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Matthew Hutton MA, CTA (fellow), AIIT, TEP presenter of Monthly Tax Review (MTR) comments on the Pre-Budget Report 2007 announcement affecting spouses and civil partners. 

Matthew Hutton

Introduction 

Legislation will be introduced in Finance Bill 2008 to allow a claim to be made to transfer any unused IHT nil-rate band on a person's death to the estate of their surviving spouse or civil partner who dies on or after 9 October 2007. This will apply where the IHT nil-rate band of the first deceased spouse or civil partner was not fully used in calculating the IHT liability of their estate. When the surviving spouse or civil partner dies, the unused amount may be added to their own nil-rate band.

The IHT provisions for alternatively secured pensions (ASP) will also be changed. Currently, a charge arises on left-over ASP funds once a relevant dependant's pension benefits cease and the rates of tax are those applying at the date of that event rather than as at the date of death of the scheme member. This rule will be modified so that, if the IHT nil-rate band was not fully used when the original ‘owner’ of the ASP died, the same proportion that was unused will be applied to the amount of the nil–rate band in force at the date of the later event and be available against the ASP.

(PBRN 16, 9 October 2007)

Some Observations

(a) Carrying forward to the second death the proportion of unused NRB on the first

The essence of the proposal is that (by introducing a new section 8A into IHTA 1984) FB 2008 will allow a claim to be made to transfer any unused nil-rate band (NRB) on an individual’s death to the estate of their surviving spouse or civil partner who dies on or after 9 October 2007.  This will apply where the NRB of the first to die was not fully used in calculating the IHT liability on their estate [so would include the case, for example, where the first estate was left, perhaps somewhat improbably, to charity rather than the survivor, either with no chargeable transfers or at least any such transfers are less than the then NRB].  On the second death the unused amount (expressed as a proportion of the then NRB) is added to their own NRB.

HMRC’s Questions and Answers confirm that in applying the s8A rule, it matters not that the estate of the first to die was below the NRB threshold (though there is some doubt as to whether the draft legislation achieves this).  Note that it is a mistake, as some newspaper commentaries do, to refer to a nil-rate band for a married couple at £600,000 (in 2007/08) rising to £700,000 in 2010.  Advantage can be taken of s8A only in computing IHT on death: chargeable lifetime transfers will be taxed in the ordinary way. 

The PBRN gives the following examples: (i) on the first death none of the then NRB was used because the entire estate was left to the surviving spouse.  If the NRB on the second death is £350,000, that would be increased by 100% to £700,000; (ii) if on the first death the chargeable estate is £150,000 and the NRB £300,000, 50% of the original NRB would be unused.  If the NRB on the second death is £350,000, that would be increased by 50% to £525,500.

(b) Multiple spouses: limitation to double the NRB on the second death

Para 9 of the PBRN goes on to comment that where a person dies having survived more than one spouse or civil partner (or dies having been married to, or the registered civil partner of, someone who had themselves survived one or more spouses or civil partners), the amount of additional NRB which can be accumulated by any one survivor will be limited to the NRB in force at the second death.

(c) Relief given through a claim on the second death

The claim mechanism operates at the second death only, to be made by the PRs of the second spouse or civil partner to die, on submitting the IHT 200.  But of course evidence will be required of the unused NRB on the first death, which could have been very many years before – and may present difficulties in digging out the paperwork.  HMRC will be publishing details of the NRB under both CTT and Estate Duty.  Obviously, a life interest protected from IHT by the Estate Duty surviving spouse exemption should be left undisturbed.  See also p6 below at Question 1.

(d) Good news, in principle?

While a variety of possible permutations present themselves, in general terms this seems to be good news (see (e) and (f) below, in particular).  However, there may well be circumstances where the traditional use of the nil-rate band on the first death will be advisable: see (l) below.     

(e) Maximise spouse exemption on the first death, with PETS or, within the survivor’s NRB, chargeable transfers shortly thereafter 

On the assumption that the NRB will generally increase over time [though note the proposal to link the NRB, in part at least, to house prices – so what happens if they fall dramatically?], it should prove sensible to minimise chargeable transfers on the first death, so maximising the NRB on the second.  Note that chargeable gifts made in the seven years before death or caught by the GWR regime will in effect eat into the NRB on the first death.  The spouse/civil partner exemption under IHTA 1984 s18 can be achieved by an IPDI as much as by an outright gift.  As soon as reasonably (and decently) possible after the first death, the survivor should make such gifts as he/she can reasonably afford to do without, keeping outside the gifts with reservation of benefit regime; however, gifts which exceed the survivor’s NRB will need to be absolute rather than in trust, to avoid an immediate 20% IHT charge.  Under an IPDI the trustees would terminate the life interest to that extent (and, being an IPDI, there would be no reading back into the Will under s144).  CGT should be considered, but should not be a problem insofar as no growth in value since death. 

(f) Helpful for dealing with the family home, in particular

As well as generally maximising the benefit of the zero rate of IHT in the two estates, the new structure will prove especially beneficial in dealing with the family home, not having to worry about the debt/charge scheme etc or NRB discretionary trusts (viz, do they in substance give an interest in possession to the survivor and what about CGT main residence relief in the light of TLATA 1996 s12 etc)?

(g) Agricultural/business property

Where on the first death there is property which clearly attracts APR or BPR at 100%, advantage should be taken of this, perhaps by a gift into a discretionary trust.

(h) Chattels – and precatory trusts

Beware the scope of IHTA 1984, s 143 with chattels or other property.  For example, a gift by the surviving spouse of a painting to a child within two years after the death (even if the wish of the deceased was expressed informally) will take effect as a chargeable transfer by the deceased.

(i) Deaths within the last two years

For estates of those who have died within the last two years, consider what should now be done (perhaps urgently if the two year period after death is about to expire) in terms of any deed of variation or appointment out of a two year discretionary/relevant property trust etc, bearing in mind that under a deed of variation one cannot have more than one bite at the same cherry (Russell & Russell v CIR [1988] STC 195).  See also the first caveat at (q) below.

(j) Discretionary Will trusts and HMRC’s puzzling comment

Para 15 of HMRC’s guidance on the new measure states:

‘Where someone dies after 9 October 2007 with a nil-rate band discretionary trust in their Will, an appointment of the trust assets in favour of the surviving spouse or civil partner (before the second anniversary of the death, but not within the three months immediately following the death) would normally be treated for IHT purposes as if the assets had simply been left to the surviving spouse or civil partner outright.  Ending the trust in this way would mean that the nil-rate band was not used on the first death, and so the amount available for eventual transfer to the surviving spouse or civil partner would be increased accordingly.’

It is hard to see why this principle should not also apply where the first death occurs before 9 October 2007, provided the appointment is made within two years after death.  Incidentally, the well-known Frankland trap no longer applies following FA 2006 if an appointment is made within three months after death on an IPDI – though the trap does continue to apply if the appointment within three months to the survivor is absolute.

(k) Deaths more than two years ago

Where the first death occurred more than two years ago and the NRB was fully used, nothing can be done to take advantage of the new regime [except by remarrying!].  And so families in such cases may have some cause for grievance – but significant changes in the legislation always bring winners and losers. Where a debt or charge scheme was effected on the first death, this should be kept under review to ensure that the planning will be effective on the second death – though this is not a new point.

(l) When might it be sensible to use the nil-rate band on the first death? 

Clearly the new s 8A should not be regarded as providing the best structure in all circumstances.  Consider for example:

(i) protection of the home from liability for care fees;
(ii) cases where the capital appreciation in the NRB Will trust is anticipated to outstrip future increases in the NRB; and
(iii) cases where it is desired, perhaps for non-tax reasons, to have two relevant property NRB trusts for children/grandchildren going forward, the one established under the Will of the first to die and the other set up inter vivos by the survivor

(m) Keeping Wills under review

So should all Wills where the couple are both alive now be reviewed?  Probably yes, over the fullness of time, as with any significant legislative change.  At least with tax-efficient Wills on the first death nothing is now lost, since an appointment can be made out of a NRB trust in favour of the survivor absolutely or indeed so as to create an IPDI.  However, a legacy/bequest of the NRB to the children or to trustees for them should probably be replaced (other things being equal) with a gift to the surviving spouse/civil partner, who would then shortly after the death make his/her own lifetime gift in the hope of surviving seven years (but watching the anti-avoidance settlement rules for income tax and CGT for gifts to minor children).  The amusing thing is of course that those couples who do have simple non-tax efficient Wills of ‘everything to the survivor’ are now shown (possibly) to be best of all!

(n) Will trusts for non-spouses/civil partners

For those couples who do not qualify for the s18 exemption, ie those not married or in a civil partnership, an NRB discretionary trust might still be appropriate, provided that where there are two or more trusts under the Will action is taken (eg by adding property to a pre-death pilot settlement) to avoid the related settlements provisions of IHTA 1984 s62.  The possible advantage of having more than one non-related relevant trust going forward (eg one for the surviving partner and the other for the children) is that the value of one will not affect the future IHT charges on the other(s).

(o) ‘Ascertaining’ the value for IHT (and so future CGT) purposes

One practical issue now looking forward, which has always applied in the case of spouse exempt gifts, is that no value will be ‘ascertained’ for IHT purposes (see TCGA 1992, s 274), so leading to more difficulty on a future disposal by the beneficiary in establishing relevant base costs.

(p) Application to the pensions regime

PBRN 15 carries over to the pension regime the new transferable spouse exemption in the case where an individual who has an alternatively secured pension (ASP) dies and the left-over funds are used to provide pension benefits for a surviving spouse or other financial dependant.  When those benefits come to an end an IHT charge arises on the then left-over ASP funds, with the rates of tax and NRB being those applying at that time.  Where the NRB was not fully used on the first death, the proportion which was not used will be applied to the NRB in force on cessation of the pension benefits for the relevant dependant.

(q) Caveats?

All this assumes that:

(i) the PBR proposal does in fact see the light of legislative day in FA 2008, some 9 months hence;

(ii) by the time of the second death the rule has not been repealed, with a lot of egg on face in relation to the lost benefit of the NRB on the first death (assuming that it is then too late to effect a variation under IHTA 1984, s 142); and

(iii) there is a ‘happy family’ and the survivor will indeed ‘play ball’, in for example making gifts to the children.  In case of any doubt, an IPDI structure should do the trick – and should continue to prove the favoured option with second marriages/civil partnerships where there are children by the first.

Three further questions

1. What happens where we have a first death under Estate Duty?

Para 7 of the draft Schedule introducing the new IHTA 1984, s 8A provides that s 8A will apply where the first death occurred before 18 March 1986, subject to regulations.  The question is answered by the following Q&A published by HMRC:

How does this work if the first death occurred during Capital Transfer Tax or Estate Duty?

The same basic principles apply, however, there will need to be some modifications to reflect the differences between IHT and Capital Transfer Tax (CTT)/Estate Duty. IHT was introduced on 18 March 1986, so points to bear in mind for deaths before that date are:

• Where the first spouse died between 13 March 1975 and 18 March 1986 then the estate would have been subject to CTT. Any transfers to the spouse would have been exempt from tax in the same way as for IHT and the transfer of nil-rate band provisions will operate in exactly the same way as it works for IHT.
• Before 13 March 1975 Estate Duty applied. Under Estate Duty there was no tax-free transfer permitted between spouses until 21 March 1972 when a tax-free transfer between spouses of up to £15,000 was introduced. This limit was removed for deaths after 12th November 1974.
• Where the first spouse died between 21 March 1972 and 13 March 1975 a claim to transfer the nil-rate band to the surviving spouse will be based on the amount of the tax free band that was unused on the death of the first spouse. For example, if a husband died in 1973 and left an estate valued at £10,000 that was all transferred to his wife, then as this is all within the spouse’s exemption the husband’s tax free band is unused. So if his widow dies in December 2007, her nil rate band can be increased by 100% to £600,000. Where any part of the first spouse’s individual tax free band was used then there will be a proportionate reduction in the amount by which the surviving spouse’s IHT nil-rate band may be increased.
• Before 21 March 1972, there was no relief from Estate Duty for transfers between spouses so the amount by which the surviving spouse’s IHT nil-rate band may be increased will be based on the proportion of the individual tax-free band that was unused on the death of the first spouse.

2. Can an IPDI be created by Deed of Variation?

Where the first death occurred within the last two years and a surviving spouse being the sole beneficiary had by Deed of Variation created a nil-rate band trust (including herself as a beneficiary), it would be open to the trustees, under IHTA 1984, s144, to make an appointment to the spouse either absolutely (being more than three months after the first death) or on an IPDI.  Expressly, I understand HMRC Inheritance Tax to allow the combination of an s142 variation and s144 appointment in this way.  I have been referred to section 52.5 of Tolley’s Taxwise where a reference to the strict wording of IHTA 1984 s 49(1A) leads to the observation that ‘this wording means that it will not be possible for an IPDI to be created using a deed of variation’. 

My response (though the point should be expressly confirmed, if needed, by HMRC) is that a variation within s142 operates for all purposes of the IHTA 1984 ‘as if the variation had been effected by the deceased’.  I would have thought that such a deeming provision would then be read into s 49A(2), with the result that the IPDI would be treated as effected by Will. 

In (general) support of this view, I note the deeming provisions of new s 144(3) and (4).  That is, an event may occur within the two-year period after death resulting in what would have been an IPDI or a bereaved minor’s trust or an age 18-to-25 trust had it been established by the Will, in which case the IHTA 1984 is to have effect as if indeed the Will had so provided.

So this represents my view unless I am told otherwise by HMRC.

3. If a variation has been effected to create an NRB trust with debt provisions, is it a case of merely appointing the fund to the surviving spouse (if death is still less than two years ago) and the NRB trustees waiving the debt?

My answer is, again combining s 144 with s 142, that the NRB trustees would appoint the debt (which is of course the trust fund) to the surviving spouse, the liability and the asset being now in the same hands would simply cancel each other out and the trust would come to an end (there being no more trust property).  So there would be no question of the trustees having to waive the debt.

I can’t see that HMRC would object to that. And, against any associated operations type argument, one would legitimately say that the 9 October PBR was an entirely extraneous event not foreseen when the NRB trust was created.

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