Finance

Inheritance Tax changes

by Ian Williams
Partner, Campbell Dallas Chartered Accountants

On 9 October 2007 Alastair Darling, as the new Chancellor, delivered his first Pre-Budget speech in which were a number of surprises and there are definitely winners and losers.

On the winning team was the change to Inheritance Tax (IHT). The Chancellor did not change the rate of tax nor the nil rate band, but did introduce a “transferable nil rate band” between husband and wife and civil partners.

What does this mean? From 9th October 2007 it is possible to transfer the percentage of your nil rate band which was not used on the first death to the surviving spouse or civil partner. For example, Mr & Mrs A have assets of, say, £1M, divided equally. They have simple wills and leave everything to the survivor, such that there is an IHT problem on the second death.

Under the old rules, assuming the nil rate band is £300K, on Mr A’s death, his estate pays no IHT as everything is left to Mrs A. On her death £700K (£1M - £300K, her nil rate band only) is subject to IHT @ 40% = £280K. Very costly.

Under the new rules, Mr A’s unused nil rate band percentage is passed to Mrs A. On her death she has her own and 100% of her late husband’s nil rate bands (2 x £350K), meaning only £300K is subject to IHT, costing £120K in tax, a saving of £160K. Suppose, Mr A leaves £150K on his death to his children. Mrs A can then be passed the limited percentage (50%). On her death, her estate benefits from her full nil rate band plus her husband’s unused 50% not measured in monetary terms on the date of his death, but 50% of the full nil rate band prevailing at the date of Mrs A’s death. This is good.

As you can imagine, people are questioning, following the Chancellor’s announcement, whether they should change their will to optimise the benefits this obviously brings about. In short, the answer, in most cases, is, yes, however, please consider what the future might hold.

Wills, which create a discretionary trust on the first death, are now probably obsolete in very straight forward circumstances, because it freezes the nil rate band settled into the discretionary trust, whereas an unused nil rate band not settled into a trust, but passed to a surviving spouse, is inflation proofed or, if the Conservatives are elected, possibly creating a £1 million plus nil rate band threshold for couples. Discretionary Trust wills have, probably, become unfashionable overnight.

However, this is not the final word, as there are circumstances where removing the discretionary trust provision in a will might be premature. Some examples, where the will trust should still be considered are:

1. Where an asset is likely to rise rapidly in value, well ahead of inflation and to freeze its value on the first death might produce a better long-term tax solution
2. Where care costs are likely to be significant for the surviving spouse/civil partner and the deceased’s assets would be better directed elsewhere.
3. Where couples are unmarried.
4. Where there are second (or more) marriages and there are complex inheritance issues around the children of some or all of the marriages.

In summary, this is a very welcome IHT change and it should provide the opportunity to revisit your will, to ensure it reflects your present circumstances and achieves IHT efficiency, at the same time.