INHERITANCE TAX (IHT)

Transcription

1 INHERITANCE TAX (IHT) A Simple Guide 2012/13 THE CHANCERY ADVANTAGE Expertise with a Personal Touch

2 INHERITANCE TAX (IHT) A Simple Guide 2012/13 Contents INTRODUCTION IHT FUNDAMENTALS MITIGATING IHT IHT CHECKLIST About us Contact Details Disclaimer 1. These products are only suitable for Sophisticated or High Net Worth Individuals. 2. The case studies are not designed to provide full information on each strategy but a brief overview of what is possible. 3. Exemptions and reliefs often have been ignored for the purposes of these calculations as they are designed purely to show overall principles. 4. Specialist advice should be sought before undertaking any IHT planning. 5. All figures are based on our current understanding of IHT legislation. 6. The tax legislation relating to IHT can change in future and is obviously beyond our control. 7. The case studies should not be deemed as recommendations as personal circumstances need to be taken into consideration. Warning The Financial Services Authority does not regulate Inheritance Tax Planning, Film Schemes, Venture Capital Trusts and some forms of Mortgages. This Document is intended to provide a brief generic explanation and overview of IHT and does not purport to promote any specific scheme which is currently in, or may come to the market place. Intending investors should not rely solely on the contents of this document to conclude on the suitability or otherwise of the use of such schemes. Chancery (UK) LLP is authorised and regulated by the Financial Services Authority 02

3 Introduction Tax is not popular at the best of times and Inheritance Tax (IHT) is one of the most unpopular taxes of all. People who have worked hard for what they own, believe they should be able to pass on their assets to their heirs free of any taxation. The next generation also feel that the property of their parents, particularly the family home, should be theirs and that taxing it is tantamount to theft, especially if the home will have to be sold to pay the tax. These days more wealth is being passed on by more people to their heirs when they die. This is the result of the boom in house values over recent years and the wider ownership of investments. IHT is certainly no longer just a tax on the wealthy. In simple terms, subject to certain exemptions your heirs will pay 40% IHT on your total assets, including the value of your house, if your estate is valued over 325,000. In this guide, we will consider the fundamentals of IHT and some of the planning strategies you should consider to mitigate IHT. Importantly, all tax planning needs careful consideration, and this is particularly relevant with IHT planning, as if it is not done correctly, you can easily compromise your own financial position. It could be argued that IHT is, to a great extent, a voluntary tax. The good news is that with some careful planning and good advice, IHT can be significantly reduced or indeed potentially fully mitigated, allowing you to leave the majority of your hard earned money to those you love rather than handing up to 40% to the taxman. 03

4 INHERITANCE TAX (IHT) A Simple Guide 2012/13 IHT Fundamentals Before starting to plan to mitigate IHT, it is important to understand the basic fundamentals. Inheritance Tax (IHT) was introduced to replace Capital Transfer Tax by the Finance Act Essentially, IHT is a tax on the transfer of value either during one s lifetime or on death. Put simply, the transfers of value is any transfer of assets that reduces the value of the donor s estate. When calculating IHT, the amount of tax charged, is usually calculated by measuring the loss to the donor s estate, as opposed to the addition to the donee s estate. Importantly, not all transfers are treated in the same way and we will cover the main different types of transfers in this guide. While not always the case, IHT rates are 20% for chargeable lifetime transfers and 40% for transfers on death. Importantly, this guide simply aims to provide a general summary of the IHT fundamentals. Professional advice should always be taken. Who is affected by IHT? UK domiciled individuals are liable for IHT on all their worldwide property. Non UK domiciled individuals are only liable for UK IHT on their assets situated in the UK. The concept of domicile is very different compared to most other jurisdictions which rely on residency, source (i.e. assets located in that Country), nationality or citizenship. Domicile IHT is applied to all transfers of assets by a UK domiciled individual. Each person may have only 1 place of domicile at any given time. The Domicile of an individual is acquired automatically at birth. A domicile of choice may be adopted which will be evidenced by actual settlement abroad, as well as the intention to remain in the new location for the remainder of their lifetime. Up to 31 st December 1973 a woman automatically acquired the domicile of the husband on marriage. Women married prior to this date will continue to take on their husband s domicile. Deemed Domicile The rules above can be overruled by the IHT legislation. Consequently, an individual may be considered domiciled in the UK if: a) they were domiciled in the UK at any time during the preceding 3 years; or b) they were resident in the UK in not less than 17 years of the 20 years of assessment ending with the year of assessment in which the relevant date falls. 04

5 The Estate on Death On death an individual is treated as having disposed of their entire estate and the tax charged depends on the value of the estate plus the value of any chargeable lifetime transfers and potentially exempt transfers made within the last 7 years (see sections on these topics). The amount liable to IHT is reduced by any legally enforceable liabilities (i.e. mortgages and outstanding bills) and reasonable funeral expenses. IHT is generally charged at 40% of the net value of an estate over and above any nil rate band threshold still available. The Nil Rate Band The nil rate band is very important when considering IHT. It is the amount of an estate that is subject to IHT at a rate of 0%. When calculating the amount of the nil rate band that is available, it is first of all necessary to take into account the cumulative value of any chargeable transfers that have been made in the previous 7 years. This is necessary, because this figure needs to be deducted from the full nil rate band. For the 2012 / 2013 tax year, the nil rate band is 325,000. It should be noted that this has been frozen at this level until the 2014 / 2015 tax year. On 9 th October 2007 there was a major change to IHT and the nil rate band. Since this date, it is possible to transfer any unused nil rate band on the death of a spouse/civil partner to the surviving spouse/civil partner. As an example, if on the first death the chargeable estate is worth 162,500 and the nil rate band is 325,000, 50% of the nil rate band would be unused. If for example, the nil rate band when the survivor dies is 350,000, then that would be increased by 50% to 525,000 assuming both nil rate bands are fully available. 05

6 INHERITANCE TAX (IHT) A Simple Guide 2012/13 Lifetime Transfers There are various ways of gifting assets during your lifetime. Generally, these fall into 3 categories: Those which are totally exempt Potentially Exempt Chargeable Exempt Transfers There are a number of gifts that are exempt from IHT and, where possible, these should be considered when trying to mitigate IHT. The main examples are as follows:- Annual transfers up to 3,000 any unused portion of this exemption can be carried forward for 1 tax year. Small gifts any outright gift to any 1 person in a tax year, so long as the total gifts to that person does not exceed 250 in that year. Gifts in consideration of marriage/civil partnership Gifts of up to 5,000 by a parent 2,500 by a grandparent 2,500 by one party to another 1,000 by anyone else Normal expenditure out of income this should be a regular contribution out of income (not capital) and should not reduce the available net income below that required to maintain the individual s usual standard of living. This is a very worthwhile exemption to take advantage of, as potentially large sums can be passed outside of the estate well in excess of the normal 3,000 annual allowance. Transfers between husband and wife or civil partners these are unlimited and are exempt provided the spouse receiving the gift is domiciled in the UK. If 1 party is non-domiciled the exemption is restricted to 55,000. Capital transfers for family maintenance - when transfers of capital are needed to provide for the family, for example, following divorce or to make a reasonable provision for a relative. Other exemptions - This includes gifts to charities or political parties, and certain gifts for national purposes or heritage property. Potentially Exempt Transfers (PETS) Most transfers are either wholly exempt from tax on the basis that they fall within 1 of the exempt categories or are Potentially Exempt and will only be subject to tax if death occurs within 7 years after making the gift. A sliding scale applies after the first 3 years for gifts in excess of the nil rate bands. Years since gift Tax reduction Less than 3 years Nil % % % % 06

7 Chargeable Lifetime Transfers These are subject to IHT at the date of the gift and are charged to tax at 20% where the gift exceeds the IHT nil rate bands. Chargeable lifetime transfers apply to gifts made to Trusts. Gift with reservation of benefit If a gift of property is made, but the donor retains a beneficial interest in that property, it is deemed to be a gift with reservation of benefit and forms part of the donor s estate for IHT purposes. For example, if an individual gifts their home but continues to live there rent free, this will be treated as a gift with reservation of benefit. No IHT benefit will therefore be available. Pre-Owned Asset Tax (POAT) The POAT regime applies from 6 th April 2005, although it applies to arrangements made since 17 th March It applies where an individual has placed an asset outside of their estate for IHT purposes, but continues to enjoy a benefit. Any asset can be caught, including those purchased with cash that had previously been gifted (which were not necessarily caught under the gift with reservation of benefit rules explained above). For details of how the charge is calculated please contact Chancery. 07

8 INHERITANCE TAX (IHT) A Simple Guide 2012/13 Mitigating IHT The first step to mitigating IHT is to calculate the value of your estate and the potential IHT liability on your estate. Where appropriate, this exercise should of course also be carried out for your spouse. Once you know the potential IHT problem, there are a number of strategies available to reduce the overall IHT liability and to help improve the situation for the beneficiaries of your estate. There follows some of the key areas that should be considered. However, as IHT is complicated and everyone s circumstances are different, we would always recommend that you take professional advice. It should be noted that this guide provides details on a number of the different IHT planning strategies available, however it is not meant to cover all the options available. Calculate the value of your Estate The first thing you should do is calculate what you are worth. There are templates available that can help you do this. In simple terms the value of your estate will be the sum total of all of your assets less all your liabilities. However, you may also need to take into account other assets, certain trusts and also non-exempt gifts that you have already made. An IHT specialist will be able to guide you through the process and help you take into account everything you need to consider. Wills A key aspect to IHT planning is to ensure you have a Will in place and that it is up to date. If a valid Will is not in place at the date of death, the rules of intestacy will be applied. This may lead to inappropriate family members receiving an entitlement to the estate. Prior preparation will also ensure that appropriate allowances are made for dependants reducing the risk to a claim against the individual s estate under the Inheritance (Provision for Family and Dependants) Act Chancery, in association with various Partners are able to offer a Will preparation and review service. Outright Gifts The simplest way of reducing a person s liability to IHT is for them to give assets away, for example to their children or grandchildren. After 7 years the value of the gift is outside of their estate and importantly all growth on the gift is outside of the estate from the date of the gift. The downside to making an outright gift is that due to the Gift with Reservation rules, access to capital and interest is lost as the asset belongs to the recipient. There is no restriction on the amount that can be gifted outright. As an alternative to making gifts directly to the intended benefits, it can sometimes be sensible to make a gift to a trust instead. Certain trusts can allow the donor to keep control of how the assets are invested, who benefits and when they benefit. This can be very valuable to the donor. It must be remembered that the amount gifted is in the beneficiary s estate and therefore their IHT position must also be considered prior to making any gifts. See the case study that follows for an illustration. 08

9 Case Study - Outright Gifts John and Julie are both 60 and have 2 children in their 30s. They have just retired and have sufficient pension income to live comfortably. They do not need to draw any income from their investments and believe that it is unlikely that they will need to do so in future. They wish to gift a percentage of these funds to their children, as they are confident that they will not require these funds. Current Situation 400, , ,000 ( 650,000) 150,000 60,000 Main Residence Investments Total Estate Less 2 nil rate bands Taxable estate on 2nd death Tax payable at 40% Possible Planning It would be possible for John and Julie to gift 150,000 directly to their children or via an absolute trust. After 7 years the value of the gift is outside of their estate, and all growth on the investment is outside of the estate from day one. Revised Position 400, ,000 ( 150,000) 650,000 ( 650,000) NIL Main Residence Investments Less out right Gift to Children Total Estate Less 2 nil rate bands Taxable estate on 2nd death 09

10 INHERITANCE TAX (IHT) A Simple Guide 2012/13 Business Property Relief Relief is available on business property, providing it is retained for a minimum qualifying period of 2 years. The relief varies with the nature of the business asset. 100% relief is available for a business or an interest in a business, including a partnership share or unquoted share holdings. 50% relief is available for share holdings in quoted companies or land or buildings, or plant and machinery used for a business carried on by an individual who controls the entity. Packaged investments are available from a variety of providers and some offer 100% capital protection. If death occurs within the first 2 years the benefits of the investment would not be lost in full as the tax payable on assets held subject to Business Property Relief can be paid in instalments over a 10 year period. Interest is therefore able to accrue to the estate. See the case study below. Case Study - Business Property Relief (BPR) Helen is aged 85 and in poor health. She is in receipt of regular pension income and does not need to supplement this from her investments. She may however require access to the capital at some point in the future particularly if nursing care is needed. She has 3 children and wishes to improve the IHT position if at all possible. Current Situation 250, , ,000 ( 325,000) 175,000 70,000 Main Residence Investments Total Estate Less 1 nil rate band Taxable estate on death Tax payable at 40% Possible IHT Planning Helen has decided to invest 175,000 in assets subject to business property relief. Revised Position after 2 years 250,000 75, , ,000 ( 175,000) 325,000 ( 325,000) NIL Main Residence Investments Business Property Relief Investments Total Estate Less Business Property Relief Total Estate after BPR Less 1 nil rate band Taxable estate on death In Helen s case she has totally negated her IHT liability once her investment is held for 2 years. She has invested into a scheme with full capital protection in the event of death. Provided that she lives for a 2 year period she is guaranteed that 500,000 will be paid to her 3 children. This is an improvement on the 430,000 they were due to receive if no IHT planning was undertaken. No medical underwriting is required for most investments, so Helen s poor health does not preclude her from this type of planning. Helen also retains complete accessibility to the underlying capital base if an emergency were to arise. 10

11 Trading Companies It is possible to invest through a trading company in the development of either commercial or residential properties, the management of car parks or public houses and debt factoring. The funds invested are IHT exempt after 2 years. These schemes are comparatively simple in that the investor owns 100% of the issued share capital of a fully managed, newly created private company. This private company then undertakes trades which qualify for Business Property Relief. This is a very original product in that the investor retains full control of the underlying assets and any income from these assets. This allows the investor to liquidate some or all of these assets if their circumstances change in the future, yet still run the investments outside of their estate for IHT purposes. AIM Shares It is possible to invest in small companies listed on the AIM stock market and again there is a 2 year period before the assets qualify for Business Property Relief. Historically the problem with investing in AIM shares is that the investment is quite risky. However, there are now schemes available which provide an in-built life assurance policy which will cover any loss should the initial investment fall in value prior to death. There is still the potential to benefit from any increase in the value of the portfolio. Furthermore, the insurance policy is written in trust so that should it be necessary to claim on it, the proceeds will be paid directly to beneficiaries without the need for profit and it will not fall into the estate therefore, avoiding IHT. Investing in an Enterprise Investment Scheme (EIS) An EIS is an investment in shares in a small unquoted company that qualifies for EIS tax benefits. Investment within an EIS has a number of benefits as follows: The investment in EIS shares is exempt from Capital Gains Tax. Qualifying investments will be eligible for an Income Tax credit of 30% of the investment to set against the investor s Income Tax liability. This is limited to the first 1,000,000 of investment, with the ability to carry back a further 500,000 to the previous tax year. There is also the ability to use the investment within an EIS to defer a gain arising up to 36 months before and 12 months after the acquisition of the EIS shares. A disposal of the investment before the expiry of 3 years is likely to give rise to a loss of all or part of your tax relief. Agricultural Property Relief This is a similar relief to Business Property Relief, but is available for agricultural properties such as land or pasture, woodland and buildings used for livestock, etc. To qualify the asset must be retained for 2 years. Relief is given at a rate of 100% where the donor has a right to vacant possession immediately before the transfer, or right to obtain vacant possession within the next 12 months. 50% relief is available if agricultural property is let on any longer term tenancy. It is possible to have agricultural property relief and business property relief available at the same time, in which case agricultural property relief is given first and any balance reduced by business property relief. Packaged schemes do become available that invest in diversified portfolios of agricultural land, this spreads risk and reduces the on-going administration of running the land. Woodlands Woodlands are IHT free after 2 years as they qualify for Business Property Relief and they can also provide a tax free income stream since Woodlands may be felled and sold without incurring income tax. Any capital growth is tax free. 11

12 INHERITANCE TAX (IHT) A Simple Guide 2012/13 Discounted Gift Trust A Discounted Gift Trust can be quite restrictive, but it offers excellent IHT benefits and a regular income stream from assets placed within the trust. Arrangement can differ, but the main features of a typical agreement follow: A Trust is established by the settlor who will also typically be a named Trustee. The beneficiaries would normally be the children. A regular income is set at outset, usually 5%. Once set the income will be paid to the settlors throughout their lifetime. However, once established the income cannot be varied. The capital can be invested in cash, equities, bonds, property etc., depending upon the Trustees choice, but the value of the investment cannot be accessed before death. It cannot even be gifted to the beneficiaries early. Capital can only be paid after the death of the settlor. Assets in the trust are managed by the Trustees so investments can be changed as can the beneficiaries at any time. The settlor therefore retains control of the trust fund monies. The investment will qualify for an immediate discount for IHT purposes depending upon age, income selected and health. Medical underwriting is required albeit a full medical will not be needed. As an example at age 65, approximately half the amount invested will be immediately outside of the settlor s estate if a 5% income is drawn. The balance falls out of the estate after 7 years. See case study below. Case Study - Discounted Gift Trusts Paul and Gemma are aged 70 and have 3 children. They have been retired for 5 years and are in receipt of pension and investment income. They need to retain income from their investments to maintain their current standard of living, but wish to reduce their IHT liability if possible. They have no need to have access to all their capital base as long as a percentage is retained as accessible. Current Situation 400, ,000 1,200,000 ( 650,000) 550, ,000 Main Residence Investments Total Estate Less 2 nil rate bands Taxable estate on 2 nd death Tax payable at 40% Possible IHT Planning Paul and Gemma have decided to gift 550,000 into a Discounted Gift Trust. The main benefit for them is that they can retain a 5% income stream for life, equating to 27,500 per annum net. The amount invested in the Trust will fall out of their estate fully after a 7 year period, but approximately 54% of the gift will be immediately outside of their estate for IHT purposes. They are therefore nearly halving their Inheritance Tax liability from day 1. All growth on the investments over 5% is also outside the estate from day Revised Position after 7 years 400, , ,000 1,200,000 ( 550,000) 650,000 ( 650,000) NIL Main Residence Investments Discounted Gift Trust Total Estate before relief Less Discounted Gift Trust Total Estate Less 2 nil rate bands Taxable estate on 2 nd death

13 It is possible to invest more than 550,000 into a Discounted Gift Trust even using a Discretionary Trust, without this producing a lifetime IHT charge. This is because only a percentage of the total is deemed to be a gift, in this case 46% of 550,000 or 253,000. Paul and Gemma if they so wish would be able to invest between them well over 1 million into a Trust of this type. Details on the different types of IHT planning arrangements are available from Chancery. Insurance For individuals who choose not to make lifetime gifts it is possible to take out a life insurance policy to cover the anticipated IHT liability. The life policy should be written in trust to ensure it does not fall into the settlers estate, therefore not increasing the IHT liability. Any insurance policy undertaken should be reviewed on a regular basis to ensure it remains appropriate. This type of planning is particularly useful for persons under retirement age, as the premiums are often surprisingly cheap and they buy time before other planning can be implemented. Insurance premiums can often fall within the normal expenditure out of income exemption. Planning after Death - Deeds of Variation A deed of variation can be a way to do some retrospective IHT Planning. Under current legislation, a deed of variation can be used within 2 years of a person s death, to allow for the beneficiary (ies) of a gift to vary the destination of assets from the deceased. Such a variation can, depending on the circumstances, save IHT. For example a child could elect to skip a generation and leave assets that have been left to them to their children (the donor s grandchildren). This would therefore save IHT by skipping a generation. Of course, for this to take place there must be agreement with anyone who is adversely affected. 13

14 INHERITANCE TAX (IHT) A Simple Guide 2012/13 IHT Checklist Estimate your wealth and the likely IHT liability on your death and, if you are married, the liability on the death of your spouse. Make sure you have an up-to-date Will. Take advantage of the exemptions between spouses. Where possible take advantage of the various IHT exemptions available. If possible try to fully utilise your nil rate band and where appropriate your spouse should do the same. Consider making a lifetime gift of assets that are likely to increase in value, as all future growth will fall outside your taxable estate. Consider making gifts to trusts when you want to keep control over the ultimate beneficiaries of your gift. Consider other taxes such as Capital Gains Tax. There is no point saving IHT if you pay more in other taxes like Capital Gains Tax. Before making a lifetime gift, make sure you will not be able to access income, capital or other benefits from that gift in order to avoid the gift with reservation rules. Make sure you are comfortable about making a gift. The worst thing you can do is to put yourself in a difficult financial position because you want to save IHT. Where your children are in a good financial position, consider skipping a generation for IHT purposes by leaving assets to your grandchildren. Consider life assurance policies in trust to meet the IHT liability that might arise on death. 14 Contact Chancery for professional IHT advice.

15 About Us The Chancery Advantage - An Integrated Financial Solution At Chancery, we put the interests of you and your business first. We are leading Accountants and specialist Tax Advisers who combine expertise with a personal touch. What sets us apart from the competition is The Chancery Advantage. Combining our accountancy and audit services with the services from our taxation business, we offer a financial proposition that it is hard to find elsewhere a fully integrated financial solution. Over the years Chancery has gained a valuable reputation both with our clients and within the industry at large for our innovative solutions and our first class service. Importantly, we believe in solutions not problems. It is no coincidence that amongst our growing client base, we have many top professionals from the world of finance. It is comforting to know that people and businesses from around the globe that deal with money on a daily basis come to us to look after their own finances. The Way Forward For further details on IHT Planning in general, investors should contact their Professional Adviser or the Chancery Tax team. As well as advising on specific IHT opportunities available, investors without an accountant can also use the Tax Service from Chancery Accounts & Tax LLP. Investors, who use this service, will receive advice on IHT in general based on their own specific situation. Details on this Tax Service are available on request. Please contact Chancery to find out more. Contact details can be found on the back page of this guide. 15

16 Contact Details Chancery (UK) LLP Head Office Chancery Pavilion Boycott Avenue Oldbrook Milton Keynes MK6 2TA Towcester Valhalla House 30 Ashby Road, Towcester Northamptonshire NN12 6PG London 25 Southampton Buildings London WC2A 1AL Telephone: +44 (0) (Milton Keynes) +44 (0) (Towcester) Fax: +44 (0) Web: Chancery (UK) LLP is authorised and regulated by the Financial Services Authority If you would like to obtain details on other Chancery guides, please telephone or Chancery at Creative and Print by Palladium Solutions Information correct at time of going to print October 2012 All rights reserved. Copyright Chancery (UK) LLP, VR1012