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KEY POINTS
- The new legislation inserted by FA 2008.
- The unused proportion at the previous death.
- The maximum transferable amount.
- Examples of the rules in operation.
- Drafting tax efficient wills.
- Practical impacts of the new rules.
The ability to transfer the unused element of the inheritance tax nil rate band came into effect on 9 October 2007 in respect of the death of a surviving spouse or civil partner on or after that date.
It should be noted that this new rule, introduced by FA 2008, Sch 4, which inserts new ss 8A, 8B and 8C into IHTA 1984, affects only spouses and civil partners. It does not help co-habitees, despite the measure being debated at some length in the Report Stage (see Ways and means).
It does not matter when the first spouse (and by this expression I also include civil partners) died: it could have been in the era of inheritance tax, capital transfer tax or even estate duty.
However, in the latter case, practitioners will need to bear in mind that there was no general spouse exemption available under the estate duty provisions so that nil rate bands were frequently exhausted in making inter-spouse transfers at that time.
Example 1 illustrates how this will work in a straightforward case.
In the example, it would not matter if Bob had had no assets at the time of his death (so that he could not, in practice, have used up his inheritance tax nil rate band) nor, for example if he had been outside the inheritance tax net altogether (for instance, because he was non-UK domiciled and owned no property situated in the UK).
The test to be applied is a purely mechanical one: had Bob in fact used up his nil rate band?
The charge on death
The transferred nil rate band can only be set against 'the charge to tax on the death of the survivor'. This will, therefore, include tax charged on the survivor's free estate; on any reservation of benefit property included in his estate, and on the value of settled property in which he had enjoyed a qualifying interest in possession.
It can also be set against tax on a failed potentially exempt transfer (which is tax arising on the death of the donor) and additional tax due on an immediately chargeable lifetime transfer which will take priority over the IHTA 1984, s 4 charge on death.
The maximum benefit
A further point to note in these days of divorce and remarriage, is that a surviving spouse can only benefit from a maximum of one additional nil rate band (s 8A(5)), as illustrated by Example 2 and Example 3.
The three new sections deal with matters as follows.
- S 8A — 'transfer of unused nil-rate band between spouses and civil partners' — explains the operation of formulae used to calculate the transferable amount.
- S 8B — 'claims under s 8A' — explains who should make the claim to the unused nil-rate band and the associated time limits.
- S 8C — 's 8A and subsequent charges' — explains the operation of the formulae where, after the death of the first spouse or civil partner there is a charge under IHTA 1984, ss 32, 32A or 126 (conditionally exempt transfers or the 'disposal of trees or underwood').
Using Example 3 as a guide, the Table below summarises the operation of IHTA 1984, ss 8A and 8B when dealing with claims to the unused nil rate band, under three scenarios where Jason pre-deceases Judith.
First, where the whole of his estate is bequeathed by Jason to Judith, secondly, where £300,00 or less is left to beneficiaries on a discretionary trust, with the residue to Judith; and thirdly, where £301,000 or more is left on discretionary trusts, with the residue to Judith.
Note, therefore, that in Example 3, the ideal inheritance tax planning advice is that, if Jason dies before Judith, he shall make a chargeable transfer equal to his nil rate band. Judith's will should use up her inheritance tax nil rate band (it will be wasted if she leaves everything to Jason).
Drafting tax efficient wills
So what is the impact of the new legislation on the drafting of inheritance tax efficient wills. Perhaps this can be summarised as follows.
- Option 1. Leave everything to the survivor outright so that there is no inheritance tax to pay and on the death of the survivor a full additional nil rate band will be available.
- Option 2. Leave everything on an immediate post-death interest (IPDI) trust for the survivor. This has the same inheritance tax consequences as in Option 1, but the capital is protected (for instance, for children of an earlier marriage or against nursing home fees). Consider combining Options 1 and 2 so that part is left outright and part on an IPDI trust. Flexible IPDI trusts offer inheritance tax planning opportunities during the lifetime of the survivor.
- Option 3. Leave assets likely to appreciate by more than the nil rate band (or which would benefit from a fragmentation discount) on a discretionary trust or, with an eye to future ten-year charges, on a number of pilot trusts.
The position on the death of the survivor is quite different.
Assume that he has a nil rate band of £624,000 available and wishes to set up long-term trusts. If he sets up a relevant property settlement in his will of £624,000 leaving the residue to charity, no inheritance tax will be payable, but in the future ten-year charges on the settlement will only benefit from a single nil rate band. Consider therefore the use of one or more pilot trusts.
Nil rate band discretionary trust
What is the position when a taxpayer has died and his will contains an inheritance tax nil rate band discretionary trust with residue to spouse?
Here, if desired, the trust can be dismantled by an appointment within two years of death in favour of the spouse which is 'read back' as a result of IHTA 1984,
s 144. The effect will then be that the deceased has not used up any part of his inheritance tax nil rate band which can therefore be used on the survivor's death.
Note the following points.
a. If the appointment is to be absolute, wait more than three months from the date of death before making it in order to avoid the 'Frankland trap'. This is because s 144(1) provides for reading back where there is an event on which tax would otherwise be chargeable. Tax is not chargeable on an exit from a discretionary trust within three months of creation.
b. If the appointment is to create an IPDI trust for the spouse, there is no need to wait three months. This is because s 144 was amended in FA 2006 (s 144(3) to (6)) to provide expressly for reading back where appointments created IPDI trusts (or IHTA 1984,
s 71A or s 71D trusts).
Power of appointment
Can an appointment be made even before the estate has been administered and property vested in the trustees?
Some wills expressly provide for this to be done, but even in the absence of such a clause it is thought that the trustees have sufficient power. The trust is constituted at death with the trustees being entitled to a chose in action. The appointment should, therefore, be of that chose.
Deaths more than two years ago
In the case of deaths occurring more than two years ago involving the creation of a nil rate band discretionary trust, nothing can be done to obtain a transferred nil rate band for the surviving spouse. Appointments of capital to the spouse will result in extra capital being included in the survivor's estate with no increased nil rate band. (Of course, after two years the trustees can give a spouse a life interest without any inheritance tax consequences. This may have income tax benefits.)
Care with words
Care will be required when administering estates where wills contain a nil rate band legacy.
Wills that were drafted before 9 October 2007 may now pass more than was originally intended. For example, a cash gift of 'an amount equal to the largest amount that can pass without payment of inheritance tax' has the potential to pass double the amount of the full inheritance tax nil rate band.
Hence, in a case where a surviving widow wanted a nil rate band legacy to pass to relatives and the residue to charity, pay particular attention to the wording used in the will. A reference to 'an amount equal to the nil rate band in force at my death' would be construed as limited to a single nil rate band.
Chris Whitehouse is a barrister at 5 Stone Buildings, Lincoln's Inn, London WC2A 3XT. Tel: 020 7242 6201.
