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Investment planning should be a continuing process to ensure your investment aims are still right and your investments correctly aligned with those objectives.

Inheritance Tax (IHT) Planning (Part 3) - Published November 2016

Chargeable Lifetime Transfers
A Chargeable Lifetime Transfer (CLT) triggers an immediate charge to IHT if, together with any other chargeable transfers made by the same person within the previous seven years, exceeds their available nil rate band. The available nil rate band is based on the amount available on the date the gift is made, reduced by the amount of any chargeable transfers made by the donor in the previous seven years. The current tax rate for CLTs is 20% (2016/17).

There is normally no further IHT to pay on the gift as long as the settlor survives for seven years after making the gift (unless the gift is made into trust where there may be periodic or exit charges).

A CLT made up to 14 years before a settlor’s death could influence the IHT liability on a later failed Potentially Exempt Transfer (PETs) or CLTs.  This is because if a PET fails and becomes chargeable, the IHT calculation takes into account CLTs made by the donor in the seven years before the making of the PET.

Up until 2006, substantial lifetime gifting was generally focused on PETs. However, the combined effect of the nil rate band and the seven-year cumulation rule can provide valuable planning opportunities, particularly in light of the current treatment of most gifts into trust. Under current legislation, nil “rate band discretionary trusts could theoretically be established every seven years with no immediate – and possibly no subsequent – charges to IHT.

In practice, discretionary trusts are well suited to those circumstances where the tax advantages of removing an asset from an estate are evident, but where the ultimate beneficiary has not been chosen at the time of the transfer.

It is tax-efficient to transfer those assets that are most likely to appreciate in value, because the capital appreciation is not chargeable to IHT on the donor. Possible examples of suitable assets include shares in a new business venture and rented property due to fall vacant on the death of an elderly tenant.

Where appreciating assets are put into a discretionary trust, the trust will need careful monitoring in order to take advantage of any opportunities to avoid or reduce the ten-year and exit charges.
Chargeable gains on transfers into and out of trusts may be subject to an election for CGT holdover relief. In some circumstances, this may be a reason to make a CLT rather than a PET.

Order of Making Gifts
The order in which PETs and CLTs are made can affect the amount of IHT payable, although there are no clear-cut rules. It largely depends on the amounts involved and how long the donor lives.
Annual exemptions are used on a strict chronological basis.  Therefore, if a PET is made before a CLT in the same tax year, annual exemptions will be wasted if the PET never becomes chargeable.
Making a CLT before a PET will minimise the periodic charge for the trust that is set up by the CLT. This is because the periodic charge will depend on what other CLTs were made in the seven years before the trust was set up. This will include the PET should it become chargeable as a result of death within seven years. The PET will not be relevant if it is made after the CLT.

Conversely, the actual IHT paid in respect of the CLT and PET could be higher if the CLT is made first. This is because the IHT on the PET must take account of CLTs made within the previous seven years, even though the CLT may be made more than seven years before the donor’s death. In other words, each transfer has to be considered separately to determine whether it has become chargeable. So, if the donor dies within seven years of making a PET, it becomes chargeable. It is then necessary to ‘look back’ seven years from the date of the PET to determine whether any other CLTs have been made to determine the amount of nil rate band available to offset against the PET.

Such problems can be avoided if at least seven years is left between each gift.

This article is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investments or course of action.  Taxation depends on individual circumstances as well as tax law and tax authority practice which can change.  Not all IHT planning is regulated by the FCA.

Raoul has a weekly radio feature (Raoul’s Rant) on the Owen Gee Solid Gold Sunday morning show on KissFM Algarve.