Inheritance Tax

Question 1

What are the three different tax rates?

Answer 1

Nil rate band (£325,000)

0%

The spousal NRB is capped at £325,000 even if multiple spouses have been survived

RNRB (£175,000)

0%

The reduction in the RNRB is £1 for every £2 above the £2 million threshold.

There is no RNRB available at all for net estates worth £2,350,000 or more (or £2,700,000 where a full transferred RNRB applies).

Lifetime rate

20%

If transferor dies within 7 years then LTR is 40%

Death rate

40%

Question 2

What are the three IHT trigger events?

Answer 2

Potentially exempt transfers (‘PET’) – Lifetime transfers of value which could become chargeable to IHT depending on whether the transferor survives for seven years after the transfer. Only failed PETs (i.e. those where the transferor does not survive for seven years) are chargeable.

Lifetime Chargeable Transfers (‘LCT’) – Lifetime transfers of value which are immediately chargeable to IHT at the lifetime rate.These are also reassessed if the transferor dies within seven years.

Death – When a person dies there is a deemed transfer of all the assets that they own (s 4 IHTA). IHT is chargeable on this transfer of value.

Question 3

What must be satisfied for RNRB?

Answer 3

· The deceased died on or after 6 April 2017

· Their death estate included a ‘qualifying residential interest’ (‘QRI’)

· The QRI was ‘closely inherited’ by a ‘direct descendent’

Question 4

What property is included in a taxable estate but often excluded from a succession estate?

Answer 4

Everything not explicitly excluded will be in a taxable estate, including:

• All jointly owned property
• Property subject to a reservation
• Donationes mortis causa
• Statutory nominations
• Some interests in possession

Question 5

What property is explicitly excluded from a taxable estate?

Answer 5

A remainder interest (sometimes called a reversionary interest) in a life interest trust

Insurance policy written on trust

Discretionary pension schemes

Question 6

How is the taxable estate valued?

Answer 6

The general rule is that the assets in the estate are valued at market value at the date of death

If assets owed by spouses are worth more when valued together (e.g. because they form a set), each party’s share is valued at their proportionate share of the combined pair.

Where land is co-owned (whether as joint tenants or tenants in common) the value of the deceased’s share is reduced (by 10-15%) to reflect the difficulty of selling a share of the property rather than the whole. The deduction is not applied where the co-owners are married, as the related property rules apply and take priority.

Question 7

What debts aren’t taxable?

Answer 7

The deceased’s debts due at the date of death: This is money the deceased owed e.g. outstanding balance on a credit card or loan at the time of death. Post-death debts/expenses: The only post death debt/expenses that can be deducted for tax purposes are reasonable funeral expenses and the cost of a tombstone.

Question 8

What are the primary tax exemptions apply?

Answer 8

• Spouse exemption
• Charity exemption
• Business property relief (‘BPR’)
• Agricultural property relief (‘APR’)

Question 9

What other tax exemptions may apply?

Answer 9

Family maintenance exemption (s 11)

Annual exemption (s 19)

Small gifts allowance (s 20)

The statutory requirements governing IHT exemptions and reliefs are set out in the Inheritance Tax Act 1984 (‘IHTA’)

Normal expenditure from income (s 21)

Marriage exemption (s 22)

Taper Relief (s 7)

Gifts of land to housing associations (s 24A IHTA)

Gifts for national purposes (s 25 IHTA)

Gifts to heritage maintenance funds (s 27 IHTA)

Gifts to Employee Benefit Trusts (s 28 IHTA)

Question 10

What are the rules of spousal exemption?

Answer 10

Gifts between spouses during life and following death are completely exempt.

Provided both parties are domiciled within the UK (which will always be the case in this module) there is no upper limit to the value of the exemption.

It does not matter why the spouse inherits. The relief applies to the value of assets received under a will, intestacy, survivorship or any combination etc.

Unmarried couples cannot claim spouse exemption, irrespective of how long they have been in a relationship or living together and there is no concept of a “common law” spouse.

A gift may be conditional provided the condition is satisfied within 12 months of death. A common example of a conditional gift is a 28 day survivorship clause.

Question 11

What are the rules for charity exemption?

Answer 11

All transfers to registered charities during life and following death are exempt irrespective of the amount given provided the gift is used exclusively for the purposes of the charity.

The gift can be conditional provided the condition is satisfied within 12 months.

The gift must be immediate and not in remainder for the exemption to apply. The gift must normally be absolute.

To qualify for an IHT exemption a gift must be made to a charity that is subject to the “jurisdiction of a UK court or that of another EU member state” (FA 2006).

However, even if a gift is confirmed as being made for charitable purposes, the IHT exemption will not apply unless the charitable body meets the other statutory requirements.

Question 12

What is the political party exemption?

Answer 12

Gifts to established political parties are exempt from IHT. In order to qualify for the exemption, one of the following conditions must apply (as at the last general election):

The party had at least two MPs elected

The party had at least one MP elected and at least 150,000 votes given to candidates representing that party.

Question 13

What are the rules for business property relief?

Answer 13

Business Assets include:

Unquoted shares:

includes all private company shares (i.e. in a “ltd” company) irrespective of the size of value of shareholding

Quoted shares: shares listed on a recognised stock exchange (i.e. in a UK “PLC”) but these are only business assets if the taxpayer controls the company (50%+)

Business or interest in a business:

transferor is a sole trader or has a partnership interest

Assets owned by taxpayer but used for business: Land/buildings/machinery owned by a taxpayer but used for business purposes by a company the transferor controlled or a partnership where the transferor was a partner

A business (or interest in a business), or shares in a company, are not business property if the business concerned consists wholly or mainly of:

dealing in securities, stocks or shares, land or buildings

making or holding investments

To qualify the transferor must have owned the business assets continuously for at least 2 years immediately prior to the relevant transfer.

The type of business does not need to be the same throughout the 2 year period but there must have been a business for all of that time.

The following are exceptions to the two-year rule:

If qualifying assets are sold and replaced with new qualifying assets within a certain period of time, the taxpayer’s period of ownership is usually treated as continuous.

If a person inherits business assets following someone’s death, they are deemed to acquire the assets on the date of death (even though the assets will have been transferred to them after this date).

If a person inherits business assets following the death of their spouse, they are deemed to have owned the property from the time it was originally acquired by their deceased spouse irrespective of how long they had been married (the survivor ‘inherits’ the period of ownership).

Question 14

What are the BRP rules regarding lifetime transfers?

Answer 14

Where a taxpayer makes a PET or LCT of qualifying business assets and this transfer is assessed to IHT following the death of the transferor within 7 years, BPR is only available for the lifetime transfer if the qualifying property transferred (or replacement qualifying property):

• is owned by the transferee; and

-qualifies for BPR when the transferor dies (or on the death of the transferee if earlier).

-There is no minimum ownership requirement of 2 years for the transferee.

Question 15

What are the rules of agricultural property relief?

Answer 15

Agricultural property includes:

Agricultural land and buildings:

used for purposes connected with agricultural activity.

Farmhouses and cottages: may qualify if they are of a ‘character appropriate’ to the associated agricultural land and have been occupied for the purposes of agriculture e.g. farmhouse occupied by a farm worker or their surviving spouse and not someone who occupies for purely domestic reasons.

Qualifying periods of ownership

Qualifying property must have been: * occupied for agricultural purposes by the transferor throughout the two years immediately before the transfer, or, * owned by the transferor and occupied by them or another for agricultural purposes throughout seven years immediately before the transfer.

The same exceptions apply to BPR (found on BPR card)

Question 16

How do APR and BPR interact?

Answer 16

APR is given in priority to BPR in scenarios where both reliefs would apply.

It is not possible to claim BPR on a business asset if that asset also qualifies for APR.

Both reliefs may apply in the context of commercial farming enterprises. Some assets may qualify for both relief and others for only one.

Agricultural buildings may qualify for both – so APR applies in priority

Livestock is not included in the definition of agricultural property but its value may qualify for BPR

Farmhouses/cottages are unlikely to qualify for BPR, but may qualify for APR

Question 17

What are the rules of woodland relief?

Answer 17

Gifts of woodland following death may qualify for woodlands relief.

If the deceased had purchased the woodland, they must have owned it for at least 5 years before dying for the relief to apply.

If the deceased had themselves inherited the woodland following someone else’s death, there is no qualifying period of ownership.

Woodlands relief is a deferral of the IHT that would otherwise be payable on the value of the woodland.

To use the deferral those administering the estate should make an election to exclude the value of the woodland from the death estate.

The value of the woodland is the value of the trees (i.e. timber) and not the land itself.

Tax is deferred until the timber, not the land, is subsequently sold or given away.

As woodlands relief only applies to the value of the timber (not the land) and is a deferral rather than reduction of liability it may be preferable to consider alternative reliefs that might apply instead.

The nature of woodland means that it could qualify as:

Business property – so business property relief (‘BPR’) might apply.

Agricultural property – so agricultural property relief (‘APR’) might apply.

BPR should be considered where woodland is used for commercial purposes e.g. commercial fishing or timber harvesting.

APR can be considered if the land is classified as agricultural land or ancillary to this.

BPR and APR are more generous reliefs and if they apply would usually be claimed instead.

Question 18

What are the rules of quick succession relief?

Answer 18

Quick succession relief (‘QSR’) is intended to help the tax-payer where the same assets would otherwise be subject to more than one IHT charge in quick succession.

QSR applies where a person dies and:

their death estate includes assets received by way of gift or inheritance,

in the 5 years before their death, and

those assets were subject to an IHT charge when transferred to the deceased.

If death occurs with one year of the previous IHT charge, the relief is calculated with reference to 100% of the amount of IHT paid previously.

This reduces each year, and only 20% of the amount of IHT paid previously is considered where death occurs 4-5 years after the original charge.

Question 19

What is a PET?

Answer 19

A PET is a lifetime transfer of value to another individual. If the individual doesn’t survive for seven years after making the transfer, it becomes chargeable alongside their death estate. The rationale behind PETs is to prevent individuals avoiding IHT by giving away property shortly before their death.

The tax treatment of a PET is as follows:

• The transfer is not chargeable at the point it is made. No IHT is payable yet.
• It becomes fully exempt if the transferor survives seven years from the date of the PET.
• If the transferor dies within seven years of making the PET, the PET ‘fails’ and becomes a chargeable transfer and thus subject to IHT.

Question 20

What is an LCT?

Answer 20

All lifetime transfers of value made by a person into a trust on or after 22 March 2006 will give rise to an LCT.

The tax treatment is as follows:

• An LCT is a chargeable transfer when it is made. IHT is payable on the chargeable value of the LCT at the lifetime rate of 20%.
• If the transferor survives 7 years following the LCT there is no further charge to tax.
• If the transferor dies within 7 years, the LCT will be reassessed to tax at the death rate, using the NRB at the date of death.

Question 21

What are the steps for calculating IHT on lifetime transfers?

Answer 21

Step A

Calculate cumulative total

Step B

Identify value transferred

Step C

Apply exemptions and reliefs

Step E

Apply taper relief

Step F

Give credit for tax paid in lifetime

Question 22

What is the cumulative total?

Answer 22

The cumulative total is relevant to lifetime transfers as it tells us how much of the nil rate band (‘NRB’) is available for the transfer. The cumulative total is calculated by adding up the value of all chargeable transfers made in the 7 years prior to the transfer.

Although cumulation only takes into account chargeable transfers made in a 7 year period, where an LCT or PET is reassessed, this can mean looking back as far as 14 years before the transferor’s death.

Question 23

What is a transfer of value?

Answer 23

A ‘transfer of value’ is a ‘disposition’ which results in an immediate decrease in the value of the individual’s estate (s 3(1) IHTA).

Broadly, this means gifts but it can also include transactions at an undervalue (e.g. selling your house to a family member for less than it is worth – the difference in value counts as a gift). It applies to gifts of all forms of property (i.e. anything with a monetary value).

For lifetime transfers, the value of a transfer is assessed by reference to the loss in value to the donor at the date of the transfer.

Question 24

What are the exemptions and reliefs relevant to lifetime IHT?

Answer 24

• Spouse exemption
• Charity exemption
• Family maintenance exemption
• Annual exemption
• Small gifts allowance
• Normal expenditure from income
• Marriage exemption
• Business property relief
• Agricultural property relief

Question 25

How is NRB applied to lifetime transfers?

Answer 25

• The residence NRB never applies to lifetime transfers.
• The NRB applicable to an LCT when it is first made is the NRB at the date of the transfer.
• The NRB that applies to a failed PET or re-assessed LCT is the NRB at the date of death.

As the NRB has been fixed at £325,000 since April 2009, this is the figure you should use unless a question tells you otherwise.

Question 26

What are the relevant rates of tax?

Answer 26

After deducting the NRB, it is necessary to apply IHT to the remaining amount at the appropriate rate. This rate will differ depending on whether you are dealing with the tax due immediately on an LCT or are re-assessing a lifetime transfer (LCT or PET) because the transferor has died within seven years.

LCTs: When calculating the tax due immediately on an LCT, the tax is payable at the lifetime rate of 20%. Step D is the final step in the calculation.

Failed PETs and re-assessed LCTs: Tax is payable at the death rate of 40%. If the transferor dies 3-7 years after making the transfer, it is also necessary to apply taper relief at the relevant rate to reduce the IHT payable.

Question 27

What is taper relief?

Answer 27

PETs or LCTs made in the 7 years before death must be reassessed to IHT. This is separate to the calculation of IHT on the death estate. Although death is the trigger for the lifetime transfer being reassessed, these transfers do not form part of the death estate. The tax payable on a failed PET or reassessed LCT must be calculated separately.

If a PET or LCT is being reassessed it is necessary to consider Step E of the calculation (which involves applying taper relief to transfers made 3-7 years before the death)

If tax was paid on an LCT during the transferor’s lifetime and it is later reassessed at the death rate, it may also be necessary to consider Step F (which involves giving credit for tax paid in the transferor’s lifetime).

Question 28

What are the percentages for taper relief?

Answer 28

Date of transfer (in years), reduction in amount of IHT due, amount of IHT due which is payable:

0-3, 0%, 100%
3-4, 20%, 80%
4-5, 40%, 60%
5-6, 60%, 40%
6-7, 80%, 20%

Question 29

What is Step F?

Answer 29

Where an LCT is being reassessed at the death rate, it is also necessary to factor in any tax that was paid at the lifetime rate.

This is done by deducting the IHT paid previously from that due as a result of the death (after taper relief has been applied). Only the balance needs to be paid to HMRC.

If the balance is reduced to nil as a result of crediting the previous payment, there will be no further tax to pay.

It is not possible to obtain a refund for the lifetime payment if the balance is negative.

Question 30

What is grossing up?

Answer 30

If the trustees do not pay the tax the donor becomes liable. Alternatively, the donor may elect to pay the tax.

If a donor pays IHT using their own funds their loss is effectively “assets settled + IHT liability”. The amount of this figure is calculated by notionally increasing (grossing-up) the original value of the transfer. The IHT payable is then calculated with reference to the grossed-up value not the value settled.

More tax is paid to HMRC where grossing-up is required.

Question 31

Lifetime transfers taxed following death

Answer 31

The following rules apply to failed PETs and LCTs that become chargeable to IHT following the donor’s death.

The general rule is that the lifetime recipient (donee) is liable to pay the IHT due.

A man made the following gifts during his lifetime in the 7 years before he died:

a) gift of cash to his son and b) gift into a trust.

Cash gift: This is a failed PET. The man’s son is primarily liable to pay any IHT due in respect of this gift even though the gift may have been made up to 7 years ago.

Gift to trust: This is an LCT that will be re-assessed to IHT following death. The trustees are primarily liable to pay any further IHT due using assets in the trust fund at this time.

Assets in the man’s death estate are not used to meet these IHT liabilities.

If the recipient of the lifetime transfer does not pay the IHT due within the deadline for payment (12 months from the end of the month of death) the deceased’s personal representatives (‘PRs’) will become liable.

The PRs should therefore be aware of this possibility and retain sufficient funds to pay the tax bill should the need arise. Where estate funds are used the ultimate burden of the tax has effectively fallen on the residuary beneficiaries.

Question 32

Taxable Death Estate

Answer 32

assets that are excluded from their succession estate.

The succession estate assets pass to PRs to be administered under the will/intestacy rules (can be called the “free estate”).

Assets outside of the succession estate do not fall to the PRs and pass in accordance with their own rules (rather than being subject to the terms of the will or the intestacy rules).

The following are examples of taxable assets which pass outside of the succession estate:

Joint tenant property

Gifts with reservation of benefit (GROB)

Whether or not an asset is part of the free estate has no effect on the overall IHT payable. However, it does affect the rules regarding who is liable to pay that tax and where the burden of payment falls.

Question 33

Death - free estate

Answer 33

IHT on the free estate is a general testamentary and administration expense - s 211(1) IHTA

The deceased’s PRs are liable to pay this tax.

IHT is paid from residue unless a contrary intention appears in the will – s 211(2) IHTA

The general rule (IHT is payable from residue unless a contrary intention is shown) is the preferred option for most testators.

As such, it is a general rule of construction that gifts in a will (other than residue) are deemed to be given “free of tax” whether or not these words are expressly stated.

Question 34

What constitutes a contrary intention?

Answer 34

gifts within a will are paid subject to a deduction of the IHT attributable to them (which relieves the burden for residuary beneficiaries)

alternatively, a testator could direct that the residue bears the burden of IHT due in respect of assets outside of the free estate (which increases the burden for residuary beneficiaries).

There is no prescribed wording. The testator’s intention to exonerate or burden parts of their estate is determined as a matter of construction of the terms of the particular will under consideration.

It is not possible to reach a definitive conclusion based purely on the meaning attributed to particular words in other wills.

In practice it is common to draft all gifts expressly “subject to” or “free of” inheritance tax so there is no doubt about the testator’s intention.

A testator may vary the incidence of IHT as between lifetime transfers and the death estate e.g. direct that IHT due in respect lifetime gifts should be met from residue and so relieve the lifetime donee of this burden.

However, clear words to this effect must be used because a reference to “tax” is normally construed as meaning the tax payable only on dispositions made by the will, and, a general direction that “all taxes” should be paid from residue has been found to mean only tax payable on property passing under the will.

Variations to the rule do not (and cannot) remove or reduce the overall liability - it is the burden/incidence of IHT that is affected.

Question 35

When does liability for burdens NOT fall to the PRs?

Answer 35

Joint tenant property: surviving co-owner

Statutory nomination: nominated beneficiary

Donationes mortis causa: lifetime donee

Trust assets: trustees

GROB: lifetime donee

Question 36

Annual Exemption (s 19 IHTA)

Answer 36

The Annual Exemption (‘AE’) allows individuals to make gifts of up to £3,000 each tax year free from IHT.

The AE is applied chronologically to transfers (PETs or LCTs) when they are made. If more than one transfer is made on one day, the annual exemption is applied pro rata, irrespective of the order in which the gifts were made.

The AE should be used after any other available exemption or relief is applied to ensure the AE is available for later transfers.

Once the AE for the current tax year is used first and in full a transferor may look back to the previous tax year (but no further) and use any part of the AE from the previous tax year that was not used at the time.

Therefore, a maximum of 2 x AE (£6,000) may be available to use against a transfer (assuming no other transfers have been made in that tax year or the previous tax year).

A tax year runs from 6 April one calendar year to 5 April the following calendar year.

Question 37

Family maintenance (s 11 IHTA)

Answer 37

Maintenance payments are not treated as transfers for IHT purposes if made to:

A spouse (or former spouse if part of a divorce settlement)

The minor child of either party to a marriage for maintenance, education or training, or if over 18 and otherwise in full time education or training

A dependent relative to make reasonable provision for their care. ‘Care’ is not defined but HMRC suggest that payments to cover the provision of services, whether privately or in an institution, would be covered (but not payments which go beyond maintenance).

Question 38

Small gifts allowance (s 20 IHTA)

Answer 38

Small gifts (of up to £250 per recipient) can also be made free from tax.

A transferor can make multiple gifts of up to £250 to as many different people as they like.

It differs from AE in that AE is an upper limit to the total value of all transfers in a tax year, whereas the small gifts exemption applies separately to each recipient with no limit to the number of different recipients.

The small gifts allowance is not available if combined with any other exemption, including the AE.

If an individual wishes to make gifts of more than £250 to any one person they should rely on the AE instead.

If a donor wants to give away e.g. £3,250 they cannot give this amount to one person and claim the AE and the small gifts allowance to cover the full value. However, if they gave £3,000 to one person and £250 to another person both reliefs could be claimed.

Small gifts allowance (s 20 IHTA)

This exemption is most useful where a client has a number of different people to whom they wish to make gifts. For example, they may have a large family and want benefit different children or grandchildren.

Clients could set up different accounts and make yearly transfers of £250. The exemption is often used for Christmas or birthday presents.

If gifts to any one person in the same tax year exceed £250 the exemption does not apply at all for that donee.

Question 39

Marriage Exemption (s 22 IHTA)

Answer 39

A gift given in consideration of a marriage to a party of that marriage is exempt up to:

£5,000 if made by a parent of one of the parties

£2,500 if made by one party of the marriage to the other

£2,500 if made by their remoter ancestor e.g. grandparent or great-grandparent; and

£1,000 in any other case.

NB: marriage exemption and the annual exemption can both be claimed in respect of the same gift.

The gift must be made in relation to a specific marriage – contemporaneously, or, before and conditional upon it, or, after if satisfying a previous legal obligation.

The relief applies to one or both parties to the marriage or civil partnership e.g. a father can give £5,000 to his own son and £1,000 to the bride and claim an exemption of £6,000.

The relief applies per donor.

Question 40

Normal expenditure out of income (s 21 IHTA)

Answer 40

A transfer of value is exempt if made:

from the donor’s income (not capital)

as part of a normal/regular pattern of giving, and

do not affect the donor’s standard of living.

There is no upper limit to this exemption.

Lightman J in Bennett v IRC said “as regards quantum, it is sufficient that a formula, or standard has been used, so that the amount can be identified”.

It is a question of fact whether the requirements are satisfied.

HMRC are more likely to accept the relief applies if transfers are made under a legal obligation, or there is clear history of a settled pattern of giving e.g. monthly payments.

Question 41

Taper Relief

Answer 41

Taper relief is not an exemption. Instead, it reduces the amount of IHT that would otherwise be payable. To apply both of the following conditions must be met:

A lifetime transfer was made 3 – 7 years prior to the transferor’s death (i.e. a PET has failed / LCT will be re-assessed)

IHT is payable in respect of the lifetime transfer (i.e. separately and in addition to IHT due in respect of the death estate)

This means:

transferor must have died (taper does not apply to the charge when an LCT is made).

the value of the lifetime transfer must have been large enough to trigger IHT (you cannot taper a tax liability of zero). In basic terms, IHT will only be due on a lifetime transfer where the amount transferred was greater than the available nil rate band (‘NRB’).

Where taper relief applies it does not reduce the value of a lifetime transfer, nor does it alter the rate of IHT.

Instead it takes effect as a proportionate reduction of the final tax bill.

The amount of the reduction depends on the number of years between the date of transfer and death.

The rates by which the IHT charge is reduced are set out in the table on the following page.

For taper relief to make sense it is important to appreciate that:

when someone dies their death can trigger an IHT charge in respect of the death estate and a separate IHT charge in respect of lifetime gifts.

It is always necessary to calculate the tax due on lifetime transfers separately from tax due on the death estate.

Although taper relief is only applied after someone has died, the relief has no effect on the IHT payable in respect of their death estate.

Question 42

What do we mean by tax planning?

Answer 42

What do we mean by tax planning?

You should be aware of the distinction between the following:

• Tax avoidance: the efficient and lawful arrangement of a client’s affairs in a manner which minimises their liability to tax.
• Aggressive tax avoidance: a form of tax avoidance which often involves the taxpayer entering into complex or artificial arrangements which have the overall effect of reducing their tax liability. These schemes comply with legislation but often do not reflect the intention behind the law. This kind of tax planning may involve exploiting loopholes or inadvertent gaps in drafting. Once HMRC become aware of a particular arrangement, ‘anti-avoidance’ legislation is often introduced to prevent further exploitation.
• Tax evasion: where a taxpayer withholds information about assets or income, or otherwise takes steps to avoid paying the tax they are liable for. This is unlawful.

Question 43

Available for lifetime transfers only

Answer 43

Annual exemption

Family maintenance exemption

Small gifts exemption

Marriage exemption

Normal expenditure out of income exemption

Question 44

Available for lifetime and death transfers

Answer 44

Spouse exemption

Charity exemption

APR

BPR

Question 45

1. Restriction on deduction of loans

Answer 45

When calculating the chargeable value of a deceased’s estate for IHT purposes, it is necessary to deduct the deceased’s debts. It is also possible to deduct financing costs when ascertaining the taxable value of a lifetime transfer. However, there are anti-avoidance rules which restrict deductions in the following circumstances:

Loans made to acquire, maintain or enhance assets that qualify for BPR. (This also applies to agricultural and woodlands relief.)

Loans which are not repaid from the estate.

Loans made to acquire, maintain or enhance excluded property (i.e. property which is not subject to IHT).

Loans which fund a qualifying foreign currency account.

The first two are considered in more detail in this element. The others are outside the scope of the module but you may need to be aware of them in practice.

Loans made for assets attracting BPR

If a loan was made to acquire, maintain or enhance assets that qualify for BPR (or agricultural / woodlands relief) the costs of the loan must first be set against the value of the qualifying assets. This reduces the value of assets which attract relief. If the loan exceeds the value of the relievable assets the remainder can be deducted from the value of the chargeable estate.

The effect of this restriction is shown by the examples on the following page. Both examples consider an estate of the same size, comprising the same assets and liabilities. The only difference is the purpose for which the loan was taken out. In the first example, the loan was used to acquire shares which qualify for BPR. The costs of the loan must therefore be set against those shares, reducing the relief available. In the second, the loan was used for home improvements. The costs of the loan are not restricted to a particular asset, meaning BPR is available for the entire value of the shares, reducing the value of the taxable estate.

Unpaid loans

Loans are only deducted from the value of the estate at death if they are repaid from the estate. Most loans will be commercial, arm’s length arrangements which HMRC expects will be repaid and does not investigate. Debts owed to the deceased’s family, related trusts or companies and those made as part of tax avoidance arrangements will only be deducted if they are actually repaid. HMRC will look at these more closely.

Question 46

2. Gifts with reservation of benefit (‘GROB’)

Answer 46

The gifts with reservation of benefit (‘GROB’) rules were first introduced in the Finance Act 1986 (‘FA 1986’).

The purpose of the rules is to prevent individuals attempting to manipulate the IHT regime by giving away property during their lifetime but retaining a personal benefit in that property.

The rules work by treating such property as remaining part of the donor’s estate, ensuring that it is taxed upon their death (unlike genuine gifts which will only be taxed – as failed PETs - if the donor dies within 7 years of making the gift)

Question 47

When do the GROB rules apply?

Answer 47

The GROB rules are set out in s 102 FA 1986. A lifetime gift will be treated as a gift with reservation of benefit (‘GROB’) in one of two situations:

· The donee does not assume “bona fide possession” of the property at or before the start of the “relevant period”.

· At any time during the “relevant period” the property “is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor and of any benefit to him by contract or otherwise”.

The relevant period is the seven year period before the donor’s death (or a shorter period if the gift is less than seven years before death). Note that it is not simply the seven years after the gift is made. A gift can be caught by the GROB rules many years after it is made if the donor reacquires an interest in the property. (This prevents donors avoiding the GROB rules by temporarily giving up an interest in the property.)

Question 48

GROB: Bona fide possession

Answer 48

For a donee to be treated as having bona fide possession of the gifted property for the purposes of the GROB rules they must:

· Obtain a vested, beneficial interest in the property.

· Have actual enjoyment of the property.

· Assume possession and enjoyment at the start of the relevant period.

Actual enjoyment of property may consist of physical enjoyment (e.g. occupation of land) or receipt of the income produced by the property. For example, if a donor transfers legal title to their home but the donee allows them to live in it rent-free, while the donee lives elsewhere, the donee has not obtained bona fide possession. Although they have a vested, beneficial interest, they do not have actual enjoyment of the property. In contrast, if the donor pays the donee market rent to remain in the home, the donee will have actual enjoyment of the property.

Question 49

GROB: Exclusion of the donor

Answer 49

The donor must be entirely or virtually excluded from benefitting from the property. There is no statutory definition of “virtually” but HMRC consider it to mean “to all intents” or “as good as”.

HMRC gives examples of situations where they deem the benefit to be de minimis. These include, for example, the donor giving away their home but returning for social visits and occasional overnight stays. In contrast, if the donor were to remain living in the house rent-free, this would be an example of a GROB.

Where the gift is into a trust, a GROB will arise if the settlor (i.e. the donor) is a potential beneficiary, whether or not they actually obtain a benefit. An obvious example is where the settlor is included as one of the objects of a discretionary trust.

Practice Alert: There are also income tax and capital gains tax consequences of naming the settlor (or their spouse or unmarried minor children) as the beneficiaries of a discretionary trust. These are outside the scope of this module.

Question 50

GROB: Effect of reserving benefit

Answer 50

The effect of a reserving a benefit depends on for how long the benefit is reserved:

· If the GROB subsists at the date of the donor’s death, the property is treated as if it were part of the donor’s estate for inheritance tax purposes. It is valued at the date of the donor’s death.

· If the donor no longer retains the benefit at the date of their death, they are treated as having made a PET on the date the reservation ceased. This deemed PET is charged in the same way as any other PET on the donor’s death but because it does not involve an actual transfer of value it will not benefit from the Annual Exemption (‘AE’).

Because the original gift may also be chargeable as a failed PET (if it was made within the 7 years prior to death) the GROB could end up being charged to tax twice. Relief is available to prevent a double-tax charge in these circumstances. This is outside the scope of this module.

Question 51

GROB: CGT consequences

Answer 51

Where a donor makes a GROB the property becomes the donee’s property for the purposes of capital gains tax (‘CGT’).

This means that CGT may be payable by the donor on the increase in value of the property since they acquired it. If the donee later sells the property, CGT will be calculated based on the increase in the value of the property between the date of the gift and the date of transfer (even though, because it is a GROB, the donee may not have actually obtained any real benefit from the property until the GROB ceased or the donor died).

In contrast, if the gift is made upon the donor’s death, there is no CGT liability in relation to gains accrued during the deceased’s lifetime for the donor’s estate, and the donee is treated as acquiring the property for its market value at the date of death. This is known as the free CGT uplift and can be a significant justification for leaving it until death to make a gift of valuable property.

Question 52

3. Pre-owned assets charge (‘POAC’)

Answer 52

The pre-owned assets charge (‘POAC’) was introduced in the Finance Act 2004 (FA 2004). It is an annual income tax charge imposed upon individuals who give away certain types of property during their lifetime but subsequently obtain a benefit from that property. (You may also see it referred to as the ‘pre-owned assets tax’ (‘POAT’) but note that it is not strictly accurate as it is not a tax in its own right.)

The POAC was introduced to prevent individuals exploiting loopholes in the GROB rules that allowed them to remove the value of their homes from their estates for IHT purposes, while continuing to live in them rent-free.

The POAC does not apply to property which remains within the individual’s estate for inheritance tax purposes. This means that property cannot be taxed under both the GROB rules and as a POAC. It is, however, possible to make an election for property to be taxed as a GROB instead of a POAC.

Whether an individual chooses to do this will depend on their personal circumstances and a comparison of their respective income tax and IHT positions.

Question 53

POAC: When does the POAC apply?

Answer 53

The POAC is set out in s 84 and Sch 15 Finance Act 2004. It applies to 3 different types of property:

Land

Chattels

Intangible property held in a settlor-interested trust. (For these purposes ‘intangible property’ means any property other than land or chattels. Examples include cash, credits in a bank account and shares.)

The rules for each type of property are different and will be considered in turn. We will also consider the circumstances in which a transaction will be excluded from the POAC. (Note that there are other exemptions and reliefs from the POAC which are outside the scope of this module but which, generally, are intended to prevent an individual being subject to both IHT and the POAC. There is also a de minimis exemption and a territorial exemption (which prevents the POAC being charged on individuals who are resident or domiciled outside the UK).)

Question 54

POAC: Land

Answer 54

Two conditions must be satisfied for land to be subject to the POAC:

· An individual occupies land (either individually or with others). This condition is not always easy to assess as there is no statutory definition of occupation but HMRC’s guidance indicates that it should be construed widely, with each case determined on its own particular facts.

· Either the ‘disposal condition’ or ‘contribution condition’ is met. You do not need to know how to apply these in detail but, broadly, they apply to situations where the individual has either disposed of the occupied land or has contributed (directly or indirectly) towards the acquisition of that land without obtaining a beneficial interest in it.

If the POAC applies, the benefit that the individual receives through their occupation is treated as income. Broadly, this means the individual will pay income tax on the equivalent of the market rent they would have had to pay in order to occupy the land.

Question 55

POAC: Chattels

Answer 55

The rules for chattels are similar to those that apply to land except that the occupation condition instead requires that the individual is in possession of or has the use of the property.

Again, there is no statutory definition of either ‘possession’ or ‘use’ meaning it is a matter of fact for HMRC to assess. There is limited guidance on the meaning of either term, although HMRC does consider that the same de minimis thresholds apply here as they would in an assessment for the purposes of the GROB rules.

If the POAC applies to a chattel, income tax will be calculated by taking the market value of that chattel and multiplying it by an official rate of interest.

Question 56

POAC: Settlor-interested trusts

Answer 56

As with land and chattels, two conditions apply:

· The trust must be settlor-interested, meaning there are circumstances in which the trust property is, will or may become payable to or for the benefit of the settlor. Examples include discretionary trusts of which the settlor is an object and trusts in which the settlor has a remainder interest.

· The trust property must include intangible property which was settled into the trust by the individual on its creation or subsequently added by them to the settlement. (It includes the invested proceeds of the original settled property – it doesn’t need to remain in exactly the same form.) The settlement or addition must have taken place 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.)

Question 57

POAC: Excluded transactions

Answer 57

The POAC does not apply to ‘excluded transactions’. These only apply to land and chattels and are broadly equivalent to other IHT exemptions. They include:

· Transfers to the individual’s spouse or civil partner are exempt from POAC.

· Dispositions for the purposes of family maintenance: If a gift qualifies for family maintenance allowance it is not subject to POAC (whether it would be caught by the disposal or the contribution condition).

· Annual and small gift exemptions: If a gift qualifies for annual or small gift exemption, it is not subject to POAC (whether it would be caught by the disposal or the contribution condition).

· Arm’s length sales: Disposals at arm’s length to unconnected persons do not meet the disposal condition.

· Occupation seven years after cash gift: If the contribution condition is met more than seven years before the occupation/possession condition, the POAC does not apply.

Question 58

4. General anti-abuse rule (‘GAAR’)

Answer 58

The general anti-abuse rule (‘GAAR’) was enacted in Finance Act 2013 as an attempt to counteract a wide range of aggressive tax avoidance. It applies to a range of taxes, not just IHT.

HMRC guidance on the GAAR indicates that it is intended to catch arrangements which are contrary to the spirit or policy of tax law, seek to exploit perceived loopholes in the law or involve artificial arrangements aimed at avoiding tax.

Where arrangements are caught by the GAAR, it is necessary for the taxpayer (to whom the tax advantage arises) to counteract the abusive effect of the arrangements by making “just and reasonable” adjustments. As a further deterrent, a penalty (of 60% of the counteracted amount) is also payable.

HMRC decisions as to the application of the GAAR may be referred to an independent GAAR Advisory Panel for determination.

Question 59

When does the GAAR apply?

Answer 59

The following conditions must be satisfied for the GAAR to apply:

· There is an arrangement which gives rise to a tax advantage: This can include a reduction, deferral or complete avoidance of tax. HMRC will usually compare the result with the tax consequences of the hypothetical transaction the taxpayer would have most likely entered into in the absence of the arrangements.

· The tax advantage relates to a tax to which the GAAR applies: This includes IHT.

· The arrangement satisfies the ‘main purpose’ test: This applies where it is reasonable in all the circumstances to conclude that obtaining a tax advantage is the main or one of the main purposes of the arrangement.

· The arrangement is abusive: The test requires HMRC to show that entering into the arrangement “cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions, having regard to all the circumstances”. This is known as the ‘double reasonableness test’.

Question 60

5. DOTAS

Answer 60

The Disclosure of Tax Avoidance Scheme (‘DOTAS’) was introduced in the Finance Act 2004 (‘FA 2004’). It is a reporting regime which is intended to make HMRC aware of potentially unacceptable tax avoidance arrangements at an early stage. It applies to a range of taxes, including IHT.

• DOTAS places duties primarily on ‘promoters’ of arrangements to inform HMRC about notifiable arrangements or proposals. Crucially, this can include legal advisers.
• Once informed, HMRC may allocate a scheme reference number to notifiable arrangements or proposals. Promoters (and their clients) are then required to provide this number to parties to the arrangements.
• Promoters must provide information to HMRC about any clients to whom they provide services connected to the notifiable arrangements.
• Parties to notifiable arrangements must also provide information to HMRC.
• HMRC has investigation and enforcement powers under DOTAS.

Penalties apply for failure to comply (but non-compliance is not a criminal offence

Question 61

DOTAS: Notifiable arrangements

Answer 61

Under s 306(1) FA 2004 arrangements in respect of IHT are notifiable if any of the following conditions apply:

• The arrangements fall within any description prescribed by HM Treasury by regulations. (These are commonly referred to as ‘hallmarks’).
• The arrangements (might be expected to) enable any person to obtain an advantage for a tax to which a relevant hallmark applies.
• The arrangements are such that the main benefit, or one of the main benefits, that might be expected to arise from them is the obtaining of the identified advantage.

The hallmarks differ depending on the tax concerned. There are three applicable to IHT. In this module we focus on the specific IHT hallmark, but note that there are two more general hallmarks that apply to IHT in practice

Question 62

DOTAS: The IHT hallmark

Answer 62

Two conditions must be satisfied for the IHT hallmark to apply:

The main purpose or one of the main purposes of the arrangements is to enable a person to obtain one or more specific advantages in respect of IHT. The specific advantages are:

• The avoidance or reduction of specified IHT charges relating to trusts and gifts to close companies. (These are outside the scope of this module.)
• The avoidance or reduction of charges arising under the GROB rules (unless the arrangement instead gives rise to POAC).
• A reduction in the value of an individual’s estate which does not give rise to a chargeable transfer or PET.

2. The arrangements involve one or more contrived or abnormal steps without which there would be no tax advantage.

Question 63

What is the IHT benefit of giving to charity?

Answer 63

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%.

Question 64

When for BPR and APR apply?

Answer 64

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.