Findings from the professional advice website, Unbiased.co.uk, predict this year will see 81 per cent of Britons do nothing to reduce their tax payments. According to the website's latest Tax Action report, British taxpayers will waste over £10bn in unnecessary tax in 2009. And despite one quarter of those questioned resenting inheritance tax (IHT) the most, it is estimated that estates will pay more than £32.2bn in unnecessary 'death duty'. But, as the new tax year kicks off, investors who have witnessed their assets wane away under the weight of the global slowdown could very well use these bad tidings to their benefit on the tax front.
Gift it away
Paula Higgleton, head of the private clients practice at Deloitte, says: "While declining asset and share values have provided many families with a continuing headache, the current historically low asset value in certain sectors may represent an opportunity for individuals and families to pass on wealth to the next generation, while minimising current and future inheritance tax charges.
"Many entrepreneurs are thinking carefully about passing on shares in family companies to benefit their children and grandchildren and there are a number of different ways in which this can be done in the form of gifts."
Under current IHT rules any assets valued at over £325,000, known as the nil rate band, will be liable to a 40 per cent tax charge, but when assets are given away as gifts, any future growth is out of the estate, and therefore not subject to tax.
George Bull, the head of tax at accountancy firm Baker Tilly, highlights that any gifts made have to be outright and absolute. "If the donor retains any interest in the property given away or receives benefits from it, the 'gift with reservation of benefit' rule may apply and effectively treat the value of the gift as remaining in the donor's estate for IHT purposes."
Outright gifts are known as potentially exempt transfers (PETs) which means that no IHT will be due on the gifts, unless the donor dies within seven years. In the event of death within seven years of making a gift, the value added back to your estate is the historic gift value, not the value as at date of death.
Julie Hutchison, head of estate planning at Standard Life, explains that with current lower asset values, the IHT cost in getting an asset out of your estate will be lower since the value is 'frozen' for IHT purposes as at the date of the gift.
If an investor makes a gift of shares worth £500,000 and dies within seven years, during which time the shares have risen in value to £1,000,000, the amount included in his taxable estate will still be the value at the date of the gift, in other words £500,000. In addition, if there is tax to pay, the tax rate is reduced by tapering relief if the death occurs more than three years after the gift.
"Making a gift now, when the value of investments, property and assets have all fallen significantly, is an attractive, possibly once in a lifetime opportunity to significantly reduce an IHT bill," says Nick Gartland, senior financial planning director, Rensburg Sheppards.
The catches
Outright gifts can be made by simple share transfers, but Mr Bull points out that here the biggest potential catch is capital gains tax (CGT).
A gift to an individual cannot be held over and although values may have fallen, there is still the potential for CGT to arise because the share portfolio may still have grown in comparison to its purchase cost.
Mr Bull also highlights the fact that outright gifts to the donor's children may also carry potential difficulties, given that income on the gifts is still assessable on the donor until the recipient reaches the age of 18. "Children below 16 cannot personally give a valid receipt for a gift of shares and so they cannot legally be registered as the owners, therefore some form of bare trust is required," he adds.
Try a trust
The biggest advantage of placing gifts into a trust is that it can keep assets removed from beneficiaries who might otherwise dissipate them. It also provides the donor with a degree of flexibility given that they will still have the right to receive an income from the trust. If the donor is appointed as the trustee, they will also have a say in how the portfolio is invested and how distributions are made.
But, despite these advantages, trusts have waned in popularity since the new rules governing trusts were introduced in 2006.
Patricia Mock, director of private client services at Deloitte, explains that under these rules, transfers into most types of existing or newly created trusts above the IHT nil rate band will be charged 20 per on the amount exceeding that band.
Once the trust has been in existence for 10 years it becomes liable to the Principal Charge, currently 6 per cent on all property above the nil rate band in force at the tenth anniversary of the trust. Income of a trust is subject to the Tax Rate on Trusts (TRoT).
"Where beneficiaries are already paying tax, careful management of the tax on the trust and tax deducted on payments to beneficiaries is required to avoid tax paid by the trustees being irrecoverable by beneficiaries," says Mr Bull.
A flexible alternative
Ultimately consideration has to be given to the family circumstances as a whole, says Ms Mock, before deciding on whether to make a gift absolutely, or setting up a trust.
She says investors are increasingly exploring the possibility of a family limited partnership which tries to provide the best of both worlds by combining the flexibility of a trust without the upfront IHT charge.
Based on the concept of a limited partnership, a family limited partnership will essentially have a business or company owned by the parent as the general partner, with the children set up as limited partners. "The business is a bit of a nebulous concept, given that it is not a 'business' as in a trade. Holding residential property will also not qualify as a business but a share portfolio which is being traded, with decisions made around what to buy or sell, will qualify," explains Ms Mock. "The structure enables the parent to give away shares within this partnership without that being liable to IHT when the gift is made because this will qualify as a PET."
Ms Mock however warns that the structure of a family limited partnership is complicated and investors will need to seek the advice of a tax specialist. "While it is not as simple as making an absolute gift, in certain circumstances a family partnership might just tick all the boxes given that they allow a measure of control similar to a trust but in a much more tax efficient manner as far as IHT is concerned."
