On 9 October, the Chancellor announced some significant changes to inheritance tax and capital gains tax, which have been heavily reported in the media. The purpose of this briefing is to comment on how the changes are likely to affect you, particularly in relation to any inheritance tax planning measures you may have included, or may be contemplating including, in your will.
Inheritance tax: the changes to the nil
Before 9 October 2007 a person’s estate was entitled to an amount, known as the inheritance tax nil rate band, which was chargeable to inheritance tax at 0 per cent. Any amount above the nil rate band is chargeable at 40 per cent. (For 2007-08, the nil rate band is £300,000.) Transfers of assets between spouses and civil partners are generally exempt from inheritance tax. So, an individual who died leaving some or all of their estate to a spouse/civil partner may not have utilised, or fully utilised, their nil rate band; any unused portion of the nil rate band is effectively wasted and this could give rise to an increased inheritance tax bill on the survivor’s death.
From 9 October 2007 onwards it will be possible to make a claim for the transfer of any unused inheritance tax nil rate band on a person’s death to the estate of their surviving spouse/civil partner. The legislation covering this change will be included in the Finance Bill 2008 but the intention is that it will have retrospective effect. It will apply to estates where the person dies on or after 9 October 2007 and it will apply if the first spouse/civil partner died before 9 October but the surviving spouse/civil partner dies on or after 9 October.
Will this affect the way in which wills are drafted?
To date, it has been fairly common practice for spouses/civil partners with substantial estates to include provision in their wills for a gift of a sum equivalent to the nil rate band to the children or to a discretionary trust. Such a gift would only take effect on the death of the first to die and the aim was to make use of the nil rate band, which would be wasted if the entire estate passed to the surviving spouse/civil partner.
As there were sometimes difficulties with funding the gift, particularly where the bulk of the estate consisted of the family home, well drafted wills usually included provisions that would allow the gift to be funded by a debt or a charge over the family home. If the proposed changes are implemented, it may no longer be necessary to include such a gift as the unused portion of a person’s nil rate band will be available to his/her spouse/civil partner on the latter’s death.
Should I change my will?
The proposed changes to the inheritance tax nil rate band do not mean that existing wills that include nil rate band legacy provisions should necessarily be changed, but they should certainly be reviewed in due course
Issues that should be taken into account include the following.
- Nil rate band legacies can serve a dual purpose: not only do they offer a way of using the nil rate band on the first death but they also provide a vehicle for asset protection.
- There may be some advantage to having an asset held outside the estate of the surviving spouse/civil partner if the asset is likely to grow significantly in value.
- If the nil rate band legacy is held on a discretionary trust, the surviving spouse/civil partner may have access to the funds but s/he will not own the funds outright. If you would be happier with the surviving spouse/civil partner owning the funds outright, taking advantage of the new rules and having simple wills leaving everything to each other on the first death may be an attractive option.
- If the first spouse/civil partner to die has any business or agricultural property, which is covered by the inheritance tax business property relief or agricultural property relief, care should be taken to ensure that full advantage is taken of those potentially valuable reliefs, which may require an outright gift on the first death to someone other than the spouse/civil partner or a gift into a discretionary trust.
- Setting up and running a nil rate band discretionary trust is not to be undertaken lightly. There are formalities to be complied with (filing returns with Revenue & Customs, preparing accounts) and the trustees must meet regularly, take decisions on the investment and distribution of funds and record their decisions. There are inheritance tax charges on discretionary trusts (although they are unlikely to apply in the first ten years and the rate is low).
- If no action is taken now it may still be possible to “undo” any nil rate band discretionary trust within two years of the death of the first of the spouses/civil partners to die. This will depend on the trustees of the trust being satisfied that unwinding the trust (in favour of the surviving spouse/civil partner) is the correct action to take.
- We would not recommend making changes to your will before the measures announced in the Pre-Budget Report have been implemented (not least because there is the chance that they will not take effect or will not take effect in their current form).
Should any action be taken in relation to nil rate discretionary will trusts that are up and running?
The short answer is that it depends on the individuals concerned and their respective interests. If all (or indeed some) concerned are satisfied with the arrangement and/or the asset protection aspect of the trust is of value, then it would be sensible to leave the trust in existence. If the surviving spouse/civil partner is not happy with the arrangement and/or feels that the complications of running the trust are unwarranted, then it would be worthwhile considering winding up the trust. This must be done within two years of the death of the first spouse/civil partner. It cannot be done unless the trustees are satisfied that this would be the right and proper thing to do.
Capital gains tax
Legislation will be introduced in the Finance Bill 2008 to give effect to a new single rate of charge to capital gains tax at 18 per cent. This rate will apply to disposals on or after 6 April 2008. Taper relief and indexation will be withdrawn and the share identification rules will be simplified. The announcement by the Chancellor states that draft legislation will be published later this year and that, in the interim, the Revenue will be discussing the detail of the proposals with “interested parties”. We will comment further on the impact of the proposed changes when the detailed legislation has been published.