Enter Your E-mail

Bob Fraser, MBE, MBA, MA, FPFS, TEP comments on recent HMRC guidelines on a popular form of inheritance tax planning arrangements.

Introduction

HMRC has updated its guidelines on the basis on which the discounts are to be calculated by providers. This will slightly reduce future discounts and therefore increase the size of the gift or transfer.

There is a more significant issue with joint settlor cases where the guidelines make a more radical change to the basis of the discounts. This may affect a very small number of existing cases.

Background

Discounted Gift Schemes combine an effective gift into trust with a stream of lifetime income. Retaining the right to this income usually enables the value of the gift to be discounted, depending on how long the stream of income is likely to last.

The discount is based on the level of income and the settlor’s age, sex and state of health which should be underwritten with the same standards that would apply to underwriting a whole of life contract. Our position has always been to obtain full underwriting before commencement where it is available as this is vastly preferable to the executors having to ‘argue the case’ in the event of death within seven years. (HMRC have always reserved the option to re-visit discounts on death within seven years.)

The Changes

The changes to the methodology for calculating the discounts include:

• using more up to date life expectancy statistics to take account of longer longevity
• a higher interest rate for the purpose of discounting the future income stream, to take account of recent interest rate increases.

The changes are effective from the 1st June. Each of the providers will be introducing their own transitional arrangements for pipeline business.

Joint Settlor Cases

Previously the discount was calculated on the income selected and both settlors’ age, sex and health, and then the discount was allocated pragmatically on a 50/50 basis between them. This produced an unreasonable valuation where there was a wide disparity between the two settlors’ ages or states of health.

The total discount will now be apportioned between the two settlors accordingly. This means that the settlor with the relatively shorter life expectancy will be allocated less than 50% of the discount, the percentage falling with a greater disparity between the two settlor’s states of health. At the extreme, if one of them is effectively uninsurable, they are unlikely to get any discount at all whatever the other settlor’s health or youthfulness!

This new basis will also be applied retrospectively in a small number of completed cases where there is a wide disparity between joint settlors’ life expectancies and the amount involved is substantial. (HMRC do not say what size of case is ‘substantial’ but it is thought likely to be at or around the nil rate band.)

Clients aged over 89

Because it is very difficult for clients in their nineties to obtain whole of life assurance, HMRC take the view that those who have passed their 89th birthday (or rated over that age) should not be eligible for a discount. It has always been my firm's (Towry Law’s) view that for clients in this age group, because of the short statistical life expectancy, any IHT planning should be approached with caution and should probably only consist of using the exemptions and lifetime gifts.

Conclusion

In general, these HMRC guidelines are positive news as they confirm HMRC’s current acceptance of Discounted Gift Schemes. It also confirms our stance that full underwriting before commencement is preferable.

The updated basis for valuing future income streams could be described as ‘fair’ given that we are all, on average, living longer.

The change to joint settlor cases effectively closes off a loophole where it was more attractive to link someone in poor health to someone in normal health. The retrospective aspect should only affect a very small number of cases, and then in practice only on death within the seven years.

As I have stated previously, I do not believe that using these schemes for the discount only is wise since, as this note shows, HMRC are not bound to accept the discount offered by the Life Office. It is, however, an excellent way to gift capital from one’s estate whilst still obtaining a benefit from it, and yet not falling foul of the gift with reservation of benefit rules. This, in my opinion, is the proper reason for selecting a discounted gift scheme.