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Meeting Points

07 November 2008 / Ralph Ray

RALPH RAY FTII, TEP, BSc (Econ), solicitor reports an IBC Conference on tax planning for the wealthy.

Specific legacies


In cases where the residue of an estate goes to the surviving spouse, it is common practice to direct assets which are eligible for an inheritance tax relief (such as business property relief) to a chargeable beneficiary, for example a discretionary trust. Otherwise the inheritance tax relief is wasted against the surviving spouse exemption.


RALPH RAY FTII, TEP, BSc (Econ), solicitor reports an IBC Conference on tax planning for the wealthy.

Specific legacies


In cases where the residue of an estate goes to the surviving spouse, it is common practice to direct assets which are eligible for an inheritance tax relief (such as business property relief) to a chargeable beneficiary, for example a discretionary trust. Otherwise the inheritance tax relief is wasted against the surviving spouse exemption.


Matthew Hutton MA, FTII, AIIT, TEP, solicitor warned that wording in a will, such as a legacy of 'all my Lloyd's business', will give rise to a mismatch between the definition of the business itself and the relievable value of the business as defined in section 110(b), Inheritance Tax Act 1984. As a result, the legacy may carry non-relievable property.


It is possible to rectify the position after the death by means of a deed of variation or, in the case of a gift to a discretionary trust, by a deed of appointment under section 144 of the Act. Such courses of action require valuations for the open Lloyd's years to be agreed with the Capital Taxes Office at an early stage, which in practice will mean adopting the audit basis of valuation rather than the actual basis.


Gift and lease back


A taxpayer might give a property to his children, or trustees for them, followed by a leaseback at full market rent. Matthew Hutton advised that in such circumstances it is essential that at no future time the donor should occupy for lesser consideration, as otherwise the whole value of the property would fall back into his estate.


Alternatively, there could be the grant of a lease for life back for full consideration, based on the lessee's actuarial life expectancy. There is no deemed settlement under section 43(3), Inheritance Tax Act 1984 in such circumstances; however, the consideration for the lease for life would be treated in the circumstances as a lease for less than fifty years, giving rise to an income tax charge under section 34, Taxes Act 1988. This charge could be mitigated by having a gift of the house to trustees who would grant the lease and receive the premium; as the premium would be received by the trustees as trust capital, it would suffer an income tax charge of only 22 per cent.


Discretionary wills and the home


One spouse may leave his one-half share in the matrimonial home on discretionary trusts so that the surviving spouse may continue to occupy the whole property as one of the tenants in common. In order to secure the position of the surviving spouse, it may be thought necessary to make him or her a beneficiary of the discretionary trust. Matthew Hutton said that the problem here lies in the Revenue's Statement of Practice SP10/79 by virtue of which the Revenue argues for an interest in possession where a property in a discretionary trust is provided as a home to one of the beneficiaries. One may argue that the occupation is as tenant in common, but the problem with such a contention is that, while a tenant in common does have the right to occupy the whole house, it does not address the point that a person my occupy by virtue of two concurrent rights. In relation to the trust, the Capital Taxes Office might support its arguments on the basis of a secret trust or sham.


Selling the family business


A typical way of ensuring that loan notes are non-qualifying corporate bonds is to introduce a provision that they may be redeemed in a foreign currency. Patrick Way advised that a provision for conversion into euros is probably ineffective. Also, care needs to be taken if the loan notes are to become non-qualifying corporate bonds by giving the issuing company the ability to issue further shares. This fact will deny the issuing company relief on the interest that it pays, since under section 209(2)(e)(ii), Taxes Act 1988 the interest will be treated as a distribution. Consequently, the right to issue additional shares should be in a different company.


New domiciliaries


Can an individual, previously not domiciled in the United Kingdom, but now acquiring a domicile here, remit to this country accumulations of foreign income held overseas without income tax liability? The Revenue considers that he can (see Taxation Practitioner, December 1992 at page 541). The reasoning is that, once the individual becomes United Kingdom domiciled, the provisions of sections 65(4) and (5), Taxes Act 1988 cease to apply and there is therefore no charging provision for monies or other sums received in the United Kingdom. (Note that the position is different in relation to capital gains tax: see the Revenue's Capital Gains Tax Manual at paragraph 25311. The view set out in this paragraph is open to challenge, although most consider that the chances of success are not very high.)


Wills: the charge scheme


One common arrangement is to impose a charge on some assets passing under the residue in a deceased's estate (the asset concerned could, for example, be the home).


The charge would be in favour of discretionary trustees. There would need to be appropriate enabling provisions in the will, although they can be imported by deed of variation.


The charge can be index linked to take account of any increases in the nil rate band (and see also the decision in Lomax v Peter Dixon and Son Limited 25 TC 353, where a discount on a loan was held in the particular circumstances to be capital and not income). Alternatively, and perhaps preferably, the loan could be expressed to be a proportion of the value of the house from time to time, thus benefiting from any capital appreciation in the house.


The main complication arises if the particular asset chosen (for example the home) comes to be sold in the course of time, whereupon the sum charged upon it must be paid over. Matthew Hutton advised that for this reason it may be better in such cases for the residuary estate to be left on life interest trusts so that there would then be no danger of section 103, Finance Act 1986 applying to abate the deduction for the charge on the death of the surviving spouse.


The lifetime loan scheme


Matthew Hutton discussed what is sometimes known as the 'double trust scheme' or the 'lifetime loan scheme' which is carried out in relation to the taxpayer's main residence. The property is sold to a trust with the proceeds left outstanding on loan and the loan is then given away to a second trust from which the taxpayer is excluded from benefit. The advantage of the scheme is that the capital gains tax principal private residence exemption is preserved, whilst the value of the property is removed from the estate on a potentially exempt transfer.


Matthew Hutton advised that on no account should the debt be secured on the house. Also the loan should not be repayable until the death of the taxpayer; this inevitably means that the market value of it at the date of the gift would be less than its face value and it would appreciate over time until the death.


A cogent argument in favour of the scheme is that section 49(1), Inheritance Tax Act 1984 already treats the benefit as taxable in the donor's estate and therefore it cannot be used to taint the gift to the second trust. Nevertheless, Matthew Hutton thought that there remains considerable doubt as to the efficacy of this artificial scheme, particularly having the regard to the court's purposive approach, and the possibility of a gift with reservation attack by reference to the associated operations provisions.


Foreign emoluments


Section 192, Taxes Act 1988 provides an income tax relief for 'foreign emoluments'. These are defined to mean emoluments of a person not domiciled in the United Kingdom from an office or employment with any person resident outside United Kingdom. The relief applies where the duties are performed wholly outside the United Kingdom.


Patrick Way, barrister advised that in the last ten years or so the Revenue has sought to restrict the availability of the exemption and accordingly very great care must be taken in structuring the arrangements.


It is important that the offshore contract can be read in isolation from any onshore contract. Ideally it should be in completely different form and drafted by different lawyers, if possible.


The Revenue considers that the overseas employment must have the following features:


(i) Instructions must be given offshore.


(ii) No business must take place onshore. If the employee organises meetings from onshore, even if they are held offshore, the Revenue (unreasonably) considers this to be an indication that the employment is carried out onshore because the setting up of a meeting is regarded by the Revenue as being more than incidental.


(iii) The employee should have facilities to carry out the employment overseas.


(iv) The employee should have a foreign secretary who should write out reports or, at least, no reports should be written onshore.


(v) The Revenue will, of course, wish to see that there are a sufficient number of days so that by its analysis there is a proper overseas employment.


IR 35 and substitution clauses


The requirement for a worker to provide personal service was clarified by the Court of Appeal in Express and Echo Publications Limited v Ernest Tanton [1999] IRLR 367. This case shows that where a worker does not have to perform the work personally, and can hire a substitute to carry out the work, that is inconsistent with employment and the worker will be self-employed regardless of other factors such as control.


However, Patrick Way warned that there are three provisos, according to the Revenue:


(i) The right to provide a substitute must be genuine.


(ii) The engager must not have an unreasonable right of veto over the substitute chosen.


(iii) The worker must engage and pay the substitute. Where the worker merely recommends another worker whom the engager can take on, this is not what is meant by the original worker providing a substitute.


Reporting requirements


Patrick Way gave a reminder that the reporting requirements for inheritance tax chargeable transfers are relatively low. The thresholds are provided by the Capital Transfer Tax (delivery of accounts) (2) Regulations SI 1981 No 1440. If either the total of chargeable transfers (including the one in question) made in the present tax year exceeds £10,000 or the total of all transfers made in the previous ten (sic) years, including the transfer in question, exceeds £40,000, there is a requirement to submit an account. The time limit is twelve months from the end of the month in which the transfer is made. While no question of penalties or interest may arise if the account is delivered late, assuming no tax is due, it is an important discipline to remember to submit an account, in addition to registering the trust at the Inland Revenue Trusts district for other direct tax purposes.


Trustees' annual exemptions


For 2001-02, the annual capital gains tax exemption for most trusts is £3,750. However, there is an anti-fragmentation rule in circumstances where the settlor has made more than one 'qualifying settlement' since 6 June 1978 (see Schedule 1 to the Taxation of Chargeable Gains Act 1992). Patrick Way advised that separate trusts of personal pension policies, as well as other life policies written in trust, must all be counted in in establishing how many qualifying settlements there may be. However, in relation to personal pension plans, it is now fairly common to have the death benefits (payable before the whole fund is taken by way of an annuity) paid into a master discretionary trust operated by the life company, with the policyholder indicating by a letter of wishes where he would like the benefits to go. Such a trust is not a qualifying settlement. On the other hand, in the early days of personal pensions, it was the practice to make individual trusts of death benefits and these would fall within the anti-fragmentation rule mentioned. Ideally, in such a situation, the death benefits of a number of personal pensions should all be written under the same trusts to limit the application of the rule.


Deathbed planning


A deathbed scheme involves an individual acquiring an interest in a settlement which has been created by a non-domiciliary and in relation to which the trust assets are foreign. Those assets are then excluded property and on the purchaser's death the value of the interest will effectively be left out of the count (see section 48(2), Inheritance Tax Act 1984). However, Patrick Way warned that such schemes are complicated in their execution.


Selling a trust interest


It may be possible for an individual to take up residence in Belgium, or another country with a similar double tax treaty, in order to dispose of a trust interest tax-free. In effect, this may be a method by which the individual can withdraw value from the underlying trust. The interest to be sold should amount to an asset which will obtain the benefit of Article 13(4) of the double tax treaty with Belgium (or a like provision in another treaty). A sale will then be the sale which is protected by the treaty.


The charging provisions of Schedule 4A to the Taxation of Chargeable Gains Act 1992 will not apply so long as the trustees are resident outside the United Kingdom throughout the relevant year. There are a number of other issues which need to be considered. If a charge under section 86 of that Act (charge on the settlor) might be applicable, then steps will need to be taken to arrange for an appointment to be made to an appropriate beneficiary, typically the settlor, subject to a contingency to be satisfied in the following year. The contingent trust interest may then be sold before it falls in; the settlor and all other relevant people should then be removed as beneficiaries from the settlement. So long as the purchaser is non-resident, then no gains can be attributed to him or her under section 87. For inheritance tax reasons, if the purchaser is to pay a significant amount for the reversionary interest, it may be appropriate to have the contingent interest in the form of a long term interest; if the purchaser is an individual, then there should be a potentially exempt transfer in any event.


Lease for life for full consideration


Suppose that husband and wife own their residence as tenants in common in equal shares. The husband dies leaving his half share to the children. Subject to issues of valuation, the widow might sell to the children her half share in the freehold in consideration for the grant of a lease for life in her favour over the whole property. Equality money may have to be paid, plus stamp duty, if the consideration exceeds £60,000, although it may be that the values on each side of the transaction might not be too dissimilar. Should the value exceed £60,000, stamp duty could be mitigated by having a sale of one interest plus equality money which is more than merely nominal in consideration of the other. Because the lease for life would have been acquired for full consideration, it is not a statutory settlement under section 43(3), Inheritance Tax Act 1984. There would be no question of any gift and therefore no reservation of benefit. The widow would be left with a depreciating asset in her estate.


Matthew Hutton advised that the main downside would be the lack of main residence relief for capital gains tax purposes for the children's appreciating asset. Matthew Hutton's general summary of planning points in this are is set out in Part II of Volume 42(1) 'Wills and Administration' in the Encyclopaedia of Forms and Precedents.

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