The Residence Nil-Rate Band and the Downsizing Provisions:

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1 The Residence Nil-Rate Band and the Downsizing Provisions: March saw the start of the 2016 Finance Bill s passage through Parliament. Mired in controversy within hours of the Chancellor sitting down after delivering his Budget Speech, the element of the Bill that we will be examining in this month s CPD is the introduction of the so-called Residence Nil-Rate Band (RNRB) and in brief the additional RNRB, which is proposed by the Bill to implement the RNRB downsizing provisions The background: The Prime Minister, Mr Cameron, since his appointment as leader of the Tories, has held an ambition to release family homes up to the value of 1,000,000 from the bite of Inheritance Tax (IHT). His ambition was thwarted when his party failed to obtain an overall majority in the 2010 election as in order to obtain power the Tories were forced into a coalition with the Liberal Democrats. The Liberal Democrats would not approve the Prime Minister s plans to reduce Middle England s tax burden by the introduction of the RNRB. However with the overall majority achieved by the Tories in the 2015 election, Mr Cameron and his Chancellor were free to implement their political aims. Probably as a nod to their economic programme of so-called austerity the achievement of the Tories objective of releasing 1m family homes from IHT has had to be proposed and implemented in stages between 2017 and 2021 when it will be possible to transfer homes to the value of 1,000,000 between generations free of Inheritance Tax (IHT). Having been returned to power with an overall majority last May, the Tories introduced their Summer Budget in July 2015 (the 2 nd Budget of 2015), which included legislation to introduce the RNRB amending the Inheritance Tax Act 1984 (IHTA). The 2015 Summer Finance Bill containing the RNRB provisions received Royal Assent on 18 November 2015, to be known as the Finance (No.2) Act Mindful of the pressure upon national resources caused by the increasing age of the population and the need to direct resources towards the care of the elderly the Government decided that it does not want to disincentivise, by the loss of IHT reliefs, an individual or individuals, from downsizing or selling their property, for example to pay for their long term care. Hence the need to introduce additional RNRB downsizing provisions was born and, on the assumption that the proposals as contained within the draft Clause 44 of the 2016 Finance Bill pass broadly intact through Parliament, then IHT and planning to reduce its bite, has just become rather more complicated. The downsizing proposals as included in the draft Clause 44 of the 2016 Finance Bill, have yet to pass into law. The RNRB operative date of death is still in the future (6 April 2017), but the additional RNRB downsizing provisions as drafted in the Bill are to apply to any qualifying property after 8 July 2015 a date already in the past. As a result if you have a client(s) who since that date has either sold the family home to buy a new family home at a lower value or who has ceased to own a family home or who has made a gift of the family home, you will need to be aware of the effect of the additional RNRB downsizing provisions. The downsizing provisions as drafted and contained within the 2016 Finance Bill (Draft Clause 44) were put out to interested parties for consultation after the Summer Budget in September The draft Finance Bill provisions embrace suggestions made during the consultation period. This does not mean that the provisions will not be further amended before the Finance Bill receives its Royal Assent in a couple of months time and becomes law. Therefore be aware of the possibility that the current additional RNRB downsizing proposals could be further amended before becoming law. Page 1 of 6

2 This month s CPD provides a basic commentary of the qualifying RNRB rules and the proposed additional RNRB downsizing provisions, as contained in the 2016 Finance Bill. Examples are provided on the operation of the RNRB provisions. The Residence Nil Rate Band (RNRB): Legislation to implement the RNRB is contained in Finance (No.2) Act 2015 at Part 2 as above amending the IHTA. The legislation introduces a number of new terms, for will writers to familiarise themselves. The RNRB is available where all or part of a qualifying residential interest is closely inherited after 6 April What is a qualifying residential interest? A qualifying residential interest in relation to a person means an interest in a dwelling-house which has been the person s residence at a time when the person s estate included that, or any other interest, in the dwelling-house (section 8H IHTA). The definition does not therefore apply to a property that has always been used as a buy-to-let property, but could include such a property where it has been used by a person as their residence in the past but which is let out at the date of the person s death. Where the person s estate immediately before the person s death includes more than one property that meets the above definition of a qualifying residential interest the personal representatives (PRs) may choose by making an election, which of the properties is to be the nominated dwelling-house having the qualifying residential interest. But note any unused portion of the RNRB cannot be transferred to another property which also qualifies. What defines a dwelling-place? A dwelling-house includes any land occupied and enjoyed along with its garden or grounds, but does not include any trees or woodlands to which an election for woodlands relief is made (section 125 IHTA). How are multiple dwelling-places handled? Where spouses or civil partners own more than one property on the first of their deaths and for example a property in which one spouse has an interest is held as tenants in common that interest may be left to children. A second property being held by them as joint tenants could pass to the surviving spouse. The PRs may arrange to nominate a couple s RNRBs so that they can both be fully used benefits would derive from their ability to nominate especially in the circumstances where the combined value of the spouses individual properties is less than the value of 2 RNRBs. (Without the ability to nominate unused RNRB could not be transferred between two properties and would be lost). How is closely inherited defined? The qualifying residential interest must be closely inherited as described in sections 8J & 8K IHTA. Section 8J IHTA confirms that property is closely inherited whether by will or under the law relating to intestacy or otherwise by one or more of the deceased s children or grandchildren or other lineal descendants, which includes step-children, adopted children, fostered children and also children for whom the deceased had been appointed as guardian. The qualifying residential interest is treated as closely inherited where the interest has been left on trust and the beneficiary is treated as owning the assets a bare trust; or where a qualifying interest in possession is inherited such as in an immediate post-death interest (IPDI) trust (section 49A IHTA) or a disabled person s trust (section 89 IHTA) and where the conditions are met for beneficiaries Page 2 of 6

3 in settlements created after 22 March 2006 such as a bereaved minor s trust (section 71A IHTA) or an trust (section 71D IHTA). What amounts of RNRB apply? The value of the RNRB is being phased in gradually commencing on 6 April 2017 until the full amount is available after 6 April 2021, as follows: 100,000 for the tax year ,000 for the tax year ,000 for the tax year ; and 175,000 for the tax year From 2021 and subsequent years the RNRB will increase each year by an amount in line with that year s Consumer Price Index (CPI) beginning on 6 April Example: How does the nomination of the RNRB work in practice? H and W own two properties, one each in their sole names, valued at 200,000 each. Both properties have at some time been used as their residence. If upon H s (first) death after April 2017 H leaves his property to his children, then his RNRB may be set off against the transfer of the property to the children ( closely inherited ). In which case upon W s subsequent death her PRs may set off her available RNRB against the value of her solely owned property. However if instead, in the above circumstances, H left his property to W (and not to his children) so that now W owns both properties; then upon W s death, leaving her property to her children, W s PRs can only nominate the value of ONE of W s two properties to be set off against her RNRB, which would include H s transferred RNRB. With the result that up to a maximum of 150,000 (2 x 175, ,000) of W s RNRB could not be used (assuming W s death was after April and ignoring any uplift in value due to CPI indexation). Where the testator and testatrix both own multiple properties the will writer will need to consider how best their PRs would be able to make nomination and use the maximum use of their available RNRB. The Taper Threshold: For estates whose NET value at the date of death is below 2,000,000, the available RNRB at the date of death, which could include any amount brought forward from the first death of a spouse or civil partner, will make up the deceased s default allowance. Where the value of the deceased s estate is in excess of 2,000,000, known as the taper threshold, the available RNRB will reduce by 1 for every 2 above the value of 2,000,000. The resultant amount will be the adjusted allowance. The effect of the taper is that no RNRB will be available for estates which have a net value in excess of 2,350,000 ( 2m + 2 x 175,000) or a net value of 2,700,000 at the date of death of a surviving spouse or civil partner where the PRs have claimed the benefit of 100% of the first deceased spouse s transferable RNRB. The tapering of the RNRB has no effect on the value of the existing standard nil rate allowance of 325,000. Transferring the unused RNRB: Any unused RNRB can be transferred between married couples or civil partners in the same way that any unused standard NRB may be transferred between them. On the second death after 6 April 2017 Page 3 of 6

4 the deceased s PRs will need to claim any unused RNRB at the first death within 2 years of the second death as follows: The amount of unused transferable RNRB depends on how much of the RNRB in force at the date of the first death has been used upon the first death, as expressed as a percentage of the available RNRB at that date. Hence the maximum percentage available to transfer will be 100%, which is then applied to the available RNRB in force upon the second death. The total RNRB in force at the second death is the RNRB amount as uplifted by the unused percentage carried forward from the first death. But note the RNRB deeming provision where for a first death BEFORE 6 April 2017 the deceased is deemed to have a RNRB of 100,000, which can be transferred to the surviving spouse or civil partner and claimed by the survivor s PRs. Example: How to apply the taper threshold in conjunction with the standard nil rate allowance (NRB)? W, a widow dies after 6 April Ignoring any CPI indexation increase in W s available RNRB, and assuming her estate of 2.65m includes her husband s H s entire estate. H died after 6 April H used none of his NRB or his RNRB and his estate was less than 2m; so that 100% of these allowances are available to transfer to W for her PRs to claim. But W s RNRB is subject to a reduction as her net estate ( 2.65m) at the date of her death exceeds the taper threshold of 2m. Consequently the value of her available RNRB allowance is reduced by 325,000 ( 2.65m less 2m divided by 2, which is a reduction 1 for every 2 that the estate exceeds the taper threshold). Taking account of H s 100% transferable RNRB, W s combined RNRB allowance based on the RNRB in force at the date of W s death, is 25,000 (2 x 175,000 less 325,000). The increased RNRB can be added to W s standard NRB ( 325,000) as increased by 100%, H s unused transferable NRB. Therefore W s total available RNRB ( 25,000) and NRB ( 650,000) is 675,000. A Further Example: If in the above example, H upon his death had made: i) a gift of a qualifying residential interest valued at 50,000 to one of his children using a portion of his available RNRB allowance ( 100,000); then as a result an uplift of 50% ( 50,000 of 100,000 as a percentage) of H s RNRB could be transferred for W s PRs to claim upon her death, and ii) a cash legacy of 65,000 to non-exempt beneficiaries using a portion of H s standard available NRB ( 325,000); as a result an uplift of 80% ( 260,000 of 325,000 as a percentage) of H s available standard NRB could be transferred and claimed by W s PRs to use upon her death. If, as a result of H s gifts the value of W s estate on her death, after 6 April 2021, is a lower amount of say 2.45m, then W s RNRB allowance would be reduced by 225,000 ( 2.45m less 2m divided by 2, a reduction of 1 for every 2 that the W s estate exceeds the 2m threshold). W s available RNRB is 37,500 ( 175, % x 175,000 less 225,000). On W s death with the standard NRB in-force remaining at 325,000 and the default RNRB 175,000 (ignoring CPI indexation) then the value of W s total available NRB & RNRB would be 622,500 ( 325,000 x 1.80 (NRB) + 37,500 (RNRB)). Notes: For the years beyond 2021 both the RNRB and Taper Threshold will increase as CPI increases; The RNRB will always be used first before the standard nil rate band; Where upon the first death there is no qualifying residential interest, the unused RNRB is transferable to the surviving spouse to use upon their death; Page 4 of 6

5 A deemed transferable 100% RNRB can be claimed even though the first death occurred before 6 April 2017 and there was no interest in a qualifying property left to direct descendants; The standard nil rate band is set to remain at 325,000 until 5 April 2021; The RNRB does not apply to lifetime gifts; and As many residences are held as joint tenants, will writers should consider how to calculate the amount of RNRB potentially available upon the survivor s death. The downsizing provisions: As mentioned at the head of these notes the Government is introducing provisions which enable a taxpayer who has downsized either by selling a larger home and purchasing a smaller home with a lower value or who ceased to own a home or has gifted a home, not to be disadvantaged ( disincentivised ) from losing the RNRB by his actions. The downsizing provisions are contained in Clause 44 of the 2016 Finance Bill which is currently undergoing its passage through Parliament. Therefore the provisions that have been announced and are included within Clause 44 could be subject to change. Bearing this in mind the downsizing provisions are addressed only briefly in these notes. The downsizing provisions are proposed to take effect where part or all of the RNRB might be lost because the deceased has downsized to a residence which has a lower value or who has ceased to own a residence due to its sale or gift. The downsizing provisions are designed to apply where the deceased moves into a less valuable residence and that lower value residence together with assets of an equivalent value to the lost RNRB are left to direct descendants or the deceased has sold their residence or has ceased to own their only residence while as above leaving assets of an equivalent value to direct descendants. The additional RNRB: The RNRB created by these downsizing, etc. proposals is called the additional RNRB. The conditions governing the use of the downsizing provisions are proposed to be similar to the qualifications for eligibility for the RNRB; as follows: The person whose PRs are to make a claim must have died after 6 April 2017; The property disposed of must have been owned by the person and would have qualified as eligible for RNRB; The less valuable property or other assets of an equivalent value, if the property is disposed of, either form part of the deceased s estate or are deemed to be part of the deceased s estate; The less valuable property and other assets of an equivalent value are inherited by the deceased s direct descendants, as defined above. The following conditions are also proposed by the draft legislation: The event qualifying as downsizing or disposal of the property occurs after 8 July 2015; Subject to the above condition there is no time limit placed on the downsizing or disposal; Any number of downsizing events may take place after 8 July 2015 and before the date of the person s death; The downsizing proposals apply to the disposal of part of a property (including land occupied and used as a garden or grounds) or a share in property; For property that is given away assets of an equivalent value to the property when it is gifted must be left to direct descendants; The value of the property is the net value, after any mortgage or other debt has been deducted; Page 5 of 6

6 The value of the additional RNRB is subject to the taper provisions (as described for the RNRB above); The value of the additional RNRB is to be applied together with the available RNRB so that the total of the two does not exceed the value of the total available RNRB in the particular tax year; and The additional RNRB must be claimed by the deceased s PRs using the same method as a claim for RNRB. As mentioned above the proposals for the application of the downsizing and disposal additional RNRB are in draft form contained within the 2016 Finance Bill (Clause 44 as drafted) and due to obtain Royal Assent, completing its passage through Parliament, later this summer passing into law by autumn Concluding remarks: A further CPD paper will be published for members later this year, once the draft proposals have become law. That CPD will contain confirmation of the additional RNRB proposals and examples on how the downsizing provisions work in practice. Important: Because these provisions affect dispositions made after 8 July 2015 members are advised to take note where a client has taken or who is proposing to take a course of action that is likely to result in their estate qualifying as eligible for the additional RNRB. A review and further advice about the effect of the testator s (proposed) actions on his estate s IHT liability may be necessary. Important Reminder: These notes are produced solely for the benefit of SWW members when completing the April CPD test to gain 1 hour of structured CPD towards their annual quota. The notes do not represent legal advice and no reliance can be made on the content of the notes in any particular or individual specific client circumstances. Having read the notes members should cement their understanding by considering further reading around the subject cases details can be found by searching the case references using BAILII or GOOGLE. The Society of Will Writers April 2016 Page 6 of 6