Tax Doctor:
Mark McLaughlin
ATII ATT TEP

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November 2003

Q:

My wife and I are worried about Inheritance Tax (IHT). Our accountant has suggested creating a trust for family members, but we would like to make direct gifts to our adult son and daughter, particularly as our son has recently started a transport business. What are the IHT implications?

A:

Your query does not indicate the size of your own and your wife’s estates. The current IHT ‘nil rate band’ is £255,000. There is no IHT problem for estates falling within this limit, including gifts made within the seven years before death. A common IHT problem with husbands and wives is that the first spouse to die often leaves their entire estate to the surviving spouse, thus wasting his or her nil rate band and swelling the surviving spouse’s estate. This problem can be resolved or at least mitigated with planning, but that is a separate issue. For these purposes, I shall assume that your estates are sufficiently large to make lifetime IHT planning considerations important.

How much do you envisage giving to your children? You and your wife each have a nil rate band. As cash gifts escape IHT after seven years, at current rates you can give away the equivalent of your £255,000 nil rate bands (£510,000 in total) every seven years with no IHT implications. If your gifts exceed the nil rate bands and any available IHT exemptions (see below), you could consider taking out insurance against the potential tax liability if you or your wife should fail to survive the necessary seven year period.

IHT Exemptions

You each have an annual IHT exemption of £3,000. For the current year, you could give your children £6,000 between you, plus a further £6,000 if you did not use your annual exemptions in the previous year. Significant amounts could be gifted over the long term, just by utilising your annual exemptions.

There are other exemptions for lifetime gifts, including a valuable exemption for normal gifts out of income. There is no upper limit on this relief. This obviously makes the exemption potentially very valuable, and it is therefore not surprising that certain conditions must be satisfied. These are broadly as follows:

1. The gift must be made out of your normal expenditure;
2. It must be made out your income (taking one year with another); and
3. After making such gifts, you must be left with sufficient income to maintain your normal living standards.

In practice, it can be difficult to convince the Inland Revenue that these conditions are satisfied. The onus of proof rests with the taxpayer, and specific professional advice should be sought.

Business Property Relief

You state that your son has started a transport business. There is relief from IHT on certain kinds of business investment. You could therefore consider acquiring ‘business property’ qualifying for IHT relief, the categories of which include the following:

1. a business or interest in a business (e.g. in partnership between you and your son or daughter);
2. any percentage shareholding in an unquoted company; or
3. unquoted securities (e.g. loan notes) with voting power which (by themselves or together with any unquoted shares held) give you effective control over the company.

The above categories potentially qualify for 100% business property relief (whereas certain others qualify for relief at 50%), but there are various conditions to be satisfied. For example, broadly speaking the investment must be owned for at least two years (unless it replaced other business property held for a specified minimum period), and the business must be wholly or mainly trading (as opposed to, say, making or holding investments).

Whilst using money to (for example) acquire shares in your son’s trading company (if it is a company) is not a gift as such, it is an IHT efficient way of helping your son, and it does open up other tax planning possibilities later on, e.g. setting up a family trust and gifting the shares.

Finally, IHT planning may seem relatively straightforward (or perhaps not!), but the conditions to be satisfied to take advantage of IHT reliefs and exemptions can be complex. Detailed professional advice is therefore recommended.

Mark McLaughlin

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