When making a will and considering inheritance tax-saving possibilities, it comes as a great relief to realise that the complexities of gifts with a reservation and pre-owned assets can be ignored; they are only concerned with dispositions which take effect during the donor’s lifetime.

USING EXEMPT GIFTS

Several of the types of gift which are mentioned in Chapter 1 as exempt from inheritance tax if made during the taxpayer’s lifetime are also exempt if made by will, notably:

• gifts to registered charities for their charitable purposes
• gifts for national purposes including gifts to most museums and art galleries
• gifts to some political parties
• gifts of land to housing associations
• gifts the value of which does not exceed the unused nil-rate band
• gifts to a spouse or registered civil partner.

Leaving any of these gifts by will reduces the inheritance tax which would otherwise be payable.

THE IMPORTANCE OF THE NIL-RATE INHERITANCE TAX BAND

Although a taxpayer could leave his entire estate to a spouse or registered civil partner without paying any inheritance tax on death, doing so might well have compounded the problem when the spouse or partner subsequently died, in that what the taxpayer left and the survivor did not give away more than seven years before the survivor’s death or did not spend before death, was added to the assets the survivor already held in his name and in some cases to the assets of a trust under which the survivor had a right to benefit during his lifetime and might thus cause the survivor’s estate to exceed the nil-rate band and incur 40% tax.

On the other hand if a taxpayer was only moderately well off, the surviving spouse or civil partner needed the family home and other assets to live reasonably comfortably after the first death and assets could not easily be given to others to make full use of the nil-rate band. There were too many beneficiaries and not enough estate! It was important to make use of the nil-rate inheritance tax band. At present rates and allowances up to £120,000 more inheritance tax can be incurred if the nil-rate band is not used and before the Pre-Budget Proposals of 2007 this dichotomy was solved to some extent by making use of a nil-rate band discretionary will trust of which the spouse or civil partner was one of the potential beneficiaries and leaving the remainder of the estate to the spouse or partner.

If, as anticipated, the Pre-Budget Proposals of October 2007 are enacted in the 2008 Finance Act and they become law, the use of the nil-rate band discretionary will trusts described in the later section of this chapter will, in most cases fall out of use and they will be replaced by claiming transferability of the nil-rate band. However, for some time yet many will continue to exist and in special circumstances and for reasons other than inheritance tax, they will continue to have some uses. For these reasons a discussion of them is included in this book.

USING NIL-RATE BAND DISCRETIONARY TRUSTS

WARNING

No one should contemplate setting up or managing a trust without assistance from a lawyer who has considerable expertise in trusts and taxation. Trusts and the taxation of trusts are very technical subjects and the law and practice of trusts and taxation are in a state of constant evolution.

The basics of a nil-rate band discretionary will trust scheme

As explained in Chapter 7 a discretionary trust is a trust in which the trustees of the trust are given discretion as to how the capital and/or income of the trust is to be shared between the various potential beneficiaries of the trust. Although it is usual to leave a letter or note to inform the trustees how the settlor wishes the trustees to exercise the discretion they have been given, the settlor’s wishes should not be included in the document which creates the trust and the trustees must be legally free to ignore them, although they will usually feel under a moral duty to carry them out. If the trust is to have the benefits of a discretionary trust and not be considered by the Revenue to be an interest in possession trust, the potential beneficiaries must be given no right or entitlement to benefit from the trust unless and until the trustees decide to make an allocation to them from the trust funds; until that time they have only the hope of benefiting.

The basics of a nil-rate band discretionary will trust scheme are that a discretionary trust is set up in the will of a married person or a civil partner to the value of the testator’s unused nil-rate band and the testator’s other assets are left to the testator’s spouse or civil partner. On the testator’s death the assets left to the trust are exempt from inheritance tax because they do not exceed the testator’s previously unused nil-rate band and the remainder of the estate escapes inheritance tax under the surviving civil partner/spouse exemption.

The potential beneficiaries of the trust include the survivor, who is frequently appointed to be one of the trustees. The intention is that the surviving spouse/civil partner shall benefit from the trust funds or the income they produce from time to time during her lifetime, as far as is considered necessary or desirable. It is therefore possible that the survivor will have the benefit of the entirety of the testator’s estate and be in no worse a position than she would have been if the assets had been left to her directly but there is, and necessarily should be, no guarantee, because it is the essence of a discretionary trust that the allocation of the trust funds and their income shall be in the discretion of the trustees and no one shall have a right to benefit from them unless the trustees make a decision to that effect.

If the first spouse/partner to die leaves sufficient liquid assets such as cash or investments they are transferred to the trustees and then the trustees are able to exercise their discretion to make such payments as the trustees think fit to the survivor. The survivor inherits the residue of the estate including the deceased’s share of the family home if it was jointly owned. There is no problem: the survivor has the security of ownership of the entirety of the family home, there is a reduction in the inheritance tax that would have been payable on the second death and the survivor has the possibility of benefiting from the estate to the extent that she would have benefited from it if it had been left directly to her.

Using the family home in a nil-rate band legacy discretionary will trust scheme

Tenancies in common and joint tenancies

If the first spouse/partner to die leaves insufficient liquid assets (such as cash or investments) to use to pay the nil-rate band legacy and the survivor wishes to continue to live in the family home, the survivor and the trustees of the discretionary trust resort to using one of the debt/charge or loan discretionary trust schemes referred to in the following sections of this chapter.

If the family home is jointly owned and it is intended to use the testator’s share of the family home in a discretionary trust schemes the co-owners must own the home as tenants in common and not as joint tenants because property owned as joint tenants passes on death to the survivor notwithstanding any provision to the contrary in the deceased’s will. If the home is owned as joint tenants the co-ownership joint tenancy must first be converted into a tenancy in common by severing it. Severance of a beneficial joint tenancy is a simple transaction that must be carried out before death and not by will, but it can be easily and cheaply carried out as explained below, without the assistance of a solicitor.

How do you know whether jointly owned property is held as joint tenants or tenants in common? As a first step the wording of the title documents should be considered. Married couples and civil partners usually, but not necessarily, own their homes as joint tenants. If there is any evidence to show that joint owners own separate shares of the property as opposed to each joint owner owning the entirety, the joint ownership is a case of tenancies in common. Joint tenants always own property equally and words or actions indicating that the joint owners own unequally always means that the assets are held as tenants in common.

Conversion of a joint tenancy into a tenancy in common by severing it can be achieved by one joint tenant merely writing and signing a note to the other(s) informing the other(s) that the joint tenant is severing the joint tenancy by the note ‘I give you notice that I hereby sever the joint tenancy which exists between us in the property known as. . .’ will suffice. The note should be handed to the other co-owner(s) and it is a wise precaution to arrange for the other co-owner(s) to sign a receipt (which can be written on the note) to confirm that they have received the document and to place the receipted copy of the document with the title documents. If the property has a title which is registered at HM Land Registry, the receipted copy should be sent to the Land Registry at the District Land Registry (the address of which can be found noted on the official copy of the Land Registry title information document) for noting in the Registry’s records. When communicating with the Land Registry always quote the Land Registry Title Number, which appears in the copy of the Land Registry title information document.

It is possible for a joint tenant to sever the joint tenancy and create a tenancy in common by other conduct showing an intention to do so, but such a severance is much more difficult to prove.

The debt/charge discretionary will trust legacy scheme

This is a scheme which has been frequently used if the first spouse/partner to die left insufficient liquid assets (such as cash or investments) to use to pay the nil-rate band legacy, the survivor wished to continue living in the family home and the trustees did not wish to risk a large capital gains tax bill on the first to die’s share of the family home when it was eventually sold.

The will setting up the trust contained a clause which authorised the trustees of the trust to accept an unsecured debt repayable on demand or a charge on assets as part or as the entirety of the trust funds. If the first spouse/partner to die left insufficient liquid assets for the house to be transferred to the survivor and assets to fulfil the legacy being transferred to the trust, the trustees exercised that power and the deceased’s executors gave the trustees an IOU for the nil-rate band legacy or the deficiency or placed a charge in favour of the trust upon assets of the estate and then transferred the assets including the deceased testator’s share of the family home to the survivor subject to the charge. Placing a charge on the assets is, in layman’s terms, mortgaging them to the trust.

The debt or charge was paid off when the assets were sold or as and when the survivor was able to repay it or when the survivor died. If it still existed at the survivor’s death the debt or charge reduced the value of the survivor’s estate and consequently any inheritance tax payable in respect of the estate.

The loan scheme

A variant of the debt/charge scheme is the loan scheme, under which assets are loaned by the trust to the survivor, who signs an IOU for them. The loan scheme seems to differ little from the debt/charge scheme but in the debt/charge scheme it is the executors and not the survivor who create the charge or sign the IOU. The loan scheme is much riskier.

Section 103 of the Finance Act 1986

The effect of section 103 of the Finance Act 1986 is that a debt or liability cannot be deducted from the value of an estate to reduce inheritance tax if it was incurred in return for something derived from the creditor; or to put it another way, a person cannot give cash or assets to another and then borrow them back and count the indebtedness or liability as a debt against his estate for inheritance tax purposes. Section 103 therefore prevents the debt/ charge/loan schemes from successfully reducing the tax if the spouse/partner who dies is one who has never had assets not derived from the survivor spouse/partner, e.g. a spouse who has never worked and never had an inheritance.

Warnings

• If there is a danger that the net estate will be insufficient to meet the nil-rate band legacy to the trust and leave sufficient value for the home to be transferred to the survivor, the testator will need to consider carefully what he intends to achieve and the wording of his will. If he leaves a specific legacy of his unused nil-rate band to the trust and the home is included in the residue of his estate, the legacy will fail to be paid in full and residuary estate (including the home) will be reduced to meet the shortfall. If the survivor wishes to have the home transferred to him it will be necessary to make arrangements to meet the legacy. In the same circumstances of an insufficiency, if the home is bequeathed to the survivor subject to the legacy, the legacy will be reduced as far as is necessary and the home will be unaffected.
• Nil-rate band discretionary will trust legacy schemes only work if there is a valid marriage or registered civil partnership; there is no such thing in English law as a ‘common law wife’ or a ‘common law husband’ and the survivor exemption from inheritance tax does not apply in the cases of different-sex partners who are not legally married or same-sex partners who have not registered their partnership.
• A nil-rate band discretionary trust will only be effective in reducing inheritance tax if it can be seen to be a genuine discretionary trust and not a sham simply aimed at avoiding tax. If both the settlor and the trustees have the common intention that the trustees will deal with the trust assets in accordance with the wishes of the settlor, the law will consider the trust to be a sham. If only the settlor has that intention, the trust will not be considered to be a sham. To show that the trust is not a sham and that the trustees are genuinely exercising independent discretion, the trustees should hold regular meetings, minutes should be taken and kept, the trust’s investments should be monitored, accounts kept, income tax returns made and the needs of each potential beneficiary should be considered and resolutions passed. Not all the income of the trust should be paid to the survivor and it certainly should not be paid by regular payments or a bank mandate. A near cash reserve (a reserve that can be easily and quickly converted into cash) should be maintained to meet tax and administrative expenses and if necessary part of the loan should be recalled to meet them. The debt or loan can be structured to be index linked or bear interest. Every effort should be made to show that the trust is not merely a gift to the survivor, in which case it would form part of the survivor’s estate and be taxable when he or she died.
• Finally I repeat that anyone contemplating a discretionary trust must employ an expert to prepare and advise upon the trust. Remember that, as is the case with most tax-avoidance schemes, they are complicated, expensive if they go wrong and they are often difficult or impossible to unscramble if the law changes. If a government feels that too much tax is being lost it might decide to clamp down on the trusts and even introduce retrospective legislation to do so.

Taxation of nil-rate band discretionary will trusts

Tax is charged on the estate of the person whose will sets up the trust, at his death, in the usual manner allowing for the nil charge for any unused nil-rate band. As is usual with discretionary trusts, the trust funds might suffer an inheritance tax charge every ten years if they exceed the nil-rate band at that date. The current maximum rate for the charge is 6%. The tax is also charged upon capital paid out of the trust at the same maximum rate but there is no inheritance tax payable on capital paid out of the trust in the first ten years because in that period the tax rate is calculated upon the value of the trust at the date of the death which by definition did not exceed the nil-rate band. Neither is tax payable on the death of a potential beneficiary unless the trust terminates on the death, because the trust funds belong to the trust and do not belong to or form part of the estate of any potential beneficiary. No potential beneficiary has any entitlement until the trustees make an allocation to him.

Nil-rate band legacies without a discretionary trust

Married couples and civil partners can save inheritance tax by making use of each testator’s nil-rate band by leaving a legacy equivalent to the value of the unused nil-rate band to others and the residue of the estate to the surviving spouse/partner/charity without the necessity of a discretionary trust if they wish, but by not using a nil-rate band discretionary trust they lose the flexibility which a discretionary trust gives and the surviving spouse/civil partner will not have the possibility of benefiting from the funds bequeathed by the legacy.

Similarly, the estate of a testator who has no civil partner or spouse and who leaves the residue of his estate for charitable purposes and a legacy equivalent to the balance of his unused nil-rate band will suffer no inheritance tax.

The advantages of using a nil-rate band discretionary will trust scheme

The main advantage of using a discretionary trust, instead of a straight legacy, is flexibility. The trustees’ powers can be used to meet differing circumstances which arise from time to time and circumstances which cannot be foreseen at the time the trust was created.

If the spouse or registered civil partner is included as a potential beneficiary of the trust, the trustees will be able to allocate so much of the income and capital of the trust to her as is appropriate having regard to her needs, the size of the residue she inherits, her tax position and any social security benefits and entitlement limits.

The taxpayer’s spouse/civil partner can be appointed as a trustee and if the will includes her among the potential beneficiaries of the trust, the trustees can make income and capital payments in her favour and she need be little worse off than if the entire estate had been left to her. At the same time the trustees are able to consider and meet the needs of the other potential beneficiaries. Because the trust is discretionary and the funds belong to the trust and not to the survivor, they will not be taken into account for any means-tested benefits the surviving spouse/partner might make.

The costs of setting up and administering a discretionary trust are substantial and in spite of the savings that can be made by using them, as a result of the proposals contained in the 2007 Pre-budget Review described in the next section, they are likely to be superseded after 9 October 2007 by the use of the transferable nil-rate band.

USING THE TRANSFERABLE NIL-RATE BAND

The 2007 Pre-Budget Review proposals

In the 2007 Pre-Budget Review, the Chancellor of the Exchequer announced that in respect of deaths on or after 9 October 2007, the inheritance tax nil-rate band of a married person that remained unused on a spouse’s death would be transferable to his surviving spouse upon her subsequent death, no matter when the first person died and the same would apply in the case of registered civil partners. Transferability is limited to those who are legally married and to civil partners and is not available to others who inherit e.g. to different sex partners who are not legally married or to same sex partners who have not registered a civil partnership or between parent and child and transferability is lost if the marriage or partnership is dissolved before the second death. Neither is transferability available on any other occasion but death; it is therefore not available when the survivor makes an immediately chargeable lifetime gift, but it is available against additional tax payable on the survivor’s death in respect of the gift if the survivor dies within seven years of making the gift.

The transfer of the unused nil-rate band can only be claimed if the second death takes place on or after 9 October 2007; it is not claimable if both of the spouses or both of the civil partners died before that date.

If a taxpayer has had more than one previous marriage or civil partnership that ended in death, the unused nil-rate bands of all of the previous spouses or partners can be transferred up to a maximum transferable amount equal to 100% of the nil-rate band at the date of the second death. The unused nil-rate band available on the death of the survivor is increased by the proportion of the nil-rate band that remained unused immediately after the previous death, for example, if the earlier death took place in June 2002 and involved a taxable estate of £125,000 when the nil-rate band was £250,000, 50% of the nil-rate band was unused on the first death and if the second death takes place in May 2007, when the nil-rate band is £300,000, it will be possible to claim an increase of 50% of the 2007/8 nil-rate band on the second death to increase the 2007 death nil-rate band from £300,000 to £450,000. It is the mathematical proportion of the unused nil-rate band which is transferable, not the unused cash sum.

If the entire estate is left to a surviving spouse or a civil partner under an arrangement effected by a tax compliant two-year discretionary trust as explained later or presumably under a tax compliant deed of family arrangement, none of the previously unused nil-rate band will be used and 100% will be transferable.

Inheritance tax replaced capital transfer tax which had itself replaced estate duty. If a spouse or civil partner dies after 9 October 2007 and his or her spouse predeceased and died under the rules relating to capital transfer tax or estate duty, any unused allowances of the predeceasing spouse or civil partner may be used to increase the nil-rate band of the surviving partner. These allowances will not include a surviving spouse exemption and will be based on the basic individual allowances for deaths before 21 March 1972 when for the first time under the estate duty system a £15,000 surviving spouse exemption was introduced. In respect of deaths under the capital transfer system which was introduced on 13 March 1975, the surviving spouse and nil-rate band provisions apply in the same way as they apply for inheritance tax.

The law did not provide for registered civil partnerships before 5 December 2005 and consequently there was no surviving civil partner’s allowance before that date.

How to claim

The claim to transfer must be made on the prescribed Inland Revenue form which is downloadable from H. M. Inland Revenue and Customs website and it must be made within 24 months of the month in which the last death took place. The claim must be supported by a large amount of factual information and documentation concerning the earlier death and the estate and will not be agreed on the first death. It is therefore wise to retain the entire probate files relating to the first death until the second death and for those who will be the personal representatives of the second to die to be made aware of where files may be found.

The effect of the proposals

The Inland Revenue is presently acting in accordance with the Pre-Budget Report proposals and if, as anticipated, the transferability proposals are enacted unchanged in the Finance Act 2008, there will be fewer estates liable to inheritance tax. Schemes using nil-rate band discretionary trusts or equalisation of estates between spouses and between civil partners to reduce inheritance tax will become largely irrelevant in most situations because it will be possible to achieve the same inheritance tax results by claiming transferability of the unused nil-rate band, but equalisation of estates will continue to be used

• to minimise the assets that will be available when calculating nursing or residential home fees
• if there is a real fear of a future government imposing a wealth tax.

Choosing from the available post 9 October 2007 routes

After the 2007 Pre-Budget Review there are three possible routes from which a choice can be made:

• use a nil rate band discretionary trust or
• give the value of the nil-rate band directly to the beneficiary (in which case the surviving spouse or civil partner will not benefit from it) or
• transfer the assets to the survivor so that the unused nil-rate band can be used on the second death.

Nil-rate-band discretionary trusts might still be useful if made during the taxpayer’s life:

• to minimise the assets that will be available when calculating nursing or residential home fees
• if there is a real fear of a future government imposing a wealth tax

or by the taxpayer’s will if the taxpayer is undecided and wishes to retain some flexibility and have a second bite at the asset allocation cake through his trustees. In appropriate circumstances the trustees can still give the survivor the benefit of the nil-rate band by exercising their discretion and making an outright transfer to her and the unused nil-rate band will then be available on her subsequent death.

The taxpayer might choose to make a gift of the value of the nil-rate band directly to the beneficiary rather than allow his surviving spouse’s or civil partner’s estate to benefit from it or to create a discretionary trust if

• he wishes to have certainty, for example if he is in a second marriage and wishes to be the certainty that the children of his first marriage will benefit or
• he can give the legacy in assets which he believes will increase in value quicker than anticipated nil-rate bands.

The taxpayer might choose to transfer the assets to the surviving spouse or civil partner so that the unused nil-rate band can be used on the second death because:

• to do so will enable the spouse or partner to have the use of the assets without the expense and labour involved in running a discretionary trust
• the traditional increases in the nil-rate band means that the unused nil-rate band is likely to be worth more in cash terms at the time of the second death than at the date of the first death because the transferable amount is the same proportion of the nil-rate band on the second death as the unused nil-rate band on the first death bears to the full nil-rate band at the time of the first death. To put the point another way if, for example, 40% of the nil-rate band appertaining at the date of the first death is unused, that figure in cash terms is less than 40% of the increased nil-rate band applicable at the time of the second death.

If the taxpayer really wishes his spouse to benefit from the entirety of his estate but he has made a nil-rate band will trust purely to save inheritance tax and in the hope that the trustees will use the trust to benefit his spouse or civil partner after his death but during her life, if he has left an outright nil-rate band legacy in favour of others for the same reason, he should now revise the will to leave his assets directly to his spouse or partner. To do so will mean that she will have the certainty of inheriting without, in the one case, the necessity of relying upon the trustees discretion and in the other case, relying upon a deed of family arrangement to which the alternative beneficiaries might not agree.

Even after the 2007 Pre-Budget Review it is still worth making lifetime gifts in appropriate circumstances because if they qualify as PETs the donor might survive long enough for them to drop out of the remaining nil-rate band calculation or to benefit from some taper relief and if they are immediately chargeable gifts they will suffer tax at only 50% of the death rate they would suffer if the nil-rate band is exceeded.

USING A TWO-YEAR DISCRETIONARY WILL TRUST

Because the taxpayer cannot foretell the precise date of his death, he cannot know what the financial position of the individual members of his family will be at that date or indeed which of his family members or friends will survive him. Neither can he know how much of his nil-rate band will have been used up by the gifts he has made or what the value of his estate or tax rates will be at that date. It is possible to overcome these problems by creating what is commonly known as a two-year discretionary trust in his will.

To create such a trust, the testator leaves his estate to his executors upon trust, with power for them to allocate it within three months and two years of the testator’s death in such a manner as they see fit between certain specified beneficiaries and with a long-stop provision for the devolution of the estate if the executors fail to make an allocation within that period. It is usual to leave a letter with the will to explain to the executors the principles he wishes them to use in exercising the discretion he has given to them. The letter should make it clear that it is not binding upon the executors.

If the executors make their decision between three months and two years following the testator’s death, inheritance tax in relation to the estate will be calculated as though their decision had been contained in the testator’s will. A two-year discretionary trust can be a very efficient tax-saving tool and useful for a testator who has good executors and is apt to be tardy in reviewing his will. It should not be confused with a nil-rate band discretionary will trust.

USING THE INHERITANCE TAX RELIEFS

It is a waste of an inheritance tax relief such as business property relief or agricultural property relief to leave an asset that attracts the relief to exempt beneficiaries such as a spouse or civil partner, unless that beneficiary intends to give or bequeath the asset to a non-exempt beneficiary in the future. It is better to specifically bequeath the asset to chargeable people or create a discretionary trust of which chargeable people are potential beneficiaries by the will and place the asset into the trust so that the relief is used. If the asset is eligible for 100% relief the bequest can be made without adverse inheritance tax consequences and in addition to any unused nil-rate band.

The asset should be bequeathed as a specific gift and not included in a share of residue. If the asset is specifically bequeathed it will have the full benefit of the relief; if it is left as a share of residue the relief will be apportioned between all the assets of the estate. If an asset is appropriated by personal representatives in satisfaction of a share of residue or a cash legacy, it will not be considered to have been specifically bequeathed and the bequest will not attract the full relief, only its apportioned proportion. If it is desired that an asset which has not been specifically bequeathed and forms part of the residue of the estate shall achieve the status of a specific bequest after death, all parties concerned should consider a Deed of Family Arrangement.

If the spouse/civil partner wishes to have the relievable asset the testator can consider leaving it to chargeable beneficiaries (so that his estate will benefit from the relief) but on terms that the spouse/ civil partner shall have an option to purchase it. Stamp Duty, Land Tax and Land Registry Fees would be payable on the purchase but they are likely to be much less than the inheritance tax saved.

It is usually better to leave relievable assets to those able to qualify for the relief in the future and should they not be chargeable persons, the asset can be left to chargeable beneficiaries so that the estate is relieved and the exempt person can possibly be left a compensating legacy or share of residue to enable her to purchase the asset from the original beneficiary.

CALCULATING THE NIL-RATE BAND: SPECIAL RULES WHEN EXEMPT BENEFICIARIES ARE INVOLVED

The grossing up of legacies

Grossing up applies to some bequests made by will. If a will does not state that any tax payable in respect of a bequest is to be paid out of the bequest, i.e. that the bequest is subject to tax, then unless the property is jointly owned or foreign property, any tax payable will be payable out of the residue of the estate. In these circumstances, if a testator leaves the residue of his estate to an exempt beneficiary such as his spouse, his registered civil partner or a registered charity, the law directs that, when calculating the inheritance tax payable in respect of the estate, for inheritance tax purposes any legacies given free of tax shall be ‘grossed up’, i.e. treated as a legacy of the stated sum and in addition the relevant amount of tax. If a taxpayer does not remember this point, i.e. that any non-exempt legacy given free of tax is grossed up if the residue of the estate is given to an exempt beneficiary, he could inadvertently exceed the nil-rate band with the legacy and tax could be payable unnecessarily. Any non-exempt gifts made in the testator’s lifetime must also be borne in mind when calculating what remains of the nil-rate band. Grossing-up tables are published by HM Revenue and Customs to help calculate the sums involved.

In deciding which beneficiaries are to suffer payable inheritance tax, testators must bear in mind section 41 of the Inheritance Tax Act 1984 which provides, in essence, that notwithstanding any provision of a will to the contrary, no exempt beneficiary shall be made to suffer the inheritance tax payable in respect of an exempt gift or exempt share of residue.

The ‘related property’ valuation rules

When calculating whether or not a bequest will exceed the nil-rate band it is also necessary to bear in mind whether or not the Revenue will consider the subject of the bequest to be ‘related property’. Related property is property which would have an increased value if owned with other property which is owned by:

• a person’s spouse or civil partner, or
• has been owned within the previous five years by a body to whom an exempt transfer could be made, e.g. a charity, and was so owned as the result of a transfer by the person or his spouse or civil partner. The subject of related property and the method of calculating its value have been explained more fully in Chapter 3.

SKIPPING A GENERATION

If a testator’s children are wealthy he might wish to consider skipping a generation and instead of leaving bequests to his children, leaving the bequests to or for the benefit of his grandchildren to avoid increased inheritance tax being payable on the children’s deaths. In this way the bequest is only taxed once instead of twice before the grandchildren inherit it.

To skip a generation can also have income tax advantages for the grandchildren if they inherit before they come of age. The income tax advantage arises from the fact that if capital transferred to a child by a parent earns income in excess of £100 in any tax year, the income is taxed as if it were the parent’s income, but income earned by capital transferred by a grandparent is treated as the grandchild’s own income, irrespective of the amount of the income and if it does not bring the grandchild’s income above the grandchild’s personal income tax allowance, any income tax deducted from the income can be recovered on behalf of the child.