Inheritance Tax and The Chancellor’s sleight of hand

In the 9 October 2007 Pre-Budget Report the Chancellor announced the introduction of a transferable Nil Rate Band (NRB). He basked in the glory of what was perceived as a doubling of the NRB.

Although transfers on death between spouses and civil partners are exempt from Inheritance Tax (IHT), transfers to anyone else, typically children, are chargeable at 40% on the excess over the current (NRB) threshold of £312,000. Most couples want their estates to pass to each other, and then down the generations on the second death. The way to achieve this with maximum tax efficiency was to insert a Discretionary Trust equal to the NRB on the first death, with the balance of the estate passing to the survivor on a spouse-exempt basis. The survivor and the wider family would be beneficiaries of the Discretionary Trust. For most couples, their major asset is the matrimonial home. To circumvent the complications in putting a share of the matrimonial home into trust an elaborate system of charges or IOUs was adopted.

At a stroke, the Chancellor has removed the need for such fiscal engineering and equalisation of estates. Assuming, as is the likely order of things, that the husband (H) dies first leaving his entire estate to his wife (W) there is no IHT payable on H’s death. On W’s death, she is entitled to double whatever the then value of the NRB may be. This rule applies when the second death occurs after 8 October 2007, no matter how long before that the first death occurred. [For example, if H died in June 1996 (when the NRB was £200,000) and left a legacy of £100,000 to his daughter with the balance of his estate to W, on her death in June 2008 (when the NRB has risen to £325,000) her Estate is entitled to a NRB increased by a half to £487,500. The survivor’s NRB is increased proportionately, not just by the actual £100,000 unused on H’s death.]

Most couples therefore no longer need a complicated Wills structure nor to sever the joint tenancy in the matrimonial home. However, NRB Discretionary Trust Wills may still be appropriate where there are sufficient free assets to fund the trust other than the house. [and the value of the trust funds are likely to grow faster than inflation (to which the NRB is usually linked). A Discretionary Trust is also useful on the first death when there is business or agricultural property attracting 100% relief, or nursing home fees are a problem.]

Existing Wills which contain an NRB Discretionary Trust may not need altering. If desired, the trust could be “collapsed” by appointing the assets to the survivor within 2 years of the first death. This will be read back to the deceased’s death for IHT purposes so that the disposition takes effect as though the entire Estate had passed, under that Will, to the surviving spouse and so preserves the deceased’s unused NRB in full. As ever expert advice is needed.