rodgers-taxation-latha

The impact of pre-2006 IHT planning on transferable nil rate bands

Mon, 14 Apr 2025 10:17:49 GMT

Latha Rodgers points out that ‘old’ inheritance tax planning may need to be revisited in some cases.

A common assumption is that inheritance tax (IHT) is only payable on the second death if a married couple or civil partner’s total net estate is more than £1m.

However, this may not be the case if pre-2006 IHT planning was undertaken.

The main IHT bands

The two IHT bands available on death are the nil-rate band (NRB) and the residence nil-rate band (RNRB). Both the NRB and RNRB are frozen at £325,000 and £175,000 respectively until April 2030.

The NRB is available regardless of the individual’s domicile position and the total value of their gross estate.

However, the RNRB is only available if a direct descendant inherits the residence, and the band is tapered if the individual’s gross estate is more than £2m.

Assuming there is no taper and all the conditions are met, the total NRB and RNRB on death is £500,000.

Transferable nil-rate band

The transferable nil rate band (TNRB) was introduced in Finance Act 2008 and allowed the executors of the surviving spouse (or civil partner) to claim the unused proportion of the NRB of their spouse (or civil partner).

TNRB may be claimed where the surviving spouse (or civil partner) died on or after 6 October 2007. For married couples, it did not matter when the first spouse died. However, for civil partnerships, this only applies where the first civil partner died on or after 5 December 2005 – the date the Civil Partnership Act came into force.

Although the first spouse or civil partner may have died before the TNRB was introduced, the amount available to be transferred is based on the percentage of unused NRB at the date the first spouse (or civil partner) died.

For example, Steve died on 10 April 2005 and his total estate was £500,000. Under his will, there were legacies of £110,000 and the remainder passed to his wife, Julie. The NRB at this date was £275,000. The unused NRB at Steve’s death was £165,000 (i.e., £275,000 less £110,000). This represents 60% (being £165,000 divided by £275,000) of his NRB. On Julie’s death, the TNRB is 60% of the NRB at her death; assuming this is £325,000, this amounts to £195,000. At Julie’s death, the total TNRB and NRB is £520,000.

If the surviving spouse inherited all the assets, and assuming there were no failed lifetime gifts, a maximum £325,000 can be claimed by the executors of the surviving spouse.

Brought-forward allowance

Similarly, although the RNRB was only introduced in Finance (No. 2) Act 2015 and applies to deaths on or after 6 April 2017, it is possible to claim the unused RNRB on the first death; this is referred to as the ‘brought-forward allowance’.

If the first spouse (or civil partner) died before the RNRB was introduced, the brought-forward allowance is 100% of the RNRB on the second death – although this is tapered if the gross estate of the first spouse (or civil partner) was more than £2m.

On or after 6 April 2017, similarly to the TNRB, the executors need to consider the value of the first spouse or civil partner’s gross estate and they must have a residence at death. The percentage of the unused RNRB allowance on the first death is available as a brought-forward allowance.

Example: Tapered RNRB

Jack died on 1 June 2019. His gross estate was £2.1m, including his share of the residence valued at £500,000. The residence passed to his surviving spouse, Jill. The residential enhancement on Jack’s death is £150,000, but this is tapered because the gross estate is over £2m.

The reduced allowance is £100,000 (i.e., £150,000 less (£2.1m less £2m)). As the residence passed to his surviving spouse, none of Jack’s reduced RNRB was used. This represents 67% (approximately) of the residential enhancement (i.e., £100,000 divided by £150,000). On Jill’s death, the brought-forward allowance is 67% of the RNRB at the date of her death. If this is £175,000, the brought-forward allowance is £116,667.

If there is no taper, the maximum brought-forward allowance is £175,000.

Maximum IHT reliefs on second death

If the surviving spouse (or civil partner) inherited all the assets on the first death, the maximum NRB, TNRB (assuming no failed lifetime gifts) and RNRB (including the brought-forward allowance on the second death is £1m.

Pre-2006 planning

Before the TNRB was introduced, it was not possible to transfer the NRB from one spouse to another. Because spouse exemption applied first, this meant that the NRB was effectively lost.

To counter this potential loss, several tax planning options were used to negate it. Some of these and the impact on the surviving spouse (or civil partners) are outlined below:

NRB discretionary will trust

Wills were drafted to include a NRB discretionary will trust. Under the terms of the will, assets up to the value of the NRB at the time the first spouse died would pass into a discretionary trust.

In this case, there is no unused transferable NRB for the executors of the surviving spouse to claim.

Deed of variation

Alternatively, deeds of variation were entered into so that assets up to the NRB passed to beneficiaries other than the surviving spouse.

Again, this means there is no unused transferable NRB.

Main residence planning

There are two types of legal ownership, being joint tenants and tenancy in common. Married couples usually own their homes as joint tenants so that when one dies, their share automatically passes to the survivor, and spouse exemption applies. Alternatively, if the property is owned as tenants in common, on death their share in the property passes in accordance with their will.

Deeds of variation were entered into to sever the joint tenancy so that the owners became tenants in common. Consequently, on death, the first spouse or civil partner’s share in the property either passed into a will trust or created a charge over the property, both of which used the first spouse or civil partner’s NRB.

RNRB is available if a direct descendant inherits the property or, if the property was sold before death. If the first spouse or civil partner’s share in the property passed into a discretionary will trust, then RNRB will not apply.

Consequently, there is no unused transferable NRB and potentially no brought-forward allowance RNRB on the second death.

RNRB should be available on the surviving spouse or civil partner’s death, provided their share of the residence passes to a direct descendant.

There are other issues to consider with this type of planning: for example, the trust may need to be registered with the trust registration service; whether the charge is an allowable deduction for IHT purposes; and capital gains tax implications when the property is eventually sold.

Planning opportunities

If the joint assets are around or more than £2m, it may be worth considering severing the legal title in properties, so that on the first death, the residence passes to the direct descendants. This could be done to preserve the RNRB on the first death because otherwise, on the second death, the RNRB would be tapered.

However, this would also mean there is no transferable NRB. Detailed IHT calculations need to be undertaken before any planning is undertaken.

Practical point

Most cases should be straightforward, and the executors should be able to claim both the transferable NRB and a brought-forward allowance.

A detailed review of the first spouse or civil partner’s estate would still be recommended. Executors and agents should ask for a copy of the first spouse or civil partner’s will, deeds of variation, and any IHT forms that were submitted at the time. You can then confirm if the transferable NRB or the brought-forward allowance is available in full or reduced.

Wills should be reviewed and updated on a regular basis.

Claims need to be made within two years at the end of the month in which the surviving spouse or civil partner dies.

Finally, given the IHT announcements in the Autumn Budget 2024 on agricultural property relief, business property relief and pensions, It is recommend that a detailed review is undertaken and that IHT tax advice is sought.

EMI: A review of the essentials

Mon, 02 Dec 2024 09:32:36 GMT

Latha Rodgers provides a refresher of the qualifying conditions for enterprise management incentive share options and the tax benefits.

Unlike other HMRC approved share option schemes, enterprise management incentives (EMIs) can be tailored to each specific individual (e.g., for different performance conditions). They also do not need to be offered to every employee.

General requirements

EMI options must be granted for genuine commercial reasons to recruit or retain an employee. There is also an anti-avoidance requirement in that if the option is granted as part of a scheme or arrangement the main purpose of which is to avoid tax, the option does not qualify.

Employees can be granted up to £250,000 worth of shares. The value of the shares is based on the unrestricted market value (UMV) when the options are granted. The limit includes both EMI options and company share option plan (CSOP) grants. Once the £250,000 limit has been reached, no further options can be granted for three years, regardless of any earlier options being exercised.

The company can grant EMI options up to £3m. Again, this is the UMV of the shares and includes unexercised EMI options.

Qualifying conditions

Some of the company and individual conditions need only be met when the EMI options are granted, whereas others need to be met throughout the period from grant to exercise (this is explored later).

Company conditions

The company must meet all the following conditions:

its gross assets must be less than £30m;
it must be a stand-alone trading company or the holding company of a trading group;
all its subsidiaries must be qualifying subsidiaries. The holding company must own 51% of a subsidiary. For a property managing subsidiary, the holding must be 91%;
the EMI option must be granted in the holding company; and
there must be less than 250 full-time equivalent employees.

Like other definitions of trading activities, rather than define ‘trade’ there is a list of excluded activities. The relevant legislation (ITEPA 2003, Sch 15, para 16) sets out the list of excluded activities, which include leasing, farming activities and property development.

Individual conditions

The individual must meet all the following conditions:

be an employee of the company or group (directors can also qualify);
meet the working time requirement; and
does not have a material interest in the company or group.

Provided the individual either works at least 25 hours per week or 75% of their working time for the company (or group), the working time requirement is met. Part-time individuals can qualify if they meet the 75% of their working time test. Working time includes all employments and self-employment.

An individual has a material interest if they, together with their associates, hold more than 30% of the ordinary share capital of the company. Associates include the individual’s spouse, parent, children and the trustee of any settlements of which they or their associates are the settlor. Siblings, uncles, aunties, nieces and nephews are not associates. In determining whether the individual has more than 30%, shares under CSOP options are included – although other EMI options are ignored.

Critically, if the individual breaches the 30% material test after the EMI option has been granted, the unexercised EMI option is unaffected – this is because the individual met the material test at the date the EMI option was granted.

Disqualifying events

As mentioned previously, there are some conditions which the company and individual need to meet throughout. If they are not, these are called disqualifying events. They are:

loss of independence;
no longer meeting the trading requirement;
changes to the EMI option terms;
changes to the share capital;
conversion of shares;
no longer employed or a director;
working time requirement no longer met; or
the £250,000 limit is breached because a CSOP option has been granted.

If the EMI options are exercised within 90 days (subject to whether the EMI options automatically lapse under the terms of the EMI option agreement when the disqualifying event happens), any tax advantages are preserved.

If exercise takes place after 90 days, income tax charges (and potentially National Insurance contributions (NICs) charges) arise.

If the shares are readily convertible assets at the date the EMI option is exercised, NICs are due. Furthermore, PAYE is operated to collect both the income tax and NICs.

Notification and other requirements

The EMI option must be in writing and capable of being exercised within ten years of the date of the grant. This does not mean the EMI option automatically lapses after the tenth anniversary. Instead, if the option is exercised after this date, all the tax advantages are lost, resulting effectively in the individual having an unapproved share option.

The EMI option agreement must clearly state the following:

grant date;
maximum number of shares;
exercise price;
when and how the EMI options can be exercised;
granted under the EMI provisions; and
performance conditions (if applicable).

If the directors of the company agreed the UMV with HMRC, the EMI options must be granted within 90 days; if the EMI options are granted after this date, HMRC’s agreement is no longer valid.

For EMI options granted after 6 April 2024, the directors must notify HMRC of the grant on or before 6 July following the end of the tax year in which the EMI option was granted. Previously, notification had to take place within 92 days of the EMI option being granted.

Annual returns whilst the company has unexercised EMI options must be submitted by 6 July following the end of the tax years.

Taxation of EMI options

(a) Individual – Income and NICs tax charges

There are no tax charges on grant.

On exercise, tax charges only arise if the option was granted at a discount (i.e., the exercise price was lower than the actual market value (AMV) at grant). AMV is different from UMV, which is used for the £250,000 limit.

If there is a discount, income tax and NICs (if applicable) are payable based on the lower of the difference between the exercise price and AMV at grant and at exercise. Employer NICs liabilities may also be payable if the individual agreed to pay this.

If a disqualifying event has taken place and the EMI option was exercised after 90 days, income tax and NICs (if applicable) are payable on the difference between AMV before the disqualifying event happens and on exercise. In addition, if there was a discount, this is also taxable.

If the EMI option is exercised after ten years, the difference between the exercise price and the AMV at the date of exercise is subject to income tax and NICs.

(b) Individual – Capital gains tax charges

If the individual sells the shares at a profit, the chargeable gain is subject to capital gains tax. Business asset disposal relief applies if the shares were sold two or more years after the EMI options were granted.

(c) Corporation tax

The company is entitled to a corporation tax (CT) deduction when the EMI options are exercised. The CT deduction depends upon whether the EMI option is granted at a discount or not:

No discount – the CT deduction is the difference between AMV when the EMI option is exercised and the price paid.
Discount – the initial discount and the difference between AMV when exercised and the price paid.

Practical point

The directors of the company can apply to HMRC for advance assurance to confirm the company is a qualifying company. This is only necessary if there is an element of doubt over the trading activities carried out by the company or group.

I would recommend that the valuation is agreed with HMRC, as this provides certainty of whether the EMI option is granted at a discount or not.

Keep an eye on disqualifying events, such as if the shareholders are considering a sale and change in trading activities.

Remember annual reporting - even if no events took place during the tax year.

The IHT ‘Gifts Out of Income’ Exemption: Key Considerations and Common Pitfalls

Mon, 19 Aug 2024 07:47:22 GMT

Latha Rodgers looks at potential pitfalls and opportunities that individuals, executors and their advisers may encounter when considering gifts out of income for IHT exemption purposes.

Provided the chargeable lifetime transfers or ‘gift with reservation of benefit’ provisions do not apply, gifts will be treated as potentially exempt transfers (PET) for inheritance tax (IHT) purposes. If an individual makes a PET and they survive seven years, the value of the gift will not be chargeable to IHT.

However, for some cash gifts, one does not need to wait seven years; instead, depending upon the reliefs and exemptions that apply, they could automatically be exempt from IHT.

Normal expenditure out of income

The IHT legislation (at IHTA 1984, s 21) sets out the three conditions for a lifetime gift to meet the normal expenditure out of income exemption (commonly referred to as ‘gifts out of surplus income’). The conditions are broadly that:

there must be regular gifts (although a single gift may qualify);
it must be made out of income; and
the transferor’s standard of living must be maintained.

All three conditions must be met for the exemption to apply. If they do, the gift is automatically exempt from IHT. Otherwise, the normal seven-year rule will apply.

It is worth remembering that this exemption normally applies to cash gifts. However, there is one exemption – if the transferee can show that the capital asset (e.g., jewellery) was bought out of the funds that the transferor intended for the transferee, then subject to the other conditions being met, the exemption could apply.

What is ‘income’?

In its Inheritance Tax Manual at IHTM14250, HM Revenue and Customs (HMRC) states: “Income is not defined in the IHTA84 but should be determined for each year in accordance with normal accountancy rules. It is not necessarily the same as income for income tax purposes. Income is the net income after payment of income tax.”

As there is no statutory definition of ‘income’, the starting point is to look at the transferor’s tax return, as this will detail all the taxable income they received during the tax year. In addition, and if they do not prepare tax returns, it is useful to go through their bank statements and investment transaction history to collate all the income during the year.

Clearly, salary, trading profits, rental income, interest and dividends are examples of income. However, IHTM14250 states that just because a source is taxed as income, this does not mean that it is income for IHT purposes. This can lead to a few anomalies; for example, tax-free amounts that the transferor considers to be their income, and receipts that are subject to income tax, both of which are not income for IHT purposes (see below).

Tax-free payments

The transferor could be in receipt of regular or one-off payments from the government to supplement their income or towards their living expenses, which they would reasonably expect to be considered as income for IHT purposes (e.g., state benefits that are not taxable such as Winter Fuel payments and Christmas Bonus). These are not treated as income for IHT purposes.

Winnings received from premium bonds, lottery tickets and bets on sporting events are always exempt from tax. If, for example, the transferor receives regular small monthly premium bond winnings, they may consider this to be income, which they can use to make gifts. Unfortunately, the winnings are still not income for IHT purposes.

Gambling winnings are complicated, as the general principle is that they are tax-free and are not income for IHT purposes. However, if the gambling activities are treated as a business because the badges of trade are met, the winnings may be taxed as taxable profits and, in this case, would become income for IHT purposes. For most transferors, this is unlikely. If the transferor has substantial funds from gambling winnings, specialist tax advice should be obtained.

Furthermore, any non-taxable redundancy payments or compensation payments awarded by a court are also not income for IHT purposes.

Income that is not income!

The general principle is that if an amount could be both subject to income and capital gains tax, income tax has priority. Consequently, what is in essence a profit or gain on a capital asset will be categorised as ‘income’ and subject to income tax.

For example, if the transferor has invested in life insurance policies, an income tax charge arises when the policy has matured, there has been a full or part surrender of the policy, or segments have been sold or assigned. This is because ITTOIA 2005, ss 461-546 state that the payment received will be subject to income tax. However, the actual funds received are capital in nature, as they represent the growth in the underlying investments. Therefore, this amount is not treated as income for IHT purposes.

In addition, transferors are entitled to make annual withdrawals from life insurance policies up to a maximum of 5% per annum, without an income tax charge arising. Any payments received more than the permitted maximum will be subject to income tax. These withdrawals, whether they are within or exceed the permitted maximum, are again effectively returns of capital on the original investment. Consequently, they are not income for IHT purposes.

Purchased life annuities

It is worth noting that there is a specific exemption in IHTA 1984, s 21(3), which states that the capital element of a purchased life annuity (bought on or after 13 November 1974) is not income for IHT purposes.

What years do you take into consideration?

The starting point is to only consider the tax year in which the cash gift was made when calculating the transferor’s income. Usually, this should be sufficient to determine whether all three conditions for the exemption are met. If the total gifts made by a transferor are more than their surplus income for that year, the conclusion is usually that the exemption does not apply to the excess.

However, income does not automatically lose its characteristics and become capital at the start of a new tax year.

There have been cases specifically relating to when trust income becomes capitalised for the purposes of calculating any IHT charges under the relevant property regime. HMRC’s guidance at IHTM42166 states that any income that arose more than five years before a ten-year anniversary is treated as capital for IHT purposes. Although this specifically relates to trusts, the key message is that earlier year’s income can be taken into account.

Furthermore, IHTM14250 states: “income from earlier years does not retain its character as income indefinitely. At some point it becomes capital but there are no hard and fast rules about when this point is. If there is no evidence to the contrary, we consider that income becomes capital after a period of two years.”

Therefore, all is not lost, as it is possible to include unused income from the previous tax years to determine what income can be offset against the gifts made by the transferor in that year.

Practical point

Because ‘gifts out of income’ is a very valuable IHT exemption, detailed record keeping needs to be maintained by the transferor and their executors. If the transferor has life insurance policies, it may be necessary to confirm what ‘income’ they have, given that the permitted annual withdrawals and any chargeable event gains are not income for IHT purposes.

If the transferor’s income fluctuates or the level of their gifts increases, remember that it is possible to use surplus income from the previous two tax years.

Finally, the exemption can apply to gifts of capital assets; however, the onus will be on the transferee to prove that the transferor intended to use the surplus cash to acquire that asset for them.

This article was published on Tax Insider Professional in July 2024 Click HERE

Incorporate or Not: Navigating Tax Changes and Property Incorporations in 2024

Mon, 15 Jul 2024 11:49:53 GMT

Incorporate or not, that is the question

Since April 2020 there have been numerous tax changes on residential properties - basic rate tax deduction on loan interest, higher capital gains tax (CGT) on residential properties, reporting and paying CGT within 60 days, abolition of multiple dwellings relief and the proposed removal of furnished holiday lets. This together with increased property prices mean that property incorporations have become quite popular.

However, as with anything tax related there are potential tax issues and pitfalls that need to be considered.

Broadly there are two ways in which a property business can be transferred from personal to corporate ownership – sale or transfer in exchange for cash/directors’ loan or newly issued shares, respectively. The capital gains consequences are different in the first scenario a CGT liability will arise, whereas in the second provided that certain conditions are met then incorporation relief applies and there is no gain. There are several conditions that need to be met for incorporation relief, the main ones being:

There needs to be a business and not merely a passive ownership of property,
What each partner does and the number of hours they spend on the business,
All business assets need to be transferred to new company.

If there are outstanding loans on the properties, then this could a CGT charge arising. This is because if the debt is refinanced within the company rather than being novated across then this is seen as consideration and remains chargeable. The Chartered Institute of Taxation have approached HM Revenue & Customs for clarification on this point. It may be possible to write to HM Revenue & Customs under the non-statutory clearance procedure to obtain their approval before any planning is undertaken.

Regardless of how the properties are transferred from a Stamp Duty Land Tax (SDLT) perspective, the partners are treated as if they received market value for the properties. Depending upon how the properties are held and the number of properties being transferred, it may be possible to reduce the SDLT charge or reduce it altogether.

Finally, there are inheritance tax (IHT) benefits in owning properties through a corporate structure rather personally. This is because greater discounts are provided for minority shareholders then personal ownership. It is also easier to bring in the next generation without giving rise to large tax charges.

Property incorporation can offer significant tax advantages, however commercial considerations such as third-party lenders need to be fully considered and explored before any planning is undertaken. We can provide you with honest tax advice on whether this is correct route to be adopted, and if it is we will assist you throughout the process.