Surrey has been labelled Britain’s inheritance tax capital by a national newspaper, the county southwest of London where the average UK inheritance tax (IHT) bill is £234,000 ($303,000).
With property prices in Surrey and across the UK continuing to rise, and the tax-free threshold (known as the ‘nil rate band’) of £325,000 ($421,000) frozen, family business owners could be forgiven for thinking that IHT is a fact of life.
General lifetime planning opportunities
There are a number of IHT-saving strategies available, the simplest and most common of which is to give assets away during lifetime; provided that the person who has made the gift survives seven years, there is no tax to pay. An often overlooked, but sometimes very valuable exemption, is that for “normal expenditure out of income”. Subject to certain conditions, an individual who makes regular gifts of their surplus income does not need to survive the seven years in order for the money to leave their taxable estate permanently. And there is no limit on how much income may be considered 'surplus'; some individuals have successfully given away hundreds of thousands of pounds under the umbrella of this exemption.
But apart from giving away cash, what are ultra-wealthy individuals doing to mitigate their exposure to IHT?
Family businesses: How to pass the value to the next generation without giving up all of the control
The shares in a family business are likely to loom large in the estate of the founder or owner. But passing them down a generation brings into play a host of issues for the business and, moreover, for the family. The challenge can be to remove value from the estate of the elder generation without ceding control entirely to the younger.
For example, Paul and his two children, Fiona and David, are all involved in the family business. Paul owns all the shares and wishes to get their value out of his taxable estate. The problem, though, is that Paul is concerned that Fiona and David will at some point fall out if they are each given 50% of the voting shares (and he does not think it is fair to give them unequal shares). A potential solution is for him to give them each 49%, and to retain 2% for himself. This way, Paul retains control of the company and, under the terms of his will, he can settle his 2% shareholding into a trust, presided over by a disinterested trustee—perhaps his lawyer or accountant—who can be called in to be de facto referee in case of tension arising between Fiona and David.
This simple division of the company means that, provided Paul survives seven years, he has shifted a great deal of value out of his taxable estate, and although he has given up control of the company, he knows that there is no risk of it being hijacked by one of his children at the expense of the other. Paul would be advised to set out clearly in a letter of wishes, accompanying his will, how he would like his trustees to deal with the 2% voting shares that they will be looking after.
International families: How to protect family members living in the UK from an IHT headache
Without careful planning, non-UK domiciled individuals can inadvertently create an IHT problem for family members who are domiciled or deemed domiciled in the UK.
To illustrate this with a second case study, Layla, a mother of three children, lives in Uganda and is non-UK domiciled for all tax purposes, meaning that her assets are outside the scope of IHT. Her estate is worth $60 million and she would like her children to benefit equally from her estate. But her eldest son, Ali, has become “deemed domiciled” in the UK, because he has been UK resident for more than 15 out of a 20 year period, which means his worldwide assets will be exposed to IHT on his death.
Rather than Ali receiving his $20 million inheritance outright, and so being landed with an IHT headache thereafter, Layla might do well instead to settle some or all of Ali’s inheritance into a trust during her lifetime, with his remaining inheritance settled into trust on her death. The funds in trust would remain outside the scope of IHT, so wouldn't be taxable on Ali's death, but they would be available to benefit Ali and his family in the UK. In addition, of course, they could be settled with a trustee in a low-tax jurisdiction and invested likewise, meaning that, if Ali had no immediate need for the funds, income and gains could roll up tax-free.
Development land: Transfer the value into a company at the embryonic stages
If an individual invests in property that is likely to grow significantly in value, for example, development land, it may be sensible to transfer it into a company while its value remains low.
In this final case study, Mark owns 10 acres (4ha) on the outskirts of a town which he is told may have significant development potential. He has several million available to invest, and a taste for development projects. At present, the land is worth only £100,000 ($129,000). But if planning permission is obtained and the site built out, which would probably cost around £7 million ($9 million), it could be worth £20 million ($26 million).
Mark's estate is already substantial, and while he will be pleased to turn a £100,000 piece of land and £7 million of cash into a £20 million development, it will only exacerbate his IHT problem. A properly set-up company might be a solution. He would create the company, and sell the land to it. He would hold the voting shares in the company but would have no rights to benefit economically from it, and his children would have non-voting shares on which dividends could be paid.
Having sold the land to the company, Mark would lend it the £7 million required for the development. Assuming everything went to plan, after some years Mark would hold the pure voting shares in a £20 million company. Provided that the rights attached to the shares were created correctly, there would be a good argument that those shares were worth nothing, and therefore that all the growth in value—around £13 million—would have accrued outside his taxable estate. Finally, because the built-out site was then in the company, it would pay only corporation tax on its rent, and would be able to deduct more expenditure for tax purposes than if the site had been owned by Mark and his family.
Potential for IHT reform
As a final note, it needs saying that all the strategies discussed above relate to IHT in its existing reform, and that there has been much discussion recently about the likelihood of reform or even a complete overhaul or replacement of this tax. Consultations and papers have been published with proposals to this effect. The economic impact of the current global pandemic will almost certainly lead to increased taxes, and it is possible that new and innovative methods of taxation may be introduced. It remains to be seen what, if any, effect any changes may have on IHT planning for the future.
This article reflects the opinion and views of Forsters LLP as of 29 October, 2020 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.