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Matthew Hutton MA, CTA (Fellow), AIIT, TEP, Presenter of Monthly Tax Review, highlights an interesting analysis of the clawback provisions affecting Business Property Relief (BPR) and Agricultural Property Relief (APR) for Inheritance Tax purposes.

Context

There is an interesting distinction in the operation of the clawback between the case where there is an initial PET on the one hand and an immediately chargeable transfer on the other (IHTA 1984, s 113A(1) and (2) for BPR and s 124A(1) and (2) for APR).  I have been discussing the point in detail with Adrian Baird of the CLA who has produced this valuable analysis.

The Analysis

The basic position is as follows:
 
1.  On death any chargeable transfer made within 7 years of death is reappraised for the purposes of additonal tax (subject to taper) - in this process the nil-rate band at death is used.
 
2.  The essential difference of the APR/BPR clawback for immediately chargeable transfers and for PETs is that:

2(a). if a PET becomes chargeable and the clawback operates there is no relief - which could make the full value of the (then) chargeable transfer of value chargeable; but

2(b). for an immediately chargeable transfer subject to the clawback, the rule operates only for the purposes of the additional tax.

3.  So suppose £350,000 of in-hand eg property qualifying for 100% relief on all of its value is transferred at a time when the nil-rate band is, say, £312,000.  Annual exemptions are £3,000 pa and the transferor has not made any previous transfers.  The transferor then dies 2 years 8 months later when the nil-rate band is £350,000 and the clawback operates.

3(a).  If a PET when made, then there is no IHT charge at outset.  However, on death the whole of the £350,000 value transferred is chargeable, so the whole nil-rate band is absorbed.
 
3(b).  If a transfer to a trust, it is then immediately chargeable when made, but when made full 100% relief is due reducing the value transferred to nil.  On death the clawback operates and, for the purposes of the additional tax only, it is assumed that the value transferred is £344,000 (ie £350,000 less two annual exemptions).  As this falls below the nil-rate band on death, no additional tax is due and the full amount of the nil-rate band is available because no additional tax is payable.

4.  Now suppose the transfer was £1M.

4(a).  If a PET, then no tax when made and then the whole NRB on death is applied against the chargeable transfer of £994,000, leaving £644,000 liable at 40% = IHT of £257,600.
 
4(b).  If to a trust, then when made the value transferred is nil, but the clawback operates now to reinstate a chargeable transfer of £994,000, leaving £644,000 liable at 40% producing exactly the same tax as above in 4(a).
 
4(c). In both cases the NRB on death has been fully absorbed.

5.  Accordingly, as the IHT effect in 4(a) and 4(b) must be identical, the advantage of the differing treatment of clawback arises only where the clawback does not produce any additional tax on the chargeable transfer.  That arises where, after clawback, the value transferred after cumulation is less than the nil-rate band on death.
 
(Email to Matthew Hutton from Adrian Baird, Chief Taxation Adviser CLA, 19.9.08)

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