enhance tax efficiency. - Distinctions must be made between the considerations for married couples and unmarried couples, as their tax implications differ significantly.

Answer 48

'Using' the NRB refers to transfers made to non-exempt beneficiaries, taxed at 0% within the NRB limit. Key points include: - **No use** of NRB if the entire estate is left to an exempt beneficiary, resulting in a taxable value of zero. - **Partial use** of NRB occurs if the estate's total value is less than the NRB or gifts to non-exempt beneficiaries are below the NRB. - **Full use** of NRB happens when gifts to non-exempt beneficiaries exceed the NRB. IHT is payable only when the NRB is fully utilised. Married clients can choose how much NRB to use by leaving their estate entirely to their spouse or making gifts to non-exempt beneficiaries.

Answer 49

When planning for estate distribution, married couples often wish to leave assets to each other and then to their children. Important strategies include: - Leaving the whole estate to the spouse to utilise the spouse exemption without using the NRB. - Making gifts to non-exempt beneficiaries and allocating the remainder to the spouse, which may result in partial or full use of the NRB. - Clients typically aim to reduce the overall IHT burden for their family, focusing on long-term benefits to ensure more assets pass to children or grandchildren. - The will drafter must consider the IHT implications for the couple's combined estate following their deaths.

Answer 50

Before 2007, a spouse could not transfer their unused NRB to the survivor, resulting in potential wastage. Key points include: - If a testator left their entire estate to their spouse, none of the NRB was used, as the estate qualified for spouse exemption. - For example, if A left their £500,000 estate to B, A’s NRB was wasted when B inherited everything. - Upon B’s death, their estate would be taxed as it included A’s assets plus their own, resulting in a taxable estate of £1 million subject only to B’s NRB. - To prevent wastage, A could gift an amount equal to the NRB to a non-exempt beneficiary or trust, allowing both NRBs to be used effectively, minimising overall IHT liability.

Answer 51

The 2007 introduction of transferable NRB allowed the survivor to claim both their own NRB and any unused proportion of their spouse's NRB, reducing prior concerns about wastage. - The survivor’s entitlement to both NRBs means that it is no longer crucial for the first spouse to utilise their NRB before death. - As long as the survivor dies after the introduction of transferable NRB, they can access the unused NRB of the deceased spouse. - This change simplifies estate planning, allowing for greater flexibility in how assets are passed and ensuring that tax liabilities are minimised for the family as a whole.

Answer 52

In a scenario where one spouse (A) leaves their entire estate to their spouse (B), no NRB is used initially due to spouse exemption. When B later dies, the following applies: - B’s estate, including assets inherited from A, is valued at £650,000. - B’s estate passes to non-exempt beneficiaries (e.g., children) but is entitled to both A’s and B’s NRBs. - The combined NRB (£325,000 + £325,000) covers the entire estate. - **Result**: No IHT is due, and no NRB is wasted.

Answer 53

A client might choose to use their NRB, rather than leaving everything to their spouse, for various reasons, including: - Desire to benefit non-spouse beneficiaries (e.g., children or others). - Preventing the surviving spouse from controlling all family assets, particularly if there are children from a previous marriage. - Keeping the survivor's estate smaller to reduce assets assessed for care home costs or to retain eligibility for the residence NRB if their combined estates exceed £2M. - Anticipated asset growth that may outpace increases in the NRB. - Insufficient assets for the survivor to fully use a transferred NRB.

Answer 54

A client might opt to preserve their NRB if they expect it to increase by the survivor's death, as leaving everything to a spouse allows flexibility and potentially greater tax efficiency. **Will 1 Structure**: £NRB to children and the remainder to the spouse. - If the NRB is £325,000 at the first death and increases to £400,000 by the survivor’s death, the total NRB for combined estates is £725,000 (£325,000 + £400,000). **Will 2 Structure**: Entire estate to spouse. - By transferring 100% of the unused NRB to the spouse, the NRB is calculated at the time of the survivor’s death. With a £400,000 NRB, the combined estates have a total NRB of £800,000, maximising tax efficiency if the NRB increases. This approach can allow a larger NRB application for combined estates, reducing IHT liability and potentially increasing the inheritance passed to beneficiaries.

Answer 55

Unmarried couples do not qualify for spouse exemption, so IHT applies on both the first and second deaths if their estates exceed the NRB. This can lead to ‘**bunching**,’ where the survivor’s estate combines their own assets and those inherited from the first to die, potentially resulting in double taxation on inherited assets. Example: **Scenario 1**: * A dies leaving an estate worth £500,000 to B. * IHT payable: £70,000 (£500,000 – NRB of £325,000. Balance of £175,000 @ 40%) * Assume B dies leaving an estate worth £830,000 (residue of £430,000 from A plus £400,000 of B’s own assets) to their children. * IHT payable: £202,000 (£830,000 – NRB of £325,000. Balance of £505,000@ 40%) **Scenario 2**: A dies leaving an estate worth £500,000 to a discretionary trust. B and the children are the trust beneficiaries. * The discretionary trust is not exempt so all of A’s estate is taxable. IHT of £70,000 is payable as per Scenario 1. * B dies leaving an estate worth £400,000 to their children. * IHT payable on B’s death is: £30,000 (£400,000 - NRB of £325,000. Balance of £75,000 @ 40%). - Total IHT paid: £100,000.

Answer 56

If one partner’s estate is below the NRB and they die first, part of their NRB is wasted. To prevent this, the wealthier partner might make lifetime transfers to balance the estate values, ensuring the NRB is used fully by both estates regardless of the order of death. Approach: - Transfer assets during the wealthier partner’s lifetime to equalise the estates. - Each partner should then create wills that benefit the other. - This approach maximises NRB usage and minimises tax, as both estates will be able to claim the full NRB in any order of death.

Answer 57

The criteria for claiming the RNRB are: - **Qualifying residential interest**: The property must qualify. - **Left absolutely**: The property must be transferred without conditions. - **To lineal descendants**: The beneficiaries must be children, grandchildren, etc. Additional considerations include: - If a specific gift of property is made or if the property is part of the general residue shared with non-lineal descendants, this complicates RNRB application. - The property must pass directly to lineal descendants; if there is an age contingency attached, and the beneficiary is under this age at death, the RNRB may not apply. - RNRB may not apply if property is left in certain types of trust. - The tax savings from RNRB should align with the client's overall objectives.

Answer 58

The RNRB is subject to tapering for estates valued at more than £2 million. Key implications for clients include: - Clients with estates exceeding this threshold may have a reduced RNRB, impacting potential tax savings. - If a client owns residential property and wishes to benefit lineal descendants, they must structure their will effectively to ensure eligibility for the RNRB. - Advising clients on how to allocate their residential property in their wills can help maximise tax efficiency and support their estate planning goals.

Answer 59

When drafting gifts of the NRB to non-exempt beneficiaries, it is important to: **Identify intent**: Clearly specify what is intended with the gift. **Avoid fixed sums**: A fixed sum gift (e.g., “I give the sum of £325,000 to my daughter”) is not advisable because: - If the testator does not have a full NRB available at death, part or all of the gift may become taxable unintentionally. - The NRB may increase over time; thus, a fixed sum may miss the opportunity to utilise the tax-free amount fully. A formula clause is preferred, such as: - “I give as much of my nil rate band as is available to my daughter.” - However, clarity on the NRB definition is essential, as it may refer to: NRB transferred from a pre-deceased spouse Residence Nil Rate Band (RNRB) and any transferred RNRB

Answer 60

Testators can maximise the use of their NRB by considering the following: **Opt for a comprehensive formula clause:** Instead of capping the gift, use a clause that encompasses all possible NRB amounts to maximise tax efficiency. **Balance with other estate planning objectives**: A testator who wants to ensure the maximum NRB utilisation often drafts the clause before any residue is paid to their spouse, compared to those wishing to limit the beneficiary’s amount. **Clarify intended gifts**: Understand the difference between gifting the NRB itself and gifting the maximum amount allowable without tax, as the latter may be greater than the NRB alone.

Answer 61

- A married testator should consider whether or not to make use of their NRB in the event they pre-decease their spouse. -The first of a married couple to die may leave everything to the survivor and avoid using their NRB, which can be transferred to the survivor and claimed on their death instead. The amount of the transferred NRB is determined on the second death. -There are practical reason why a married client may not want to leave their whole estate to their surviving spouse. -An unmarried couple may want to ensure that both NRBs are used in full, and prevent assets inherited from the first of them to die being taxed again as part of the estate of the second to die. - If a client wishes to make use of the residence nil rate band, the will must be carefully drafted to ensure that the qualifying criteria can be met. - When drafting a gift of the nil rate band, a formula clause should be used instead of specifying a fixed sum. The wording of a clause should make the value of the gift clear; will it include or exclude any transferred or residence NRB?

Answer 62

**Trust Structure**: A trust lacks separate legal personality, so a gift into trust is a transfer to the trustees, who become the legal owners of the trust assets (the trust fund). The beneficiaries hold the equitable and beneficial interests. **Types of Gifts**: The testator can leave: - A specific gift of cash or assets, or - The whole or part of the estate residue to the trust. **Adding to Existing Trusts**: If adding to a pre-existing trust, the will must identify the specific trust receiving the assets. **Creation of New Trusts**: More commonly, a new trust is created in accordance with the terms of the testator’s will, coming into existence upon their death. This approach allows the testator to control asset distribution and potentially manage estate tax implications for the beneficiaries.

Answer 63

Clauses in a will can either create a new trust or add to an existing one: **Creating a New Trust**: - A clause like “I give the sum of £325,000 to my Trustees to hold on trust in accordance with the following terms…” establishes a new trust. - Detailed provisions follow this clause in the will. - Often, the same individuals are appointed as both executors and trustees. **Adding to an Existing Trust**: - A clause like “I give my Residuary Estate to the trustees of the ABC Family Settlement to hold in accordance with its terms” adds to an existing trust. - No further detailed provisions are needed in the will. **Assumption**: The will is professionally drafted, and any gift into trust meets legal validity requirements.

Answer 64

A trust created on death by a testator’s will is known as a ‘will trust,’ with the following characteristics and drafting requirements: **Key Roles**: - Will serves as the trust deed. - Testator is the settlor. - Trust Commencement occurs on the testator’s death, when the will’s provisions become operative (not when the will was executed). **Drafting Requirements** - Express wording in the will must: - Outline the terms of the trust. - Appoint trustees. - Identify beneficiaries. - Specify which part of the estate the trust applies to. - Define the scope of trustees’ powers.

Answer 65

For tax planning purposes there are four main types of will trust you are likely to see: **Discretionary Trust**: A trust for the benefit of a group of beneficiaries, none of whom have any fixed right to trust assets. The trustees have absolute discretion over capital and income i.e. when, how much and to whom any distributions should be made **Life Interest Trust**: A trust for the benefit of a life tenant (entitled to income during their lifetime) and the remainderman (entitled to capital when the life interest ends, usually on the death of the life tenant). The trustees do not have complete discretion over distributions from the trust fund. **Trusts for young people**: Trusts that benefit of the testator’s children. **Trusts for disabled people**: Trusts that provide for those with physical or mental disabilities.

Answer 66

Although creating a discretionary will trust does not offer immediate IHT savings for the testator (or their estate), it can have long-term tax benefits for beneficiaries: **No Immediate IHT Savings**: - Compared to an outright gift, there’s no immediate IHT reduction. - No Spouse Exemption applies, even if a spouse is a beneficiary. **Benefits of Discretionary Trusts**: - Prevents Wealth Accumulation: Allows beneficiaries to benefit without individual accumulation of wealth. - Estate Exclusion: No beneficiary is treated as owning the trust fund, so when a beneficiary dies, their taxable estate excludes trust assets. **Long-Term IHT Advantage**: - Assets in a discretionary trust aren’t included in a beneficiary's estate upon their death, avoiding IHT on these assets. - By contrast, if a testator leaves their estate directly to their children, these assets form part of the child’s estate and incur IHT on the child’s death.

Answer 67

When drafting a discretionary will trust, there are two primary structures and key tax implications to consider: **Types of Discretionary Will Trusts:** - **Discretionary Trust of Residue**: Involves the whole or part of the residuary estate, with the exact amount determined only after administration is complete. - **Legacy to a Discretionary Trust**: Involves a fixed sum or a sum ‘equal to the nil rate band’ passing to the trust, where the amount is predetermined or calculated. **RNRB Limitations**: - The **RNRB** does not apply if the deceased’s residential interest passes to a discretionary trust. - This is true even if the testator’s children are beneficiaries, as they are not inheriting directly. - If a client wishes to utilise the RNRB and leave assets to a discretionary trust, careful planning is required, such as structuring gifts into trust of specific assets.

Answer 68

A discretionary will trust provides several succession-related advantages, including: **Flexibility**: - Allows the testator to avoid deciding the exact distribution of their estate in advance, giving trustees the ability to adapt to the beneficiaries' needs over time. - The testator may draft a ‘letter of wishes’ to guide trustees on how to exercise discretion, although this is not legally binding. **Protection**: Trust assets are not owned or controlled by individual beneficiaries, helping to shield these assets from claims by: - **Beneficiaries’ creditors** if a beneficiary becomes bankrupt. - **Beneficiaries’ spouses** in divorce proceedings.

Answer 69

There is no inheritance tax (IHT) charge on the discretionary trust assets in relation to the estate of any individual beneficiary. Instead of taxing an individual beneficiary, HMRC applies IHT charges to the trust itself. These charges are paid by the trustees from the trust fund. The IHT charges on the trust are generally **significantly smaller** than the IHT that would be payable if a beneficiary owned the trust fund outright on their death. This taxation approach for discretionary trusts is known as the ‘**relevant property regime**’.

Answer 70

A two-year discretionary will trust is intended to last for two years following the testator's death. This trust is created with flexibility in mind: - The testator does not need to decide on the exact distribution of their estate when drafting the will. - Instead, the trustees decide which beneficiaries should inherit and what they should receive after the testator’s death. This trust relies on the testator’s confidence in the trustees to make appropriate decisions, often leading to the surviving spouse being appointed as a trustee.

Answer 71

Section 144 IHTA allows for capital distributions from a discretionary trust within two years of the testator’s death to be treated as though they were made under the deceased’s will, not by the trustees. **IHT benefits**: - Allows distributions within two years to be assessed for IHT as if part of the will, which can create tax advantages. - However, this treatment does not apply for Capital Gains Tax (CGT) purposes.

Answer 72

Example scenario: - A testator leaves an estate worth £400,000 to a two-year discretionary trust, with beneficiaries including their spouse, children, and a charity. - No exemptions initially apply, and the NRB is £325,000. - On the testator’s death, IHT is payable as the estate value exceeds the NRB. Distribution strategy within two years: - After one year, trustees distribute ½ of the trust to the spouse, ¼ to charity, and ¼ to the children. Under s.144 IHTA, these payments are treated as distributions by the will, not the trustees: - Spouse and charity exemptions can be claimed. - Estate value then falls below the NRB, potentially allowing the RNRB if property is distributed to children. A full **IHT refund** can be claimed, as the estate value is now under the NRB. The trust ends after all assets are distributed.

Answer 73

If a testator creates a life interest trust by will: - The spouse exemption can be claimed on the amount passing to the trust if the testator’s spouse is the life tenant. - No spouse exemption applies if the spouse is merely a remainder beneficiary. This leads to the following: - There is a tax advantage for the testator (or their estate) compared to making a gift to a non-exempt beneficiary. - The IHT position is the same whether the testator leaves their entire estate to their spouse outright or in a life interest trust with the spouse as life tenant. **Examples**: - Testator A leaves their entire estate to a life interest trust with their spouse as life tenant and children as remainder beneficiaries; no IHT is payable due to spouse exemption. - Testator B leaves their estate to a life interest trust with their sister as life tenant and spouse as remainder beneficiary; IHT is payable unless the estate value is below the nil rate band, as no spouse exemption applies. - Testator C leaves their estate outright to their spouse; no IHT is payable due to spouse exemption. Thus, Testator A and Testator C have the same tax treatment, allowing a married testator to enjoy practical advantages of a trust while benefiting from IHT exemptions.

Answer 74

A key practical advantage of a life interest trust is that it allows the testator to control the ultimate destination of their estate: The testator can specify who benefits as the life tenant while preserving capital for other beneficiaries. This structure is particularly beneficial in scenarios such as: - The testator has remarried and has children from a previous marriage. - Concerns that a surviving spouse may remarry and potentially leave inherited assets to a new spouse or children from that new marriage. For example: A testator who sets up a life interest trust with their spouse as life tenant and their children as remaindermen can: - Maintain the tax advantage of spouse exemption as if their estate passed directly to the spouse. - Ensure that their assets are preserved for their children after the spouse's death, thereby safeguarding their estate for future generations.

Answer 75

A life tenant is entitled only to trust income, not capital, which may not always be sufficient to meet their needs. The testator should carefully consider the following: - The needs of the life tenant. - The expected income that will be generated by the trust. - The other resources available to the life tenant. The ideal scenario is to achieve the equation: **Life tenant's needs = life tenant's resources + trust income** If the life tenant's needs are likely to exceed their resources plus trust income, the testator should consider other options, such as: - Making the trust fund larger (if feasible) to generate more income. - Ensuring that trustees have express powers to advance capital and/or make loans to the life tenant if necessary.

Answer 76

A testator may create or add to an existing trust by operation of express clauses in their will. A discretionary trust offers the advantage of flexibility regarding the future needs of the beneficiaries and a longer-term tax advantage to the beneficiaries compared with a direct inheritance. However, no spouse exemption can apply on a gift to the trust and the RNRB cannot be claimed if the residential interest passes to a discretionary trust. S144 IHTA will apply to distributions made from a discretionary will trust in the 2 years following a testator’s death and these distributions are treated for IHT purposes as having been made under the testator's will, not by the trustees. A life interest trust creates fixed interests in the trust fund (the life tenant and remainder beneficiaries have defined rights) and spouse exemption can be claimed if the spouse is the life tenant. The testator can retain control over the destination of their estate. However, if a life tenant is likely to require access to the trust capital express powers permitting trustees to pay or loan capital to the life tenant must be expressly drafted.

7 - IHT: Tax Planning Flashcards

(100 cards)