IHT Planning - Special News Topic

Two related articles in the Sunday Times (Money section) entirely concur with our view that loan trusts, IOU schemes for property or Gift-and-Loan Trusts should not be promoted as an IHT planning method. You will have to register on the Times site first - click this link http://www.timesonline.co.uk/newspaper/0,,2770-1236291,00.html to read the full article. The related article Can you beat the IHT trap? which can be read at http://www.timesonline.co.uk/newspaper/0,,2770-1236292,00.html
confirms what we have always recommended.

Also see the report Advisers push families into costly tax plans about the pitfalls of bond sales and the likely survival of Gift-and-Loan schemes

Using a Discretionary nil rate band trust (shown below) now appears to be the only reliable way of doubling IHT exemption between spouses.

Calculating IHT liability is simply a matter of totalling the assets of both spouses, deducting the exempted amount (£263,000 from April 2004) from the total estate and working out 40% of the balance

Example: Spouses have a total estate of £520,000. No IHT is payable between spouses so when the first dies the survivor inherits the whole estate. However, on the second death there is only one allowance to the exemption level

Taxable estate = £520,000 - £263,000 = £257,000
Inheritance Tax Paid = £257,000 x 40% = £102,800

Easy Solution: In the above case it would be easiest for both spouses to give a monetary legacy in their Wills directly to their children. Provided the total amount of the legacies don't exceed the exemption level no tax is due on the gift even though it's going to someone other than the spouse.
Problem: Can the surviving spouse make do without the use of the funds given in the legacies?

Loan trusts to avoid IHT have been sold by several large insurers and their advisers. They appear to work by nominally 'selling' large assets (such as the family home) to a trust. The trustees don't have access to sufficient funds to buy the property so the owners only get an IOU for the market value.
When the first spouse dies the trustees allow the survivor to live in the property but on the second death IHT is either eliminated or reduced because the house is theoretically not part of their estate.

Government regulations changed with Finance Act (April 2004). Testators who have set up loan trust schemes to avoid paying IHT must dismantle them or pay income tax on the earnings they should be gaining from the property. This is regarded as an unusual mechanism for clamping down on such schemes but the outcome may be the surviving spouse paying tax of up to £12,000 per year.
If the surviving spouse lives for another 8 or 9 years the tax paid may exceed the amount saved if a discretionary trust had been set up instead.

Trying to have your cake and eat it ... The problem with loan trusts is that they are obviously nominal schemes. On one hand, the testators want to be seen having given away the property - but on the other hand they are retaining the right of the survivor to carry on living in it.
Inland Revenue always regards Reservation of Benefit like this as something that has been kept within the estate - so it must still be taken into account for tax calculations (either IHT or under the new income tax rules above).

The difference with Discretionary Trusts is that there is the possibility that the surviving spouse may not necessarily use any of the assets or property in the trust fund. In practice this may well be the type of joint decision the trustees (which usually includes the surviving spouse) agree between themselves.

E.g. the trustees may agree that the main family home is too large for the surviving spouse alone and so there is no need to immediately utilise this part of the deceased's assets. The option of the trustees to use their discretion in the use of the funds is sufficient (at present) for the Inland Revenue to regard the establishment of the fund as a gift outside of the marriage and therefore using up the exemption allowance of the first deceased.

On the death of the surviving spouse there will be a second exempted amount allowed without IHT so that a married couple will be able to leave a total estate value of double the exemption level (currently £263,000 x 2 = £526,000) without having to pay any Inheritance Tax.

Discretionary Trust arrangements must be written into the Wills of both spouses (it is not possible to predict which spouse will die first). Additionally clients should:

• Appoint at least two executors/trustees to act jointly. The spouse can be included but must not act solely
• Equalise their assets as far as possible. Each spouse should have an amount approaching the exemption allowance owned in their sole name
• Rearrange joint bank accounts, investments, etc. so that the assets are owned in individual names
• Split the tenancy on the family home (if it is owned jointly) so that they own it as Tenants in Common

Under no circumstances should there be any obligation to ensure that the surviving spouse has the absolute use of any of the trust assets e.g. being allowed to live in the house. Although it may well be allowed in practice, it is a common mistake to try to make this an obligation of the trustees by including a Lifetime Interest in the share of property in the same Will.
This would be regarded as Reservation of Benefit and the assets/property would still be included as part of the estate for IHT calculations.

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