RegulationOct 1 2015

Section 11 provides more relief

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Section 11 provides more relief

When I speak to other advisers about tax planning for families with young children it always surprises me how few advisers consider the planning opportunities presented by the often forgotten provisions of section 11 of the Inheritance Tax Act 1984.

This section provides, among other things, that where one party to a marriage makes a “disposition” (that is, a gift) to a child of either party to that marriage, which is for the maintenance, education or training of that child, then that gift is not a transfer of value.

What does this mean in plain English? Well, when a gift is not a transfer of value it means that the gift has no inheritance tax implications. Consequently, there will be no IHT on the gift, even if the parent dies within seven years of making the gift.

This presents tax planning opportunities for parents paying school fees. Let us take the example of Mr and Mrs Vincent and their two sons, Daniel and Jack, who are about to start at a fee-paying school at which they will stay through to completion of their A-levels. The fees total £60,000 per school year, so over the course of their primary and secondary education their school fees (excluding any annual fee increases) will total £600,000. Mr and Mrs Vincent also expect Daniel and Jack to attend university. Mr and Mrs Vincent anticipate that university tuition fees and living costs will be around £40,000 a year for each child, so depending on their choice of university and course of study, the Vincents will spend £840,000 on their boys over the course of their education. They want to set aside funds to cover these costs in a tax-efficient manner.

One option is for the Vincents to place the funds into a trust for the benefit of Daniel and Jack. Ordinarily, when transferring assets of this size into trust the Vincents would have to pay an IHT charge at a rate of 20 per cent – called an IHT entry charge – on the value the assets transferred into trust in excess of the couple’s available nil rate band. There would also be the potential for a further IHT charge if they died within seven years of setting up the trust, and if they created further trusts during that seven-year window then further IHT charges would arise on the creation of those trusts.

However, using the section 11 relief, Mr and Mrs Vincent can transfer this money into a trust for the benefit of their boys, without any IHT implications for their estates. A further advantage is that any growth in the value of the trust assets will be outside the Vincents’ estate. IHT charges will apply within trust, but the tax payable by the trust will be substantially less than the tax payable by the couple’s estates.

Careful planning is required: it is important to make sure that the trust does not continue beyond the completion of the children’s full-time education. It is also important for Mr and Mrs Vincent to calculate carefully how much money to put into the trust for two reasons. Firstly, the Vincents must be able to demonstrate to HMRC that the funds in trust are for the children’s maintenance, education and training needs, and that they are not excessive. Having calculated that the boys need £840,000 to cover their education costs, the Vincents cannot put twice that amount into trust in an attempt to move further value out of their estate. In those circumstances the funds in excess of the children’s educational costs will not get the benefit of the section 11 relief.

Secondly, the trust must come to an end when the younger of the two children finishes tertiary education. At that point any funds left in the trust must go somewhere. Mr and Mrs Vincent must decide when setting up the trust where any residual balance of the trust fund will end up. It could go back to them, but this is best avoided and so it is usual for any residual balance of the trust fund to be paid directly to the children. If the Vincents miscalculate the education costs at the outset then this could leave Daniel and Jack with a large windfall just as they finish university.

The section 11 relief is a valuable one, which extends beyond providing for the maintenance and education of a child. It can also allow an individual to make provision for a dependent relative.

So, returning to our example of Mr and Mrs Vincent, they have Mr Vincent’s elderly mother, Anita, living with them at home. Anita does not own her own property and has only a small amount of money in a savings account. Due to her deteriorating health there is an increasing need for her to have round-the-clock care.

Mr and Mrs Vincent decide to buy Anita a £300,000 bungalow with a second bedroom that can accommodate a live-in carer.

Provided that Mr and Mrs Vincent can demonstrate that the bungalow is reasonable for the purpose of providing care and maintenance for Anita, and having regard to her financial and other circumstances, then this gift will not be not be a transfer of value. So, as with the money that the couple has set aside for Daniel and Jack’s education, there are no IHT implications attached to the gift. Mr and Mrs Vincent do not have to survive seven years before the gift is outside their estate immediately because of the section 11 relief.

It is not usual IHT planning to make a gift up a generation, but this can be very effective where an elderly dependant relative such as Anita has little or no assets of her own. Where, on the other hand, the parent is independently wealthy, then the section 11 relief is unlikely to apply.

The cost of Anita’s live-in carer is £4,000 per month, which cost must be met by Mr and Mrs Vincent. Over the course of the next few years they spend £160,000 paying for Anita’s live-in carers. The section 11 relief refers specifically to provision for a dependant relative’s “care or maintenance”. Neither word is defined in the Act but it is generally accepted that “care” can include the provision of services.

Consequently, over a relatively short period of time we have seen Mr & Mrs Vincent make provision for their children’s education and an elderly relative’s care to the tune of £1.3m, none of which, with careful planning, will have any IHT implications for their estates.

Nick Mendoza is an Associate in the Private Client team at law firm Howard Kennedy.

Key points

A spouse’s “disposition” for the maintenance, education or training of their child is not a transfer of value.

One option is for parents to place the funds into a trust for the benefit of their child or children.

Provided that a couple can demonstrate that the gift of a bungalow is reasonable for providing care for an elderly relative, then this gift will not be not be a transfer of value.