What Does the Government Say?

Robert Schon looks at government nudges on inheritance.

It has been suggested that an article on tax planning for families might be an interesting adjunct to my earlier item on wills. Not everyone agrees with the concept of tax planning, but it seems at least fair to share the sort of information that those who retain tax lawyers might receive, and in a sense, all you have to do is follow the government signposts.

What amazes me about our tax code is how often it is well thought out. Governments know what they want to encourage and support, and what they don’t. They achieve their goals by putting up signs saying in effect, ‘this way please’.

They encourage saving in ISAs and pensions by making income and gains in these ‘wrappers’ tax free. And when it comes to passing on wealth, they make that tax free for those who are married or in a civil partnership. 

My job is to help clients understand tax options like the ones above, which you can call the blessed routes, and avoid the non-blessed routes, metaphorically equivalent to parking on double yellow lines, or even red routes.

When it comes to passing on money to the next generation, this is easiest with at least one parent still alive and discussing with them how you/your family want to receive whatever you might inherit. The parent’s will can be structured to reflect the wishes of each of their children and the example below illustrates how that can benefit more than one generation.

Let us assume Sarah has one surviving parent, Helen, and two underage children. Sarah has asked for the part of the estate she is to inherit from Helen (say a rental property) to be left in a discretionary will trust where the beneficiaries will include herself, her siblings and their issue (children, grandchildren etc) with Sarah and her partner named the initial trustees.

After Helen dies, in terms of inheritance tax (IHT) and capital gains tax (CGT) this structure is treated in tax terms as if the property had been left outright to Sarah in Helen’s will. The Government receives exactly the same amount of tax.

The rental property passes to the named trustees who, going forward, grant the tenancies and receive the rent.

At this point the discretionary will trust creates a separate taxable entity which owns an income generating asset that Sarah, her children and heirs can benefit from without the asset or income belonging to her or any beneficiary, including when a beneficiary dies. This means that on say Sarah’s death, her taxable estate will not include the value of the trust fund.

This is because the trust is a separate legal person, with its own income tax; CGT and IHT regime. For income tax the default position is that the trust incurs tax at 45% on its taxable income to 5^th April annually. For IHT it incurs an IHT charge every 10 years at a maximum IHT rate of 6% on the then trust fund value above £325,000, and it incurs a reduced IHT charge if capital assets are ‘advanced’ out of the trust to a beneficiary between 10-year anniversaries. The trustees need to ‘save’ from the post-tax rents received to fund these IHT outlays.

The reasons Sarah wanted Helen to leave the inheritance via the trust include:

• Sarah as a ‘beneficiary’ is able to benefit from the trust during her lifetime should she wish;
• The trust has a wholly independent IHT profile from Sarah, so her death has no impact on the trust IHT position;
• The trust enjoys its own £325,000 IHT nil rate band;
• During the period Sarah doesn’t want/need to access to trust income it can be paid to her school age/university age children who have no other income to 5^th April. This allows Sarah on behalf of her receiving child/children to claim a tax rebate from HMRC of the 45% income tax withheld at source up to each receiving child’s income tax personal allowance with any excess being taxed at 20% to that limit;
• Should Sarah, on behalf of her receiving minor child, choose; trust income can be used to help finance school fees or if a child is at university, their education or living costs, in effect income tax free up to the recipient’s income tax personal allowance which is currently £12,570.

Throughout my working career our tax law has prevented parents avoiding tax by giving income-generating assets to their children, taking advantage of the child’s personal tax allowance.

Except for a minimum income threshold each tax year, as a general rule, any gift by a parent to a child that generates income is taxed as that of the donor parent at his/her highest income tax rate. This anti-avoidance legislation does not apply e.g., to income paid to a grandchild from a will trust set up and funded exclusively by a grandparent.

A word of caution. Trusts are like a garden. They need care, attention, time and a close eye to income tax and IHT compliance. Somebody has to do it, and if an outside third party is involved, fees are usually charged and the cost needs to be factored in when deciding if a will trust is a good idea.

One other ‘sign-posted’ trust would be for a disabled beneficiary, ‘disabled’ being a defined term. In essence HMRC ‘blesses’ these by saying discretionary benefits received by the disabled person are left out of account when determining the state benefits s/he is eligible to receive. What is more, such qualifying trusts are not affected by the IHT 10 year and periodic charges referred to above and can be set up without triggering an IHT charge so long as the person creating the trust survives the creation by seven years. Such trusts can be set up in lifetime or on death. I am very happy to provide further information on this if there is interest.

Tax is the one place where accountants and lawyers overlap.  As a general rule accountants are excellent at tax compliance, but the best place to get tax right is in the initial legal structure. 

What I see is that most clients, whether corporates or individuals, have no appetite for aggressive tax planning. They want blessed routes with no comeback. It is my job to help point my clients in the right direction. If I can be of help, please get in touch.

Robert Schon was a tax partner for 17 years in a City-based international law firm and has worked as a sole practitioner for 18 years in Swains Lane, since 2021 with Streathers Solicitor. He can be contacted at 020 7267 5010, rschon@streathers.co.uk.