Many married couples and civil partners can reduce their combined inheritance tax bill by ensuring that full use is made, on the death of the first to die, of the nil rate band that is free of inheritance tax - this tax-free slice currently stands at £300,000, giving a tax saving of up to £120,000.
Creating a discretionary trust under each Will saves this tax, but in many estates it is not easy to set aside specific 'spare' assets to form a discretionary trust and this can be a particular issue where much of the value of the estate is in the family home in which the surviving spouse would want to continue to live.
This lack of 'spare' assets need not, however, be an insurmountable problem, as it is not necessary for the trust to contain assets in the usual sense. One route is to loan assets to the surviving spouse and the other is for the trustees to secure a charge over property passing to the surviving spouse. On the surviving spouse's death, the value of their estate would be reduced by the outstanding loan or charge, thus reducing the amount of inheritance tax potentially payable at that time.
The Special Commissioner's decision in Phizackerley has attracted a significant amount of press attention and may have led some to believe that the use of such trusts is no longer possible where the family home is involved. This is not the case.
The facts in Phizackerley
Dr Phizackerley was an Oxford don and he and his wife had lived in college accommodation until his retirement in 1992 when they then bought a house.
It was bought in their joint names, but all the funds were provided by Dr Phizackerley. In 1996 they made new Wills under which a sum equal to the nil rate band was left on discretionary trusts, with the residue going to the survivor absolutely. Mrs Phizackerley died first and a discretionary trust arrangement was implemented, using the loan route mentioned earlier.
Why did the loan arrangements in Phizackerley not achieve an inheritance tax saving?
It was expected that, on Dr Phizackerley's death, a deduction would be available for this loan, reducing the inheritance tax payable on his death. The Revenue refused to allow this deduction, on the basis that Dr Phizackerley had made a gift to Mrs Phizackerley when he put the house in their joint names and so the loan fell to be disallowed under a specific antiavoidance provision. This provision applied because Dr Phizackerley was entitled outright to the residuary estate; this would not have been the case if he had been left a life interest, or if the charge route had been used instead of the loan route.
How does the Phizackerley decision affect planning by Will?
It has always been necessary to take care in structuring nil rate band discretionary trusts and this case reinforces the point. With a potential saving of £120,000, the trouble is worth taking. Careful consideration needs to be given as to how the purchase of the property was funded, how the property title is owned, and how the residue under the Will should be held. Whether it is possible or desirable to effect either the loan or the charge route will depend on the circumstances at the time of death. It is therefore important that both spouses' Wills are drafted to allow for maximum flexibility.