Background: 

Dr P gave a half share in the family home to his wife who neither contributed to the purchase price of the house nor any subsequent mortgage repayments. Mrs P died first and her share in the house was used to meet the nil rate band discretionary trust under her will (“the NRB Trust”). The terms of the NRB Trust allowed Dr P to live in the house until his death in exchange for an IOU he gave the trustees. The executors of his estate claimed that the IOU to the trustees was a valid debt by which they could reduce his estate for inheritance tax purposes. The Special Commissioners rejected this on the basis that Mrs P had not contributed to the share of the house that she had left on trust. Dr P was effectively borrowing from something he had previously owned and given away and the Special Commissioners rejected this circular arrangement involved with the house and the subsequent IOU. The outcome was that the share of the family home previously owned by Mrs P became subject to 40% inheritance tax on Dr P’s death. 

Does this decision affect you? 

1. We own our house as joint tenants are we affected by this recent decision? 

No. 

2. We own our house as tenants-in-common are we affected? 

Not unless the circumstances at paragraph 6 apply. 

3. What is a nil rate band? 

The nil rate band is the amount of an individual’s estate (less substantial gifts made within 7 years of death) that can be passed on to another person free of inheritance tax. In the current tax year 2007/08 the allowance stands at £300,000. 

4. Why is the nil rate band placed on a discretionary trust? 

A nil rate band discretionary trust is a mechanism under wills to usthe nil rate bands of both spouses (or civil partners). At current rates this can save up to £120,000 of inheritance tax on the second death. 

If on the first death the deceased leaves all of his assets to his surviving spouse (or civil partner), there will be no inheritance tax to pay by virtue of the spouse exemption. However, the survivor’s estate is increased by the full value of the deceased’s estate. On the survivor’s death, only her own nil rate band will be available against the value of the combined estates and inheritance tax at 40% will be payable on the balance. The first deceased’s nil rate band will have been wasted. 

By making wills which place the nil rate bands on trust for the survivor and, say, the children, the individuals ensure that both nil rate bands are preserved whilst funds can still be made available to the survivor if they need access to them. 

5. How is the family home involved? 

If the main asset in the deceased’s estate is the family home then the house (or part of it) may need to be used to meet the nil rate band being placed on discretionary trust on the first death. However, in such circumstances it is usual for the survivor to remain in occupation of the family home. He or she will usually live there in exchange for giving the nil rate band trustees an IOU or debt equal to the nil rate band which remains outstanding until the survivor’s death. Alternatively, the trustees could take a charge over the home which is equal to the nil rate band and the survivor then occupies the home subject to that charge. Such debt or charge schemes are still capable of saving substantial inheritance tax if the wills are drafted carefully and the trust set up correctly. 

6. Who is affected by the Special Commissioner’s decision? 

Those couples: 

  • who are married (or in a civil partnership) AND
  • who own their home as tenants-in-common AND
  • only one spouse (or civil partner) has paid the purchase price of the house or repays or has repaid the mortgage (or one spouse (or civil partner) has made a substantial gift to the other prior to the purchase of the house) AND
  • they have drafted mirror wills that set up nil rate band discretionary trusts on death AND
  • it is intended that all or part of the value of the family home might be used to meet the value of the nil rate band to be held on discretionary trusts.

7. Do you need to take any action?

Even if you satisfy all of the conditions at paragraph 6, it may be that no immediate action is required because of the flexible way in which your wills have been drafted. The decision does not affect the general use of a nil rate band discretionary trust in the will of the first spouse (or civil partner) to die. However, it has made it all the more important that a will contains the full range of options for how the trust could be funded. We would recommend that you seek advice from your usual advisor in the first instance.