Inheritance Tax -Overview & Recent Developments

Society of Trust and Estate Practitioners

3rd July 2013

Terry Baucher, Baucher Consulting Ltd

Summary of Session

1. Introduction to Inheritance Tax

2. Trusts and Inheritance Tax

3. Latest developments

1. Introduction to Inheritance Tax

"Inheritance Tax is, broadly speaking, a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue."

•Roy Jenkins MP,1986

Inheritance Tax – Why?

•Three groups potentially affected by IHT

New migrants from the UK, particularly within three years of arrival

Anyone with assets situated in the UK

Anyone who has spent more than 15 years in the UK recently

Inheritance Tax - Background

1894 Estate Duty introduced

1975 Capital Transfer Tax replaces Estate Duty

1986 CTT “Rebranded” as Inheritance Tax

Inheritance Tax Act 1984 (“IHTA”) main legislation

Inheritance Tax – Basic Principles (1)

IHT is a unified gift and estate tax

Worldwide estate of any person who was domiciled in the UK at time of death subject to IHT

Value of estate includes any lifetime gifts made within 7 years of death

Certain lifetime transfers may be subject to IHT

Also applicable to all UK situated assets held by non-UK domiciled person

Inheritance Tax – Basic Principles (3)

IHT applies at 40% on the value, in excess of nil rate band (£325,000), of person’s estate

Rate drops to 36% if 10% or more of estate gifted to charities

20% rate applies to lifetime chargeable transfers in excess of nil rate band

Inheritance Tax – UK situated property

Sec 6(1) IHTA, Property situated outside the United Kingdom is excluded property if the person beneficially entitled to it is an individual domiciled outside the United Kingdom

Property situated in the UK NOT “excluded property”

Property held in UK subject to IHT includes:

Real property Bank deposits Shares in UK incorporated companies Pension funds Other assets physically located in the UK (e.g. artworks,

jewellery)

Inheritance Tax – Domicile (1)

Domicile crucial to determining whether IHT will apply and what reliefs are available

Separate concept from tax residence (although residency can have some bearing on domicile)

Domicile determined by common law principles

Inheritance Tax – Domicile (2)

Everyone has domicile of origin (father’s domicile if legitimate otherwise mother’s)

For UK purposes domicile of origin is never lost, other than by adoption

Technically, domicile of origin is temporarily suspended when domicile of choice adopted

Inheritance Tax – Deemed Domicile

Section 267 IHTA a person not domiciled in the UK at “the relevant time” will be treated as domiciled in the UK if-

a)The person was domiciled in the UK within the three years immediately preceding the relevant time; or

b)The person was resident (for UK income tax purposes) in the UK for 17 of last 20 tax years

Inheritance TaxContinuing Domicile - UK

Domiciled 1 September 2010 a UK domiciled person

migrates to New Zealand

Under Section 267(1) IHTA if person dies before 1 September 2013 then still UK domiciled and worldwide estate subject to IHT

Inheritance Tax Deemed Domicile – Non UK Domiciled

5 April 2011

End deemeddomicile

Arrives in UK

1 July 2010

5 April 2012

(1)

5 April 2013

(2)

5 April 2014

(3)

Three full UK tax years must pass

6 April1993

Returns to NZ

“Just when I thought I was out… they pull me back in”

Inheritance Tax – Exemptions (1)

Principal exemption is £325,000 nil rate band

From October 2007 unused balance transferrable to spouse/civil partner

Unlimited transfers between spouses and civil partners – if BOTH are UK domiciled or BOTH are non UK domiciled

If one spouse/civil partner not UK domiciled transfer limited to nil rate band (£325,000)

Inheritance Tax – Exemptions (2)

£3,000 annual exemption per tax year

Unused balance from prior tax year may be used in subsequent year e.g. Aaron gifts £1,100 in 2012-13, balance of £1,900 may be used in 2013-14 year

£250 small gift exemption (unlimited)

Value of agricultural property and business assets, including unlisted shares, can qualify for either 50% or 100% reduction in value

Inheritance Tax – Exemptions (3)Potentially Exempt Transfers

Lifetime gift of any amount may be exempt from IHT if donor survives more than seven years after gift

If donor dies within seven years gift included in estate but tax payable may be reduced depending on period lapsed since gift

A gift with reservations (for example giving house to children but continuing to live in it) not PET

Inheritance Tax – Potentially Exempt Transfers

Number of years after gift made

•0 – 3 years

•3 – 4 years

•4 – 5 years

•5 – 6 years

•6 – 7 years

•7 or more

•0%

•20%

•40%

•60%

•80%

•100% (fully exempt)

Percentage Reduction in tax

charge

2. Trusts and Inheritance Tax

Trusts and Inheritance Tax (1) Highly complicated area – proceed with caution.

Until March 2006 distinction between discretionary trusts and interest in possession (“IIP”) trusts. Latter had more beneficial IHT treatment (e.g. gifts to IIP trusts not subject to 10 year charge).

From March 2006 all transfers into discretionary and IIP trusts are treated as a lifetime chargeable transfer (exceptions for transfers to 18-25 trusts and trusts for bereaved minors).

Trusts and Inheritance Tax (2) From 2006 most trusts are subject to 10 year periodic

charge - roughly 6% of trust fund above nil rate band

IHT exit charge on assets transferred out of trust (again @6% of value of assets transferred)

IHT will apply to ALL trusts settled by UK domiciled person regardless of where assets situated and subsequent domicile status

Value of IHT collected in 2011-12 from discretionary trusts and number of trusts affected:

£74.3 million from 573 trusts

Trusts and Inheritance Tax Periodic Charges – example

Samit settled trust (“the No. 2 Trust”) on 18 April 2002

£350,000 added to the No. 2 Trust held equally in two separate funds, one discretionary (“relevant property”), the other an interest in possession (“non-relevant property”) for Samit’s aunt

Previously settled £175,000 on another discretionary trust in September 2000

Value of relevant property in the No.2 Trust on 18 April 2012 was £250,000

Trusts and Inheritance TaxPeriodic Charges example

•Current value of relevant property•Historic value of non-relevant property•Total subject to charge•Less Nil-rate band (net of September 2000 gift)•Value to determine rate of tax•Tax at 20% (lifetime rate)•Initial rate of tax (55,000/425,000)•Ten yearly charge rate (30% of initial rate)•Tax payable £250,000 @ 3.882%

•£•250,000•175,000•425,000•-150,000•275,000•55,000

•12.941%•3.882%•£9,705

Trusts and Inheritance Tax Exit Charge – example

Samit settled trust (“the No. 2 Trust”) on 18 April 2002

£350,000 added to the No. 2 Trust held equally in two separate funds, one discretionary (“relevant property”) other interest in possession (“non-relevant property”) for Samit’s aunt

Previously settled £175,000 on another discretionary trust in September 2000

Distributed £100,000 on 6 June 2007 (the nil-rate band for that year was £300,000)

Trusts and Inheritance TaxExit Charge - example

•Historic value of relevant property•Historic value of non-relevant property•Total subject to charge•Less Nil-rate band (net of September 2000 gift)•Value to determine rate of tax•Tax at 20% (lifetime rate)•Initial rate of tax (45,000/350,000)•Exit charge rate (30% of initial rate)•Tax payable £100,000 @ 3.857%•As only relevant property for 20 quarters tax reduced to 20/40 x £3,857

•£•175,000•175,000•350,000•-125,000•225,000•45,000

•12.857%•3.857%•£3,857

•£1,928

Trusts and Inheritance Tax – “Pilot Trusts”

Based on decision in Rysaffe Trustee v IRC [2003] STC 536

Charles has 7 grandchildren and settles £100 on 7 separate trusts settled on successive days

Charles’ will leaves £250,000 after IHT to each trust

On Charles’ death his estate will be subject to IHT. But each trust will benefit from its own nil-rate band and the trusts will not be treated as related. So long as the value of the settled property remains below the nil-rate band no periodic or exit charges payable.

Trusts and Inheritance Tax Possible for a non-domiciled settlor to establish

trusts outside IHT so long as trust resident outside UK and all trust assets situated outside UK

But… UK income tax charge can arise on “pre-owned assets” where donor can has continued enjoyment of asset

Note also potential issues around gifts with reservation. Could be an issue if a settlor is a beneficiary

3. Recent Developments

Recent Developments (1) Supreme Court decision in Futter & Anor, Pitt &

Anor v HMRC

New general anti-avoidance provision

Specific measures targeting non-UK domiciliaries holding high value property in the UK

Changes to rules regarding non-UK domiciled spouses

Recent Developments (2)

Supreme Court decision in Futter & Anor, Pitt & Anor v HMRC [2013] UKSC 26

“Increasingly strong and general recognition that artificial tax avoidance is a social evil”

(Lord Walker Para 135)

UK is introducing anti-avoidance provision or “General anti-abuse rule”

Some commentators have picked up on Penny-Hooper decision and are concerned at implications for UK tax advisors

Recent Developments (3)Anti-avoidance measures effective from April 2013 targeting residential property worth over £2 million owned by non-natural persons:

15% stamp duty land tax payable on acquisition; An annual tax on enveloped dwellings (ATED) ranging

from £15,000 to £140,000 on properties worth more than £20 million;

CGT at 28% payable on disposals of high value residential property on or after 6 April 2013.

In addition there are further restrictions on the deductibility of debt which finances excluded or relievable property.

Recent Developments (4) Inter-spouse transfer exemption where the

donor spouse is UK domiciled but the recipient is not increased to £325,000 and linked to future increases in the nil-rate band from 6 April 2013

Also from 6 April 2013 a non-domiciled spouse may elect to be UK domiciled and may therefore benefit from the inter-spouse transfer exemption

Election is generally irrevocable although it will laps if the person making it is subsequently not UK resident for four successive tax years

The Trust is dead. Long live the Trust?

Possible for a non-domiciled settlor to establish trusts outside IHT so long as trust resident outside UK and all trust assets situated outside UK

Still opportunities to use trusts either through transfers under nil-rate band or which have specific IHT exemption

The use of trusts has been greatly circumscribed for IHT planning purposes but reports of their death are much exaggerated

Conclusions New migrants from UK have exposure to IHT for

up to three years after arrival, longer if retain links

Returning New Zealanders are also exposed either on basis of retained assets in UK, or deemed domicile (rare)

Pre-migration planning for UK domiciliaries requires great care because of capital gains tax issues and risk of triggering a lifetime IHT charge

IHT issues manageable but keep an eye on clock

For further information please contact Terry Baucher

09 486 6200

terry@baucherconsulting.co.nz

Questions?