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Toby Harris LLB CTA TEP comments on recent developments affecting inheritance tax planning, and comments on pre-owned assets a year or two down the line since its introduction.

Introduction 

Actually, a considered study of Finance Act 2006 does not show that the position of the moderately wealthy family has been prejudiced excessively by Finance Act 2006. It would be better to say that a number of established loopholes have been closed and that, more than ever before, it will be worthwhile for families of moderate wealth to consider their tax planning options and work within the new rules.

The moral is: “get on with it” and start planning early in life.

Lifetime giving

This is where the big change has arisen. Many families, on reaching the age of 60 or so, will begin to think about making provision for subsequent generations, particularly if there are grandchildren with educational needs that cannot properly be met by local state schools. Traditionally such families would establish an “Accumulation and Maintenance” Trust, perhaps with only modest capital, and would add to it over the years. The tax treatment of these trusts has changed significantly. All new lifetime trusts, except for disabled persons, will be taxed in the same way as discretionary trusts have always been taxed.

For the moderately wealthy, this is not desperately bad news. Where the trust is set up within the nil-rate band the tax regime is very light (though the administration is tiresome). That means that a couple wishing to make provision for their grandchildren can still set aside nearly £600,000 between them as a fund for education etc without immediate tax penalty.

Where the family assets run into millions of pounds it becomes more urgent to use the rules and to make discretionary trusts now, so as to start the 7 year period running before a further such gift can be established without any complication. (That is a simplification of the rules but it will serve for the general purposes of this article).

Similarly, where the family wealth is in farmland or business property, it is more important than ever before to check the exact way in which the assets are held to make sure that best use is made of the reliefs.

Winter, with Christmas and the New Year, is traditionally a time for taking stock. What is the impact of all this on existing Wills?

In brief, not a lot! Whilst the changes originally proposed in the Budget would actually have forced about 3 million families to review their Wills, the final version does leave spouse or civil partner relief intact for most families with Wills that include on-going trusts. There has been no direct legislative challenge to the “debt or charge” scheme. There has been no fundamental change to the rules on domicile, though one recent case has tightened up the law on residence. Whilst it is always a good idea to review a Will after three to five years, there seems to be no need for panic measures.

How do the changes affect existing trusts?

This is difficult. Many trusts may be able to continue as before, particularly those where an adult beneficiary enjoys the income of the trust for life. However, the new rules do affect existing accumulation and maintenance trusts. There will generally now be an advantage in CGT for younger beneficiaries but a disadvantage in IHT terms where the fund is substantial. As a result, virtually every existing trust now needs to “come in for an MOT”. The trustees need to know how the new rules affect their beneficiaries and whether there is any action that they should take. The urgency is that certain opportunities are open to the trustees until 5th April 2008 and trustees will almost certainly be negligent if they do not check the tax position of the trust between now and then. Some trustees carry insurance against personal claims, but it must be remembered that generally trustees are responsible for the care and skill with which they carry out their duties and in an extreme case the beneficiaries could, in effect, ask the trustees to pay any excess tax out of their own pocket.

Are there any new rules affecting farm buildings and farmhouses?

Yes, there has been one farmhouse Decision, McKenna, in favour of the Revenue. It concerned a fine house with stunning views, the value of which overshadowed the value of the agricultural land enjoyed with it. The occupant was no longer a “hands on” farmer. In the Decision the Special Commissioner, though with some reservation, took a step in the direction of agreeing with the views of the Lands Tribunal in Antrobus Number 2. The effect of this is to suggest that agricultural relief is more readily available to “real” farmers than to “lifestyle” farmers. This is a difficult area and we learn a little more from each case that is decided. A significant decision was made some time ago, in the Williams case, that agricultural relief is not available on buildings that “dominate” the holding of land. They must be “ancillary”. This was always the law: see s115(2) Inheritance Tax Act 1984: the case is merely an example of how the rules will be applied. Whether a building “dominates” will be a question of fact in each case.

How is the pre-owned assets tax settling down?

Quietly! Many of the situations on which we are asked to comment actually show that the new tax will not apply because, perhaps, the existing arrangements which had been put in place to save IHT were ineffective and there was a gift with reservation. Just a few people are having to make the hard decision whether or not to pay the tax or, in effect, to say to the Revenue “it’s a fair cop Guv” and to surrender the IHT advantages that had originally been hoped for. We are involved in unscrambling some of the more sophisticated schemes that were put in place a few years ago. It is certain that the legislation has created a good deal of uncertainty and distress for taxpayers, many of whom will obviously be elderly and will have only modest resources with which to pay the tax.

The above is taken from Toby Harris Consultancy's 'Whats New? / Winter Newsletter  2007' and is reproduced with the kind permission of Toby Harris.