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An introduction to inheritance tax (IHT)

An introduction to inheritance tax (IHT)This guidance note provides a background to the basic principles of IHT, including the loss to the donor principle, chargeable transfers and transfers that are not subject to inheritance tax.Background to inheritance taxInheritance tax is a tax on the value passing from one individual to another person. This typically arises when an individual dies and all of the property that they own (their ‘estate’) passes to beneficiaries. An individual may also transfer their assets to others during lifetime. This could be an outright gift of assets to another person or a gift into trust.Assets in trust are held by trustees for the benefit of others, whose entitlement to them is restricted in some way. Special inheritance tax rules apply to trusts to reflect the separation of legal and beneficial ownership.IHT arising on a death estate is a tax on the donor ― the person who is transferring the asset. It is calculated with reference to their estate. It is not a tax on the beneficiaries, though what the beneficiaries receive may be reduced by the amount of tax. This position contrasts with the law in certain other jurisdictions where ‘death duties’, gift tax or the equivalent are a tax on the people receiving the property and is taxed in accordance with their status or wealth. Clients who receive an inheritance often ask if they have to pay tax on it. Generally, the answer is ‘no’, because any tax due has fallen on those administering

Employee trusts ― implications of disguised remuneration and where are we now?

Employee trusts ― implications of disguised remuneration and where are we now?Employee benefit trusts (EBTs) are commonly used to support employees’ share schemes and to provide other benefits to employees. For example, EBTs were used to provide additional benefits where the previous reduction of the pension lifetime allowance resulted in employees having significantly less tax efficient pension provision than was intended. Many employers established employer financed retirement benefit schemes although the trusts were in fact an EBT that permitted the provision of retirement benefits. EBTs were also used to provide what was believed to be ‘tax efficient’ bonuses ― contributions to an EBT would be held for an employee’s (or a class of employees’) benefit. The EBT would either invest for the benefit of the employees, or more widely, the EBT would provide a loan to the employee. The employee would have the benefit of the loan and not suffer the tax liability of a payment made outright to the employee.The use of EBTs has been significantly affected by the introduction of the disguised remuneration rules. For further information, please see the Disguised remuneration ― overview guidance note. There are statutory exclusions from those rules to cover many of the share scheme-related activities of EBTs. However, providing loans or opportunities for wealth creation through long-term investment schemes, has declined due to the tax and NIC treatment as a result of the disguised remuneration legislation.Legislation introduced in Finance Act 2014 promoted employee ownership of companies. Employee owners who dispose of

Heritage property strategies

Heritage property strategiesWhere an owner has claimed, or is considering claiming conditional exemption on heritage property, he may also wish to consider whether or not to establish a heritage maintenance fund; the income and capital of which may be used to support the conditionally exempt heritage property.If, on the other hand, he decides that he or his descendants can no longer maintain the heritage property, he may consider disposing of the property by gift or sale to a charity or a body listed in IHTA 1984, Sch 3 or, alternately, to HMRC in lieu of tax.Maintenance fundsAs part of the policy to preserve national heritage property, heritage maintenance funds may be established. These settled funds, whose assets (usually not heritage property itself) and income are used for the maintenance of heritage property, receive advantageous IHT treatment. Transfers of property into a maintenance fund are exempt transfers provided the maintenance fund meets the qualifying conditions set out below. The property does not rank as relevant property for the purposes of the principal and exit charges under IHTA 1984, ss 64–65. Although a recapture charge will apply when the trust fund loses its qualifying status, it can be avoided provided that the property reverts to the settlor or is used for alternative heritage purposes. Qualifying conditions for a maintenance fundThe requirements of the use of capital and income in the maintenance fund are as follows:•in the first six years after establishing the trust, the fund must only be used for:

Transfer of assets to beneficiaries ― legal, administration and tax issues

Transfer of assets to beneficiaries ― legal, administration and tax issuesThis guidance note outlines how assets are transferred to beneficiaries and the tax consequences that flow from the transfer. Whether a payment is income or capital is discussed in the Payments to trust beneficiaries guidance note.This guidance note is designed to give outline and background for accountants and tax advisers who deal with clients establishing trusts. It is not targeted at lawyers.This guidance note deals with the position in England and Wales only. See Simon’s Taxes I5.8 for details of the provisions affecting Scotland and Northern Ireland.Three issues to consider when transferring assets to beneficiariesTrustees may decide to exercise their powers by appointing assets to a beneficiary. There are three key issues that need to be considered when making or considering such a transfer:•how they must document the exercise of their powers•the formalities that should be complied with to transfer the asset•the tax consequences of the transferDocumenting the exercise of the trustees’ powersThe deed may require the exercise of the trustees’ power to be documented by deed. If no deed is required then the trustees decision and actions can be recorded by a written resolution. However, it is important that the correct documentation is prepared. If an appointment requires a deed but is made without one then the appointment is void.A deed should be used where the trustees require an indemnity for tax or other expenses.Preparing deeds is a reserved legal service and is regulated by

Expenses and liabilities

Expenses and liabilitiesThis guidance note discusses the expenses and liabilities that can be deducted when calculating a transfer of value for inheritance tax purposes. It discusses the general principles applicable as well as specific provisions about deductions in the Inheritance Tax Act and the anti-avoidance legislation that has restricted deductions in some cases. This note also covers which asset the deduction for the liability can be taken from and how to deal with outstanding tax liabilities. General principlesExpenses and liabilities will reduce the value of property to be charged to inheritance tax. The deduction of liabilities is restricted in some circumstances by anti-avoidance legislation and these are covered below.The value of any property for inheritance tax purposes is ‘market value’. The market value of assets is reduced by liabilities. The practical application of these general principles to the valuation of property for IHT means that, for example:•the value of a death estate is reduced by the deceased's outstanding personal debts such as household bills and credit cards•the value of a gift (eg a house) is reduced by liabilities attached to it (eg a mortgage)•the value of settled property is reduced by the trustee's outstanding debts such as professional feesSee Example 1, which also illustrates some of the principles described below.Specific provisionsThe general principles are qualified and expanded by a number of specific legislative provisions.Liability must be legally enforceableA liability is allowed only if:•it is imposed by law•it was incurred for consideration in money or

Accumulation and maintenance trusts

Accumulation and maintenance trustsWhat is an accumulation and maintenance trust?An accumulation and maintenance trust (A&M trust) is a particular type of settlement intended to make provisions for children and young adults up to the age of 25. The key feature is that trustees are given discretion over how to use the income for the benefit of the child up to a specified age. They may accumulate it to augment the child’s capital entitlement, or they may apply it for the purpose of maintaining the child. Income accumulated in early years may be spent in later years when the child is older. The child becomes entitled to the income as it arises when he reaches the age of 18, or at a later age if the trust instrument so provides.Typically, a beneficiary has a future entitlement to a fixed share of the trust fund and the income arising on it. However, trustees often have the power to vary the allocation of the total income among beneficiaries before they gain an interest in possession. They may also have the power to advance or re-allocate capital. Once the beneficiary gains an interest in possession, their interest in the underlying capital becomes fixed. Usually, it will be paid to them at a specified age, but in some A&M settlements the trustees retain control of the capital for the duration of the trust.A&M trusts enjoyed privileged inheritance tax treatment between 1975 and 2006, and became a popular way of making provision for children and

Due diligence

Due diligenceIntroduction to due diligenceA tax practitioner is most likely to become involved in a financial due diligence exercise by reviewing the target’s current and historical tax position on behalf of the purchaser of a company or group of companies.The overall aim is to provide a report to the management team highlighting key areas of risk, quantifying the potential exposure and suggesting what actions could be taken by management to mitigate these risks. This process is also often required by the banks and other finance providers involved in the transaction to give some comfort that the investment being made is sound, prior to funds being advanced to the acquiring group. As part of the wider due diligence process, detailed checks may also be made concerning the legal and commercial history of the target, depending upon the requirements of the purchaser.The financial due diligence report usually covers:•analysis of the financial position•analysis of the forecast results•details of the customer base, value and terms of key contracts•details of the management team•review of costs, ie staff, premises, etc•review of the tax position of the companies being acquired•asset review, ie identification of intellectual property and details of any protection, eg patents, registered designs, etc•purchasing and supply chain information•suitability of operating and IT systemsFinancial due diligence is usually carried out by experienced accountants, who may be part of a specialist corporate finance transaction support team. The work will involve close liaison with other professional advisers, eg

Trusts for bereaved minors

Trusts for bereaved minorsWhat is a trust for a bereaved minor?The special category of ‘trusts for bereaved minors’ (TBM) (sometimes called ‘bereaved minor’s trusts’ (BMT)) was introduced by Finance Act 2006 to provide IHT concessions for trusts in favour of children with a deceased parent. Before 22 March 2006, such trusts would have been included within the more wide-ranging accumulation and maintenance (A&M) regime, but no new A&M trusts can be created after that date (at least not with favourable IHT treatment). See the Accumulation and maintenance trusts guidance note. TBMs have a more limited application. Except in rare circumstances explained below, they are created on the death of a parent for the benefit of his or her minor children.Typically, trustees have the power to accumulate income and to apply capital for the benefit of the beneficiary. Therefore, they are of a discretionary nature, although it is also possible for TBM beneficiaries to have an interest in possession.A bereaved minor is a person who is under the age of 18 years and at least one of whose parents has died. For these purposes, ‘parent’ includes a step-parent or a person with parental responsibility. Inheritance tax concessionProperty that is held in a trust for bereaved minors is not subject to the relevant property regime of principal charges and exit charges. There is no inheritance tax charge as a result of:•the bereaved minor attaining the age of 18 or becoming absolutely entitled to the trust property under that age•the

Heritage property ― loss of conditional exemption

Heritage property ― loss of conditional exemptionIntroductionWhere a chargeable event occurs in relation to conditionally exempted property, the exemption may be lost and an inheritance tax charge may arise. For information on the conditional exemption, see the Heritage property ― conditional exemption guidance note and Simon’s Taxes I7.501 onwards.Chargeable eventsChargeable events may consist of:•a material breach of an undertaking•a disposal of the heritage property•the death of the person beneficially entitled to the propertyWhere a breach of an undertaking has occurred, in practice HMRC will usually give the taxpayer an opportunity to remedy the breach where possible. If there has been lengthy period of no public access, this may not be possible. Note that a failure to observe an undertaking, as varied by a proposal by HMRC and directed to take effect by the Tribunal, also amounts to a material breach of an undertaking. The meaning of ‘disposal’ is usually quite straightforward. Note that HMRC states mortgages and leases are not disposals but they could undermine the integrity of the mortgagor’s or lessor’s interest to such an extent that they do amount to a material breach of an undertaking.The lifetime disposal of a chattel by sale, gift or otherwise will amount to a chargeable event unless the disposal is:•to an exempt body within IHTA 1984, Sch 3 (eg museums, galleries, etc)•to HMRC in lieu of tax under IHTA 1984, s 230•itself a conditionally exempt transfer•to new owners who accept responsibility for the original

Making use of the tax pool

Making use of the tax poolIntroductionThis guidance note follows on from the Discretionary trusts ― tax pool guidance note, which explains how the tax pool is calculated.The ‘tax pool’ is a record of the tax paid from year to year by the trustees of a discretionary trust, which funds the tax credits available to the beneficiaries. If the tax credits on distributions to beneficiaries exceed the amount available in the tax pool, an additional charge is made on the trustees. This guidance note explains the effect of the mismatch between the rates of tax on trust income and the beneficiaries’ tax credit, and considers how to use the tax pool efficiently.DividendsThe distribution of dividend income always results in a tax credit for the beneficiary which exceeds the tax contributed to the pool by that income. This is because both the dividend trust rates and the dividend ordinary rate are lower than the trust rate. A comparison of the shortfall,is quantified as a percentage of the net dividend below:2022/23 onwardsDividend received£1,000Dividend trust rate tax credited to tax pool @ 39.35%£394Available for distribution after tax(£1,000 – £394)£606Tax credit on distribution(45/55 x £606)£496Tax in tax pool as % of dividend(394/1,000 x 100)39.35%Beneficiary’s tax credit as % of dividend received(496/1,000 x 100)49.6%Shortfall as % of net dividend(49.6% – 39.35%)10.25%The shortfall may be funded by:•tax reserved in the pool in previous years•paying a tax pool charge out of taxed income which has not been