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In the next of a series of extracts adapted from his eBook 'Hutton on Estate Planning' (3rd Edition), Matthew Hutton looks at other tax considerations in the context of Inheritance Tax (IHT) mitigation.

Possibility of Conflicting IHT & CGT Considerations

IHT, and its mitigation, cannot be viewed as a subject in isolation. Applying the maxim ‘one man’s meat is another man’s poison’, what is absolutely the right thing to do in the interests of mitigating IHT might well trigger an unexpected CGT – or indeed Stamp Duty Land Tax (SDLT) or VAT – liability which eats up the IHT saving. There may of course also be Income Tax implications, though these are not considered further in this context. 

Example

This concerns "reverter to settlor trusts", as affected by the FA 2006 regime.

Brian made a gift of Blackacre to his son Bruce in 2000. Subsequently (but before March 2006) Bruce put Blackacre into a settlement under which Brian has a right to income or occupation for life subject to which it goes back to the son for life (the revertor to settlor), with power for the trustees to advance capital, with ultimate gifts to Bruce’s children.  Under the pre-22 March 2006 regime, when Brian dies there is no IHT to pay by reason of the ‘revertor to settlor’ exemption (IHTA 1984 s 53(2)) and there is the usual CGT-free uplift to market value within the trust. 

Now, however, following FA 2006, on Brian’s death on or after 6 October 2008, the IHT exemption will apply only if Blackacre comes to Bruce outright, with a loss of the CGT-free uplift: Bruce will inherit Blackacre at the trustees’ historic base cost.  (If Brian had died before 6 October 2008, Bruce’s life interest would be a ‘transitional serial interest’, treated as if he owned Blackacre outright, i.e., with reverter to settlor relief.)

Alternatively, if the structure is left as is, the CGT-free uplift will be secured but at a cost of paying IHT on Brian’s death. So, if the IHT saving is more significant than the CGT cost on future disposal, one might consider changing the terms of the trust to ensure that Blackacre passes to Bruce outright. But the issue should be considered while Brian is still alive: once he has died it will be too late.

Happily, however, there is also one other possibility: an outright reverter to Brian’s UK domiciled spouse/civil partner (or, if Brian has died within the last two years, UK domiciled widow/surviving civil partner) will secure the twin benefits of IHT exemption and CGT-free uplift.

TAX TIP

With any reverter to settlor trusts made before 22 March 2006 where the life tenant remains alive, consider action following 5 October 2008 to change the terms of the trust (if necessary) to an absolute reverter to the settlor’s UK domiciled spouse/civil partner - assuming of course that that is a sensible thing to do in the context of family circumstances as a whole. Such an arrangement will turn out to be ineffective to secure the tax savings only if the settlor predeceases the life tenant’s spouse/civil partner by more than two years – or, of course, if the spouse/civil partner fails to survive the settlor. 

Capital Gains Tax

Lifetime IHT mitigation will, in the normal course, (except where Sterling cash is given) involve what amounts to a disposal for CGT purposes. The gain in the hands of the transferor will be a chargeable gain computed on normal principles, which, subject to the Annual Exemption, will attract CGT at up to 28% since 23 June 2010. Of course, if either the asset is a qualifying business asset or there is a chargeable transfer for IHT purposes, the gain may be ‘held over’ (under TCGA 1992 s 165 or s 260).  This assumes that the transferee is UK resident. However, if he becomes non-UK resident within broadly the following six years the held-over gain will crystallise (subject to two qualifications), to be charged first on the transferee and then, if he fails to pay within twelve months, on the transferor (TCGA 1992 s 168). So the CGT impact of any gift must be considered.

Tax Trap

Anyone (but especially trustees) making a gift (capital advance) and deferring the gain by electing for hold-over should recognise the possibility of the deferred tax charge failing on him if the donee/beneficiary emigrates and fails to pay the tax within the statutory 12 months after emigration.

Stamp Duty Land Tax

A gift, pure and simple, of land and buildings does not attract SDLT (FA 2003 Sch 3 para 1), just as under Stamp Duty a gift of shares can be certified as attracting no Duty (The Stamp Duty (Exempt Instruments) Regulations 1987 SI 1987/516). But if the land is subject to a mortgage or is transferred in consideration of the removal of a debt, the amount of the mortgage or debt constitutes chargeable consideration for SDLT purposes (FA 2003 Sch 4 para 8). So, with residential land, if the mortgage debt exceeds £125,000 (£175,000 for transfers after 2 September 2008 and before 1 January 2010), the Nil-Rate Threshold, there will be SDLT to pay. (For ‘first-time buyers’ as defined the Nil-Rate Threshold is £250,000 for acquisitions after 24 March 2010 and before 25 March 2012.) And in any case there will be compliance implications for making the transfer for a deemed consideration of £40,000 or more (£1,000 or more before 13 March 2008).

There is a further point. If land is transferred to a company with which the transferor is connected (within the meaning of TA 1988 s 839) or in consideration of shares in a company controlled by the transferor, the consideration is deemed to be not less than the market value of the land – i.e., it could be more if such actual consideration is paid, but cannot be less (FA 2003 s 53). This may be an unlikely thing to happen, though the point should be borne in mind, e.g., with the grant of a lease to a family company as part of IHT planning arrangements.

Value Added Tax

Just as for SDLT, a gift pure and simple should have no VAT implications. But if the subject-matter of the gift forms part of a VAT-registered business and involves the removal of one or more assets from that business and those assets are land, there is a liability on the business to pay VAT at 17.5% [15% from 1 December 2008 to 31 December 2009 and 20% after 3 January 2011] on the market value of the asset (VATA 1994 Sch 4 para 5).  For example, a gift by her parents to their daughter on her marriage of one of a number of holiday cottages would trigger an unexpected VAT liability on the parents. The only way that this consequence could be avoided might be to have the whole business given away and to arrange things such that the ‘Transfer Of a Going Concern’ provisions apply so as to take the transaction outside the scope of VAT. 

The above is an adapted extract from Hutton on Estate Planning 3rd Edition.

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