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TaxationWeb by Daniel Feingold, Barrister (NP)

The family home is often the main asset in a person's estate. Escalating property values are resulting in more and more people falling into the IHT net as a result. What can be done? Daniel Feingold outlines an arrangement which may have a short shelf life.When I first thought of writing this article there were three exciting tax-planning opportunities available to take the family home out of the inheritance tax net.

The avenue thrown up by the Eversden case has since been blocked via this year's Finance Act and that leaves the Double Trust or House Debt Scheme and the Reverse Ingram or Reversionary Lease Scheme.

Due to the time-scale needed to implement the Double Trust or House Debt Scheme (Exchange of Contracts needs to be done by December 1st 2003!) and because I have a personal preference for it: I shall be highlighting the opportunity in this article. I shall cover the other ideas mentioned above, in a later piece on this website.

1: AVENUES TO CONSIDER FIRST

I feel it is vital that before one rushes headlong into thinking of implementing the Double Trust or House Debt Scheme more conventional avenues should be explored.
First of all have you considered simply moving house and then giving the proceeds to your intended heirs? They can then purchase the new property in their names but using a Revertor to Settlor trust can give you and your spouse a secure life interest, whilst ensuring no capital gains tax on death and more importantly no inheritance tax.

Secondly, have you considered borrowing against the property and gifting the cash to his heirs?

Thirdly, have you considered borrowing against the property and investing in assets that can secure 100% Business Property Relief after only 2 years?

Fourthly, Have you considered any Life Insurance based planning such as a whole of life policy written in trust.

Only after all the above and other more conventional options have been explored, should you consider the Double Trust or House Debt Scheme.

2: WHO SHOULD BE CONSIDERING THE SCHEME?

This is a serious piece of tax planning and its meant for properties valued at a minimum of 500k and for those with other assets the costs will range from 8k upwards. So, if your estate is worth less than 750k you would not find it either cost effective or sensible based on the fees for the Scheme and the fact that using more conventional planning in most cases you will be able to achieve the same tax savings.

3: THE SCHEME

Many professionals and IFA's can happily outline the basic mechanics of the Scheme and when you read them they at first look frighteningly easy as outlined below:

- Suppose John has a house. He sets up a Life Interest trust where he and his spouse are the principal beneficiaries; entitled to live rent-free in any property owned by the trust.

- John then sells his house to the trust for open market value, (based on an appropriate independent surveyor's valuation), but the purchase price is left outstanding in the form of a written loan note or IOU. In other words, John is owed a debt by the trust.

- The Debt will may be subject to interest, but is more likely to be indexed linked in a special way to allow for any future increases in the amount owing to keep step with the value of the house, without there being a need to make payments to John or his Spouse from the trust during their lifetimes.

- Such a sale would normally incur Stamp Duty and for a house over 500k in value that would be 4%, or at least 20k. Many would see this as a barrier to carrying out this Scheme.

- However, there is a method of selling a house known as 'Resting in Contract' that defers any Stamp Duty until the House is sold to a third party. Stamp Duty law is changing after December 1st 2003, but it is perfectly possible to carry this method out until then.

- John after a suitable interval sets up a second trust for his children (or other intended heirs) where he and his spouse are excluded from benefit.

- He then gifts to that trust the loan or debt owed to him from the first trust. Provided that John lives for seven years, the total value of the house that will be included in his estate for inheritance tax purposes will be it's market value at death, as reduced by the outstanding debt still owing to the second trust. John may take out 7 year reducing term insurance to cover this liability.

- John has transferred the house out of his estate, at the sale value plus any indexation rise in the value of the house or of property generally.

- On John's death the value of the house will be the open market value at that date and a sale at that value will be free from capital gains tax.

4: THE TAX ISSUES

These are complex, but can all be satisfied as long as they have been considered.

- Is there is a reservation of benefit by virtue of having a right of occupation under the trust? I believe that this is a separate right and should not considered a reservation of benefit.

- Is the loan deductible from the value of the house for inheritance tax purposes? If the loan is not deductible, then the whole scheme fails. I believe that although there is no clear case law to approve such a deduction it is entirely in accordance with the tax legislation in that all debts have to be deducted in arriving at the value of an asset for inheritance tax purpose. It is vital that the loan is not secured on the property to achieve this position.

- Do any of the specific anti-avoidance rules prevent this scheme working? I believe that provided the steps of setting up the trusts and making the gift are not carried out at the same time and that the gift is a clearly separate act, then these rules should not effect the scheme.

- Occupation under the trust should preserve the principal private residence exemption for the House.

- The loan note taxation is highly problematic. If the loan note is just to exclude the current value, then this is not a great problem.

- If it is repayable on demand, then this constitutes a reservation of benefit.

- There are no less than 6 different ways of drafting the loan note to take into account the need to keep into in line with the current value. Some try to do this by creating either an actual interest liability subject to income tax at 40% and others do it by creating a capital gains charge. Some defer those charges. But either method will have a substantial income tax or capital gains charge and possible further inheritance tax when the house is eventually sold and the loan repaid.

- Another problem is that the value of the loan note when it is created will be less than the House and therefore there maybe a large income or capital gains charge in the future.

- There is no optimum solution if you want to cover the future increase in value, but clients will probably want to choose from a number of options. One can arrange the loan note so that there is a capital gains charge that will reduce to 20.4% and the other will have a possible income tax charge and a small inheritance risk.

5: THE WAY FORWARD

As you can see from the tax issues outlined above; this is a specialist area and it is important to note that this strategy is not free from risk and could be attacked by the Capital Taxes Office of the Inland Revenue.

However, following the court proceedings over the Eversden Case, it is more likely to be stopped by new law and only from the date the new law is announced.

It is vital to have this Scheme carried out properly with good advice and professionally drafted documentation. It is also key that the final steps of setting up the second trust and gifting the loan note are viewed as independent steps and that the critical loan document is well thought out and not simply a standard document that may not suit your circumstances.

Overall, it is important that you are aware of the potential pitfalls and so the above issues should be discussed and appropriate advice taken before proceeding.

Several Leading Tax Lawyers have implemented this idea for many years without any legal challenge by the Inland Revenue. The fact that after December 1st 2003 Stamp Duty will be due, may mean the Scheme will no longer be implemented in practice. Therefore, the Inland Revenue may see no need to pursue a challenge.

It is also important to be aware that you will be in no worse position from an inheritance tax perspective, if the Scheme is successfully challenged. All that is at stake are the costs of carrying out the Scheme. No interest or penalties will be applicable.

Therefore the Scheme represents a good opportunity for you to place a valuable asset outside your estate!

Daniel M Feingold Barrister (NP) October 2003.
e-mail: sedrate@easynet.co.uk
Tel: 0161 720 7244.