I read your articles over the last few weeks on inheritance tax and splitting trusts. I wonder if you could explain how the recent case will affect those who use their nil rate band to create debts against their estate.
The Phizackerley case you are referring to has shown once again that the Revenue are adamant about closing down any opportunity for assets to be passed free of Inheritance tax and this case has not been popular.
In simple terms, we all have an amount we can give away on first death free of Inheritance tax. This is called the nil rate band (currently £300,000). We can give what we wish between spouses and there is no liability to tax at all. Whilst this is nice, it is not effective for tax planning as all the deceased spouse’s assets will then be added to the survivor’s who in turn has an exaggerated inheritance tax problem.
To avoid this, it is good to use the first nil rate band on death, but many avoid it as they do not wish to lose control of their assets. To circumnavigate this, a trust is normally created on first death with the deceased’s nil rate band transferred into it.
The benefit of the trust is that the surviving spouse can still benefit from the assets after death and on second death there is a second nil rate band which can be used, which is that of the survivor. All nice and simple really, so joint estates of £600,000 or less have no real issue in mitigating the tax.
There is an added benefit that the survivor can also borrow out of that trust and create debts against their estate which means that, with careful planning, estates of £900,000 or less should have no need for any Inheritance tax.
That was all very simple until the Phizackerley case above.
The case involved Dr Phizackerley’s wife who died leaving her half share in the property to a trust as an IOU. Dr Phizackerley then borrowed that capital back and this is where the problem sits. The special commissioner in the case stated that Dr Phizackerley had paid for the whole house, despite the couple being classed as beneficial tenants in common, and therefore any loan from the trust technically originated from him and not his wife – so he was lending money from himself to himself.
This really only complicates matters where the deceased, who creates the trust on death, has not contributed to the estate (now we are contentious). The commissioner has basically stated that as Mrs Phizackerley has never worked, the half share she had in the house didn’t actually belong to her and that is why Dr Phizackerley has loaned to himself effectively. Had Mrs Phizackerley worked, it could be proven she had contributed to the purchase and the loan scheme above would have been fine. Had Dr Phizackerley not borrowed, once again, the arrangement would have been fine.
The hilarious aspect to this, is that it cuts across the progress in other aspects of law, particularly divorce, where the contributions of the wife – whether she works outside the home or not – are deemed equal to those of the husband through his working outside the home.
It seems there is clearly a double standard here and I would expect some developments.
One point to look for however, is that of capital gains tax.
When property is placed into a trust, there is the future potential capital gains tax to consider. Whilst any gain on your personal home has no capital gains tax liability (currently), any gain on the share of the property within a trust is liable to capital gains tax. A method of circumnavigating this is to use an IOU, or a promissory note instead. As there is no property in the trust (just an IOU) there is no CGT – if structured properly.
The value of shares and investments can go down as well as up
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