Inheritance tax planning in uncertain times

In this article we look at how to carry out inheritance tax (IHT) planning in a way that is timely and does not lead to an unwelcome amount of immediate financial detriment.

“May you live in interesting times” reads the Chinese curse; the last several years in the UK have been notable for many things but instilling a sense of boredom amongst its citizens cannot be said to be one of them. Food and power costs have soared while stock markets have been rocky, house prices have stopped their seemingly inexorable rise and Prime Ministers change with alarming regularity.

Steps have been taken to try to stabilise the country’s financial position, including the freezing of the inheritance tax (IHT) nil rate band until 6 April 2028 which will inevitably lead to more estates being brought within its ambit. Many clients will be keen to maximise the assets they pass onto their children but will be understandably reticent about depleting their assets and income to too great an extent by IHT planning.

IHT planning which is flexible, and which does not involve large gifts of income producing capital assets, might have the most appeal to many people until world and domestic events stabilise.

Wills

Your clients should have their Wills reviewed to ensure that they are as tax efficient as possible. Several measures can be included within Wills to mitigate IHT liabilities. These include checking that the provisions of the Will allow the residence nil rate band to be claimed in full, using nil rate band discretionary trusts for various purposes, including enabling multiple nil rate bands to be claimed for those married for the second time who have been widowed previously. Another IHT planning possibility is to leave a small share of the family home to a trust for the children on the death of the first spouse, enabling a valuation discount of up to 15% to be claimed on the death of the surviving spouse on the share of the property owned by them; a valuation discount which is intended to reflect the increased difficulty in realising a property share in these circumstances.

Flexible lifetime inheritance tax planning

Your clients may feel more comfortable at present with a form of IHT planning that can be changed if their circumstances alter. The normal expenditure out of income exemption is worth considering if your clients have excess income not required to maintain their normal standard of living. Gifts must be made on a regular basis but can -and should- be stopped if income levels fall to an extent that the exemption can no longer be claimed.

Gifts of second homes

If clients with adult children have holiday homes they might like to consider transferring the home to the children or to a trust for their benefit. This would achieve an IHT saving after seven years. The parents would have to pay a market rent for their future occupation of the house but this could be used to pay outgoings, so ensuring that their income position is relatively unaffected.

Maximising reliefs

If clients own business and/or agricultural property which is likely to qualify for IHT reliefs now is a good time to review whether action could be taken to increase the likelihood of successfully claiming reliefs. Will planning is also relevant here in the context of including exempt asset trusts in Wills and enabling a couple to have a “double dip” of IHT relief.

If clients own business assets which are unlikely to qualify for IHT relief, perhaps because the business is classified by HMRC as being an investment company, further action could be considered.

Asset value freezing for investment companies

The objective of this planning is to freeze the value of the shares belonging to the business founder so that future growth in value accrues not to the founder but typically to the next generation. This is achieved by dividing the company shares into two classes which will involve an alteration of the company’s Articles of Association. The founder retains one class of shares which carries an entitlement on winding up equivalent to the current value of the company. A new class of shares is created to which all future growth in value of the company will accrue and the younger generation are invited to subscribe for these. Alternatively, the new shares could be given to a trust for the benefit of the younger members of the family.

There should be no IHT implications at this stage because the new class of shares will have only a nominal value as initially they have no voting rights, no dividend rights and no capital value above face value. s98 Inheritance Tax Act 1984 imposes an IHT charge on the alteration or extinction of share rights but the argument against a potential s98 charge is that the value of the existing shares is not substantially reduced by this planning. Capital gains tax implications will have to be considered.

If the planning is successful, the founder of the company will be taxed on their death only on the value of the company at the date the two share classes were created.

For example, Marcus is the founder of a company which owns ten properties in Brighton which are let. The current value of the company shares (net of lending secured against each property) is £2 million. New B shares are issued to Marcus and the original ordinary shares are re-designated as A shares. The company’s Articles of Association are amended to provide that the B shares are entitled to dividends and capital on winding up, only if the A shares have already received £2 million. Marcus gives the B shares to a discretionary trust for his children and grandchildren. By the time Marcus dies five years later the total value of the company has increased to £3.5 million. £1.25 million (£2 million less dividends paid of £750,000) is within Marcus’s estate and subject to inheritance tax but the remaining £2.25 million belongs to his family trust leading to a substantial IHT saving. In the meantime, Marcus’ income and immediate standard of living are unaffected by this planning.