Despite the spin surrounding the Budget’s introduction – from 2017 – of a “new £175,000 allowance for your house when you leave it to your children or grandchildren” this new legislation is unlikely to make much impact when you consider the chancellor’s opening statement in introducing this new relief. He said, “Today there are more families pulled into the inheritance tax net than ever before – and that number is set to double over the next five years. It’s not fair and we will act.”
HMRC’s latest statistics
On 30 July 2015 HMRC released its inheritance tax (IHT) statistics for 2012-13. The highlights included tax receipts of around £3.8bn in 2014-15, up by 11.9 per cent from 2013-14. On top of this, approximately 3.1 per cent of all deaths in 2012-13 led to an inheritance tax (IHT) charge, up from 2.9 per cent for the preceding two years.
Each year residential property makes up approximately a third of the total value of taxpaying estates and about 17 per cent of cases where information was provided to HMRC on tax returns about estates with a tax liability had either missing or invalid postcodes.
This last statistic is perhaps most surprising. HMRC’s Form 400 (reporting the assets in a taxable estate) specifically asks for the postcode. If almost a fifth of personal representatives (or their advisers) is not correctly filling in HMRC’s form, what reliefs are missed, or other mistakes made, to the detriment of the estate?
I recall reviewing a Form 400 some years ago when asked to give a second opinion towards the end of an estate’s administration and picking up that the preceding year’s annual IHT allowance of £3,000 had not been claimed to set against a lifetime gift. When this additional relief was claimed, HMRC sent a refund of £1,200 plus a small amount of tax-free interest almost immediately.
More detail on the IHT statistics 2012-13 is shown in Box 1.
Lifetime IHT advice
The starting point must be that IHT is unlikely to go away and could get worse, that is to say, more onerous. If the current government simply took no further action, IHT would increase, probably significantly, due to the static nil-rate band of £325,000 and increasing real estate prices. Apart from London house prices, security prices are likely to have increased most over the past two to three years. HMRC has now released figures showing IHT receipts for the first four months of this fiscal year were £1.62bn – 27.3 per cent higher than during the same period last year.
A change of government could bring more focus on levelling the distribution of wealth by raising tax and less focus on reducing state expenditure. IHT is an easy target; in the 1970s estates were facing estate duty rates that could take up to 80 per cent of their value.
The worst situation for any client is an unexpected early death, triggering an IHT charge. Could this be covered by insurance? For a married couple, or one in a civil partnership, a joint life and survivor whole-of-life policy is very good value and buys some breathing space to action plans to reduce the anticipated IHT liability.
Otherwise the main strategic steps available are: to emigrate; to make gifts; to hold assets that are exempt from IHT on death; to make exempt gifts (to charities, say, or a spouse or civil partner) to have an exempt estate, for example due to the extended death on active service relief; or to cover the anticipated liability with an insurance policy with the proceeds written in trust.
I have been told that putting in place a discounted gift bond (DGB) is another strategy, but effectively that is a gift. Some advisers will remember the difficulties that can occur in a falling stock market with DGBs if the growth within the bond is not in excess of the amount withdrawn each year by the donor.
Of course there has been an unexpected bonus with the change to the pension drawdown rules and the introduction of the ability to pass on at death a drawdown fund to the next generation with no immediate tax charge.
There is a widely held belief that uncrystallised pension funds are free of IHT if the holder dies before 75. That is not always so. Box 2 shows question 18 asked on HMRC’s form 409, which is submitted when a deceased person dies with pension entitlement.
Box 3, meanwhile, sets out the first paragraph from HMRC’s IHT Manual paragraph 17015. It is clearly HMRC’s continuing view that any deathbed attempt to redirect undrawn pension benefit is a lifetime gift with an actuarial value. Another trap for taxpayers, particularly as some providers are asking pension holders to review their expression of wishes in the light of the recent changes.
In dealing with a seriously ill client who wishes to change the designation of undrawn pension funds, there are steps that can be taken to reduce the danger of a successful challenge by HMRC that a chargeable gift has been made following the client’s death within the arbitrary two-year period. After the death, HMRC will request sight of medical records.
What do those records show at the time the client wants to make the change? Great changes have occurred in medicine over the past few years, particularly in prolonging life in the face of serious illness. Obtaining a written specialist medical opinion during the client’s lifetime to the effect that the client could survive a two-year period will be helpful evidence if that survival did not occur and the adviser was arguing about the actuarial value of the gifted fund later with HMRC’s actuary.
The other commonly used strategy is to hold assets that will be exempt from IHT on death. Implicit but hardly ever mentioned is that these assets must be exempt at the time of death, not at the time of purchase. IHT rules and reliefs can change. Prior to the current relief, introduced in 1992, for the agricultural value of agricultural land used for agricultural purposes the relief was given to “working farmers,” which could mean that some agricultural land had no IHT relief. Over the years there has been a differentiation between the agricultural value and the amenity value of land, but such is the demand prices are still rising. In rural Somerset a three-and-a-half acre grazing field has just sold at auction for £60,000. What would happen to prices if the rules changed again?
Reversionary interests
A gift of a reversionary interest is free of both IHT and capital gains tax (CGT). Sometimes such interests are overlooked by both clients and advisers. At the basic level a reversionary interest is an ultimate right to property or assets which is subject to another person’s prior limited right to such property. An example would be a gift by a mother in her will, for example, “I give to my daughter, Matilda, the right to live in 29 Riverside (or other my principal residence at the date of my death) (“my Home”) until Matilda’s death and after Matilda’s death I give my Home to my son, David.”
Following his mother’s death and while his sister, Matilda, is still alive, David has a vested reversionary interest in the house.
If David gifts this reversionary interest before Matilda’s death, that gift is free of IHT, even if Matilda dies the day after the gift is completed. To complete the gift there must be a short deed of gift executed and after execution, formal notice of the gift must be served on the trustees of the mother’s will. If David did not make a gift but died before Matilda the reversionary interest is still exempt from IHT as an asset of David’s estate. I recall one case where there was protracted correspondence with HMRC before it would accept that a reversionary interest existed.
If David dies after his sister’s death the interest would have vested. From Matilda’s death it belongs unconditionally to David and the IHT exemption is lost.
As an aside, David’s mother may have left her home to Matilda as recompense for Matilda looking after her mother during her mother’s lifetime. If that is the case there is a significant valuation discount from the vacant possession valuation of the home to negotiate with HMRC on the mother’s death. This would be based on the principles of proprietary estoppel (See Money Management, July 2013 “IHT: valuations and variations”).On Matilda’s death the current vacant possession value of the house would be added to the value of the assets in Matilda’s personal (“free”) estate to determine any IHT liability at that time.
IHT advice after death
When a client dies, if there is going to be IHT to pay and you have contact with the client’s personal representatives the best immediate advice is to ensure that a proactive adviser, not a processor, deals with the administration of the estate. Many types of advisers now offer to deal with estate administration: some will have more experience than others in applying reliefs and negotiating with HMRC.
As a rule of thumb it should often be possible for an adviser to more than cover, with proactive advice about tax reductions and reliefs, the estimated fees to be charged for the estate’s administration. There are several areas where a good adviser will add value.
Valuations, particularly of property and chattels, are very much a matter of judgement and experience. I recall a young farmer, following the death of his mother, obtaining a valuation of a farmhouse, outbuildings and about 30 to 40 acres of land which separately highlighted the farmhouse and outbuildings as a dwelling not of a character appropriate to the land and thus not eligible for agricultural property relief. A more seasoned valuer was consulted who produced a report valuing the whole as one agricultural unit, which was accepted without query by HMRC following a visit by HMRC’s district valuer.
Just as important is consideration of what reliefs may apply: could a business carried on from home make the home or part of it eligible for business property relief? The contents of a home, particularly jewellery, can often be overvalued when the family consults a friendly antique dealer (promising low valuation fees) as opposed to a member of the Society of Fine Art Auctioneers and Valuers (SOFAA).
If assets are to be sold at a likely profit to the probate valuation, should they be sold by the personal representatives or by the beneficiaries? There are different CGT rules that apply. Is a loss on sale anticipated, particularly for some of the securities in the estate? In which case how best to maximise the IHT loss on sale reliefs?
The income generated by the estate is most likely to belong to a beneficiary. Some estate administrators produce a basic tax certificate for the beneficiary certifying the share of income and basic-rate tax paid. It is unfair for a beneficiary who is a higher-rate taxpayer to pay higher rate tax on this income where some of it has been charged to IHT as net accrued income at the date of death. Tax law recognises this unfairness and allows an amended income tax certificate to be given – section 699 of the Taxes Act 1988. Has the estate’s administrator raised this point?
Advisers beware
As IHT starts to affect more of the population there are three areas in particular where advisers must be careful.
The first point most likely to catch out clients is the reservation of benefit rules, which are wide and – if breached – bring a gifted asset back into the donor’s estate for the purposes of calculating IHT. The most obvious example is the gift of a house. Where a benefit is retained the usual course is for the donor to pay a full market rent for the benefit. But that has to remain a full rent until the donor’s death and, as the years progress, the rent can slip back to below market rates. A holiday home may have been gifted and then continued to be used by the donor.
The second point is not considering or advising on insurance as a first line of immediate defence. Death can sometimes call unexpectedly early.
The final problem area is the urge among some clients to cheat the taxman by not fully declaring the assets in an estate. If an adviser has knowledge – or even a reasonable suspicion – that this is occurring, the client should be urged to make a full disclosure and at the same time the adviser should make a proceeds of crime report. HMRC has checking procedures.
I remember on one visit to HMRC’s office in Nottingham seeing the client’s Times’ obituary on HMRC’s file. At a more sophisticated level HMRC has computer links to all sales and purchases at the major auction houses. If caught out it is easy for a client to say his adviser knew of or did not counsel against the breach.
HMRC is quite rightly targeting professional ‘enablers’ and for an adviser to be embroiled in such an incident could be professionally disastrous.
Box 1
•The average net value of the taxpaying estates was £957,000. The average net value of all estates obtaining a grant of representation was £255,000.
•One “noticeable” difference between these two types was that the IHT paying estates had an average of £302,000 in securities, whereas for all estates the average in securities was £38,000.
•1558 estates in 2012-13 benefited from the reduced 3 per cent IHT rate.
•Just under 800 discretionary trusts reached their 10 yearly charge with total assets of about £900 million
•London & the South East is being hardest hit due to house prices. The average IHT paid per taxpayer by geographical region was –
£236,000 for London
£176,000 for the South East
£134,000 for the North East and
£120,000 for Wales.
Box2
(Question 18 on HMRC’s form 409)
Did the deceased, within 2 years before they died, make any changes to the benefits to which they were entitled under a pension scheme or personal pension policy?
Box 3
(Extract from HMRC’s IHT Manual paragraph 17015)
“Examining form IHT 409 boxes 17 – 24
Most lump sum death benefits are not chargeable to inheritance tax. This can prove an opportunity for people in ill health to use pension schemes to pass value to chargeable beneficiaries without a tax charge. There is a risk even if the estate is spouse or civil partner exempt, as it involves lifetime transfers of value. Other indications of tax planning such as a recent Will, power of attorney or gifts or evidence of ill health in the two years before death may alert you to this possibility. ...”
