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Inheritance Tax planning

By Robin Beadle
12th Aug 2020

There is a very useful automatic tax relief that you are granted when you die:  any assets that you hold as at the date of death receive an automatic uplift to market value for Capital Gains Tax (CGT) purposes for the person to whom they are left.

A quite common situation can therefore arise whereby value can pass through the Inheritance Tax (IHT) review of someone dying and into the hands of beneficiaries without triggering a tax charge if, when the death occurs, the assets either attract an IHT relief themselves or are left to an exempt person (usually a spouse)

For example, Jack owns several Furnished Holiday Cottages.  One of which he bought in 1990 for £50,000.  It is now worth £500,000 (and therefore has an inbuilt capital gain of £450,000 giving a maximum capital gains tax liability at 28% of £126,000).  Jack is married and has utilised his IHT nil rate band with bequests to other family members.  Jack wants the value of the property to pass to his son, Michael.  On death, Jack leaves the property to Sarah, his spouse.  As Sarah is an exempt beneficiary, there is no IHT liability – but Sarah receives the CGT-free uplift and inherits the property at current market value of £500,000.  Sarah then sells the property for £500,000 and pays no CGT.    Sarah can then gift the money to Michael and provided that Sarah survives the 7-years, there is no further IHT or CGT liability.

Contrast this with the position were Jack to have left the property in his Will to Michael intact (potentially a £500,000@40% = £200,000 maximum IHT charge remembering Jack had used his IHT nil rate band elsewhere) or if Jack had sold the property (initially a £126,000 CGT charge) and then left the balance of cash to Michael (a further (£500,000-£126,000)=£374,000@40%=£149,600).  By leaving the property to Sarah who then sells and gifts the cash to Michael, there is no tax.  Leaving the property to Michael suffers £200,000 on death and selling first and gifting the cash balance on death suffers £275,600 in taxes

Sometimes the best planning is the simplest route.

The historic reason for the CGT uplift is so that beneficiaries should generally not receive an IHT charge and then a CGT charge for receiving an asset which is converted into cash.  However, with various IHT reliefs, (Business Property Relief, Agricultural Property Relief) and an IHT allowance of £1m for a couple (including the main residence relief), the government is now considering that the contribution that IHT makes to the country is falling and may no longer be fit for purpose.  So much so, in fact that in the last year there have been two major reports to Government in relation to changes to IHT;

  • An Office for Tax Simplification (OTS) review commissioned by the Government; this recommended significant changes to (but within) the existing system; and
  • An All Party Parliamentary Group (APPG) review; this recommended a radical rethink of the way that IHT/ CGT are applied (introducing a lower rate but effectively scrapping all reliefs such as APR/BPR)

Both called for a review of the CGT uplift on death.

With the Government looking at ways to fill the chasm in finances caused by Covid-19, whilst I am loathe to suggest action being taken over an unknown, I do suggest that you consider whether it would be prudent to bring forward a review of any estate planning that you may have in place and consider whether there are alternative routes to achieve your aims.

For example, were Jack still to be in good health, he could consider making a gift of the cottage to Michael during his lifetime.  Provided that Jack survived seven years from the date of gift, there would be no IHT on the gift.  Additionally, there is currently a gift hold-over relief available upon the transfer to Michael as the Cottage is considered a business asset.  Using this relief, the in-built capital gain is passed to Michael who would only trigger the gain were he to sell the property.

The above alternative is not necessarily a panacea to all as there several implications that would need to be considered such as the in-built gain has merely been passed to Michael and not extinguished; if Michael does not let the property as part of an FHL business there can be implications and of course you are assuming that Jack will survive the seven-year period.

What is clear from the current trend in government thinking however, is that you should consider

  • There is a possibility that IHT gifting may be more problematical moving forward;
  • It is unlikely that CGT rates will remain at current historically low levels;
  • Some assets may currently have a reduced value (for whatever reason) which will reduce the tax impact of gifting on now.
  • Tax rates do not only change at the end of the tax year – governments have changed them with immediate effect from the announcement.

I would not advise taking action merely because it may be more tax efficient to do so now, and certainly never without professional advice.  It is always essential that you should never pass on more than you can afford to as well.

But with the prospect of higher tax rates in our future, is it not worth dusting off the plans and see if something could be done differently?