Spelling out the options

In the first of his two part series on inheritance tax Richard Warner goes through the ABC of IHT planning

Assets

All assets held in your sole name at the time you die will form part of your estate and may be liable for inheritance tax (IHT). Assets you own jointly with another person will pass by survivorship to the joint owner and may, or may not, be liable to IHT dependent on your relationship with the joint owner.

Business Property Relief

This relief may be available if your estate includes an interest in certain types of business, business assets or private company shares. However, to qualify you need to have held the asset for at least two full years and, in some cases, hold a controlling interest. The relief can vary from 50% to 100%, depending upon the type of business asset involved.

Capital Gains Tax

When you die, the assets that form part of your estate are uplifted to probate value (market value at the date of death) and could be charged to IHT. These uplifted values also apply for capital gains tax (CGT) purposes, meaning that any inherent gains remaining at the time of your death are wiped out.

Your personal representatives/executors will only have to pay CGT if the values of the assets increase between the time of death and when subsequently sold, subject to their annual CGT exemption (equal to that of an individual for the year of death and subsequent two tax years). When assets are passed over to beneficiaries they will normally pass across at probate value.

Domicile

How much IHT will be payable by your estate is governed by your domicile status at the time of your death. If you are UK domiciled, IHT will be due on assets held worldwide. If non-UK domiciled your estate will only pay IHT on those assets situated in the UK.

The concept of domicile is based on case law, not legislation. However, generally speaking your domicile is where you have established a permanent home and you intend to remain there indefinitely.

Normally, when you are born you assume a domicile of origin which is based on your father's at the time of your birth, not that of the country you are born in. You keep this until such time as you assume a domicile of choice, for example by moving permanently to another country and staying there for at least three full years.

Excluded Property

This covers certain types of property which, provided conditions are met, fall outside of the scope of IHT in the UK. Examples could be UK authorised unit trusts and OEIC's, British government stock and overseas assets, provided they are held by a non-UK domiciled person. Offshore situate assets settled into a trust by a non-UK domiciled person are also considered excluded property.

Funding the payment of IHT

Following your death, your executors will apply to the court for a Grant of Probate to enable them to administer and distribute your estate in accordance with your will. If IHT is payable then, depending on the nature of the property in the estate, it is due in advance, when the probate application is submitted. This can cause problems if assets of the estate have been frozen, pending the Grant.

Your executors can pay some or all of the IHT due directly to HMRC from an account held in your sole name with a bank or building society account, using the IHT direct payment scheme. Most banks and building societies participate in the scheme. It is also possible for your executors to arrange for direct payment using a number of British government stocks and various national savings accounts and certificates.

Gifts

Gifts you make to registered charities, political bodies, registered housing associations or for national purposes e.g. museums, are exempt from IHT, as are gifts to spouses, those made in consideration of marriage (subject to specific limits), small gifts or gifts within the annual exemption of £3,000 per year.

Outright gifts made to other individuals with no strings attached are considered potentially exempt gifts and will be fully exempt from IHT provided you survive seven years from the date made.

Since March 2006, most gifts made into trust (except for bare trusts) are now subject to the IHT regime applicable to discretionary trusts and as such are treated as chargeable lifetime transfers (CLT). Provided the gift, when taken into account with any other CLTs made in the previous seven years, does not exceed your nil rate band (NRB) then no IHT will be due. Where the gift does cause a charge, IHT will be payable at the lifetime rate of tax, 20%, on the amount of the gift exceeding the NRB.

Gifts which you make from income as part of your normal expenditure are exempt from inheritance tax but it must be possible to show that after allowing for the gifts you had sufficient income remaining to maintain your usual standard of living.

Heritage assets

Where an asset of your estate is of "national interest" it is possible to claim an exemption from IHT provided certain conditions are met. Broadly, the conditions ensure that the general public have access to the asset, that it is properly maintained and that it remains in the UK. An asset qualifying for the exemption can also be accepted by HMRC in satisfaction of any IHT liability.

Intestacy

If you die without leaving a valid will in place you are deemed to have died intestate. In most cases, the court will issue a Grant of Letters of administration and appoint an administrator to distribute the estate.

There are complex provisions laid down in the law to decide who will take benefit, with spouse/registered civil partners and minor dependants being given priority. It does not matter what you may have wished for or promised while you were alive. The rules on intestacy do not recognise "common law" partners, and the term "children" include natural, adopted and illegitimate children, but not stepchildren.

Joint Property

In English law there are two types of property ownership, legal ownership and beneficial or equitable title. With legal ownership, the people named on the title document are the owners. A beneficial owner has the right to enjoy the use of the property, as well as take a share in any sale proceeds.

Where property is owned jointly it can be held in two different ways, either as joint tenants or as tenants in common. With a joint tenancy the owners do not have distinct separate shares, they own the whole together. Both have the right to enjoy the property during their joint lifetimes and when one dies the property passes outright to the other and he or she becomes the sole absolute owner.

On the other hand, with a tenancy in common each owner has a clearly defined share, which would normally represent the proportions, which each owner contributed to the acquisition of the asset.

Killed in War Exemption

If you are unfortunate enough to die on active service or as a result of an injury or illness sustained while on active service in the past, your estate may well be exempt from IHT.

For enlisted members of the armed forces the exemption is granted if a valid certificate, provided by the Ministry of Defence, is submitted to the probate court. In situations where you are not in service at the time of death so no certificate exists, it will be necessary for your next of kin to apply for the certificate from either the Defence Council or the Secretary of State.

Lump sums payable on death

It is possible that when you die a lump sum may be payable in respect of any interest you held while alive e.g. whole of life and/or term assurance policies, lump sum pension death benefits, etc. If this is the case, unless you take action beforehand, the proceeds of such policies may potentially form part of your estate and be taken into account for IHT. One of the easiest ways to avoid this is to write the prospective benefit of the lump sum on death into trust, for the benefit of your surviving spouse or your children.

Marriage

Strangely, there is no strict legal definition of the term "spouse" within the IHT legislation. However, apart from the obvious, spouses can be people who are separated but still legally married and also parties to a valid polygamous marriage.

An interesting point to note is that in England and Wales, marriage automatically revokes a will, unless the document was drafted in contemplation of marriage. In Scotland the law on inheritance differs and getting married there does not revoke an existing will.