UK Accountants Warn Over Problems With IHT Schemes

by Robert Lee, Tax-News.com, London

06 April 2007

According to UK business advisers Target Accountants, a recent controversial court ruling means that married couples who switch ownership of their family home using a common tactic to minimise inheritance tax (IHT) bills could lose any IHT savings.

The case is unlikely to affect the super rich, says Target. However it could have a severe impact on ordinary families whose wealth is mainly tied up in their home, and result in them paying up to GBP114,000 in extra tax.

It is now common practice when drafting a will for solicitors to provide that on the death of the first spouse or civil partner, their IHT-free amount, currently £285,000, is passed into a trust for the family, with the remaining estate passing free of tax to the surviving partner. This ensures that no tax is paid when the first partner dies and the estate of the survivor is not swelled on their subsequent death.

Establishing a ‘nil rate band trust’ is relatively easy for the super-wealthy, as the GBP285,000 can be paid in cash. However, it is not so easy for those in ‘middle England’, where the family home often makes up the lion’s share of their wealth.

One popular solution is for the estate to pass entirely to the survivor, who gives an IOU for that amount to the trust. When he or she dies, the IOU reduces the value of their estate and hence the tax the family has to pay.

However a recent ruling has highlighted a major pitfall. The case, brought by Her Majesty’s Revenue and Customs, concerned the death of the second partner, who had inherited his late wife’s estate and paid an IOU to a trust.

The court agreed with HMRC that the IOU could not be deducted when calculating the tax due on his estate because the debt related to his wife’s half of the home, which he had previously gifted to her many years before when he made her a joint owner.

“Gifts between spouses or civil partners are generally free from IHT or capital gains tax (CGT) due to specific spouse exemptions,” explains Karen Harwood, senior manager at Target Accountants. “However, whilst the spouse exemptions were not in question here, the existence of the gift ultimately led to the IOU being disallowed on death, due to a little known quirk in the IHT rules.”

Harwood says the case shows that IHT is no longer a tax on the wealthy. She is advising people who may be affected to seek professional advice about the practical implications of the ruling.

“This could affect thousands of families, as many people who have structured their wills to benefit from these tax savings will have also made gifts between each other at some point in their lifetime. It is still possible to achieve the tax savings, but advice should take account of such gifts, and the will should allow sufficient flexibility as to how the gift is constituted.”

Target is a ‘top 50’ firm of chartered accountants specialising in owner managed businesses and people who want to maintain and increase their wealth. The firm has offices in the South West, Thames Valley and Midlands.

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