Inheritance Tax Planning Book from Taxcafe

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LIFE REALLY isn’t fair – so why should death be any different?

A typical business owner spends their life struggling to keep their business going, through good years and bad, through the peculiar vagaries of one Government after another and against the backdrop of an ever-changing tax regime.

In the end, after protecting their business and family from the ravages of Income Tax, Capital Gains Tax, VAT, and many other state-imposed costs and charges, there is one final hurdle to face: Inheritance Tax (‘IHT’)!

The most important IHT reliefs for business owners are the spouse exemption and business property relief (‘BPR’). The spouse exemption merely postpones the problem until the second spouse dies. Furthermore, BPR is not always available and there are many cases when business owners are still exposed to a very large IHT bill, such as:

• On a business which does not qualify for BPR – e.g. property investment businesses
• On the proceeds remaining after the sale of the business – e.g. on retirement
• On private wealth accumulated outside the business

In short, many business owners need to look at other ways to protect their family from IHT.

Entrepreneurial Generosity
British entrepreneurs have a long history of benevolence – often in the form of charitable legacies on their death.

Charitable legacies themselves are generally fully exempt from IHT: provided that they are made to a UK-registered charity or an equivalent body registered elsewhere in the European Union or in Iceland or Norway.

But, an additional relief now also applies where the deceased leaves 10% or more of their ‘net estate’ to charity.

The ‘net estate’ for this purpose is the deceased’s remaining estate after deducting the nil rate band and any other applicable IHT exemptions and reliefs, including the spouse exemption and BPR (but before deducting any charitable legacies). Widows, widowers and surviving civil partners may also have a transferable nil rate band to deduct where their spouse or civil partner did not wholly use their own nil rate band on their death.

Where the estate qualifies for the additional relief, a discount of 10% applies to the IHT rate. In other words, the IHT rate on the remaining estate is reduced from 40% to 36%.

Example
Carter divorced many years ago. Since then, he has built up a successful property investment business. Sadly, however, he dies in October 2012, leaving an estate valued at £2.5m. He leaves £217,500 to the local dog and cat home (a registered charity) and everything else to his daughter Yvonne.

Deducting the nil rate band of £325,000 from his estate leaves Carter with a ‘net estate’ chargeable to IHT of £2,175,000. He has given 10% of this amount to charity, so the IHT rate on Yvonne’s inheritance is reduced to 36%.

After deducting the charitable legacy (which is exempt), and the nil rate band, the chargeable estate amounts to £1,957,500, so the IHT payable at 36% is £704,700.

Yvonne will therefore inherit a net sum of £1,577,800 (£2.5m - £217,500 - £704,700).

Of course, I should point out that, if Carter had not left anything to charity, his IHT bill would have been £870,000 and Yvonne would have then received a net sum of £1,630,000 – i.e. £52,200 more than in our example.

Hence, the new relief does not leave the main beneficiary better off than they would have been if the deceased had not left anything to charity at all. In other words, you cannot leave your family better off simply by making a charitable legacy when you otherwise would not have done.

But, if you are already planning to leave something to charity, it is certainly worth checking whether you will meet the 10% threshold.

If, in our example above, Carter had instead left £200,000 to charity, this would not have been sufficient for his estate to qualify for the new relief and IHT would have been payable at the full rate of 40%. His chargeable estate would have amounted to £1,975,000 (£2.5m - £200,000 - £325,000), giving rise to an IHT bill of £790,000 and leaving Yvonne with a net inheritance of just £1,510,000 (£2.5m - £200,000 - £790,000).

So, as we can see, a small increase of £17,500 in Carter’s charitable legacy in order to reach the critical 10% (of his ‘net estate’) threshold, has actually left his daughter £67,800 better off overall!

Planning Issues
Initially, when the proposals for this relief were first announced, it had been hoped that it would be possible for charitable legacies to be ‘topped up’ to the required 10% threshold by way of a Deed of Variation.

Sadly, however, this does not now appear to be the case and it seems that it is necessary for the deceased to have made the appropriate provisions within their Will.

As no-one can be quite sure exactly how much their ‘net estate’ will amount to, this requires a formula-based approach to ensure the correct result.

As we saw in our example, however, there is no point in making charitable legacies just for the sake of saving IHT: your main beneficiaries will still suffer an overall cost equal to at least 24% of the legacy, even after taking account of the new relief.

But, as we also saw, where charitable legacies are already planned, there may actually be an overall saving for your family if you can ‘top up’ those legacies so that they reach the 10% threshold.

When does a ‘top up’ become worthwhile?
The answer to this is that your family will generally benefit if you ‘top up’ your charitable legacies to the 10% threshold whenever you would otherwise have left charitable legacies equal to more than 4% of your ‘net estate’.

Hence, for example, in Carter’s case, he had a ‘net estate’ of £2,175,000, so Yvonne would benefit from an increase in his charitable legacies to the 10% threshold if he had already planned to give more than £87,000 to charity anyway.

It’s up to you how much of your ‘net estate’ you want to leave to charity – 1%, 3%, 10%, 20%, all of it, or nothing at all, but I certainly wouldn’t want to leave anything between 4.01% and 9.99%!