Inheritance Tax Planning – act now
Inheritance Tax (IHT) can be very expensive. You pay 40% over the Nil Rate Band Thresholds and often assets have to be sold just to pay the tax meaning your inheritance is reduced.
With careful and forward planning, IHT can be mitigated.
With the use of Trusts becoming increasingly difficult to manage and their inflexibility, the family investment company is fast becoming a popular alternative to trusts for parents seeking to pass assets to the next generation.
A practical case study
Take a typical family. Mum and Dad with two adult children. For our example they are quite wealthy.
They have become concerned about the inheritance tax exposure on their estate which comprises the following assets:
|Rental property portfolio||1,000,000|
|Cash and Investments||500,000|
Rental property portfolio
The rental property portfolio is held by Mum and Dad equally and all properties are residential and are all let on assured shorthold tenancies. The portfolio currently generates annual rental income of about £100,000. The property portfolio originally cost £800,000 and therefore the value has grown by £200,000.
Based on their current estate, their inheritance tax exposure is a staggering £750,000 as below.
|Total Value of Estate||2,500,000|
|Dad nil rate band||325,000|
|Mum nil rate band||325,000||625,000|
|Net Estate Chargeable||1,875,000|
|Inheritance Tax at 40%||750,000|
Their most valuable asset is the property portfolio. To save IHT they are happy to give up the income it generates, they do not want to part with the capital value as they wish to use this. Mum and Dad decide to set up a family investment company (FamilyCo) to hold the portfolio. The company is created with 100 ordinary shares.
Before the transfer of the rental property portfolio to FamilyCo, Mum and Dad each transfer 50 shares to each of their children. At this point, the company is a shell with no assets and no liabilities and it follows, therefore, that the gift of shares has no more than a nominal value. Thus, no potentially exempt transfer arises for inheritance tax purposes on the gift and because the shares have a nominal value at the time of transfer, there are no capital gains tax consequences.
Mum, Dad and the two children are appointed as company directors.
Transferring the property portfolio
After the incorporation of FamilyCo and the implementation of the desired company share structure, Mum and Dad then transfer their rental property portfolio to the company and, in return, they each receive a director’s loan account equal to 50% of the market value of the properties transferred, so £500,000 each. The loan is provided on an interest-free basis and is repayable on demand.
The benefit of this loan account is that that can draw down on this money with no tax consequence.
Because Mum and Dad are connected to FamilyCo, an immediate charge to capital gains tax arises on the transfer of the properties to the company based on their market value.
The properties are all residential so capital gains tax will be payable on the shares at the rates of 18% up to the basic rate tax band, and 28% thereafter. Given their level of income, the capital gains tax liability arising for Mum and Dad will be as follows:
|Proceeds (deemed Market Value)||500,000||500,000|
|Less base cost||400,000||400,000|
|Less Annual CGT Exemption||12,000||12,000|
|CGT at 28%||24,640||24,640|
What about Stamp Duty?
Stamp duty land tax (SDLT) will be payable based on the market value of the properties at the time of transfer.
Note that the 3% surcharge contained in FA 2003, Sch 4ZA will apply. However, because the portfolio consists of two or more dwellings, the multiple dwellings relief will be available to mitigate the amount payable.
So why would you do this? What are the benefits?
At this stage, what Mum and Dad have done, in effect, frozen the value of the rental property portfolio for inheritance tax purposes albeit this is now represented as a director’s loan account in their estate. A director’s loan account can be repaid to Mum and Dad when funds permit.
Essentially, the value of the Property Portfolio of £1,000,000 will fall outside of their estate meaning that there will be a £400,000 IHT saving.
The company will pay corporation tax currently at 19% (shortly reducing to 17%) on the rental income after expenses and they can draw funds from the company as dividends should they require this.
Further IHT planning?
Since Mum and Dad will be drawing on their joint £1,000,000 loan accounts, they will of course be increasing their cash and investment pot with the money that they draw and as such which will form part of their estate.
To overcome this, Mum and Dad should consider gifting cash to the Children from their loan account drawdowns. A gift to each of the children will be treated as a Potentially Exempt Transfer and provided Mum and Dad survive 7 years then the gift will fall outside of their estate completely.
They should be considering doing cash gifts every year to start the 7 year cycle on a regular basis.
Should Mum or Dad die within the any of the 7 year periods then some or all of the gift value will be added back into the Estate depending on the time of death after the gift was made.
A family investment company can provide tax-efficient succession planning and has the flexibility to be tailored to suit the various demands and requirements of different families.
If you require any help with your Inheritance Tax planning or have any questions contact us today to arrange a FREE consultation, we have Chartered Accountants and Tax Advisers in Canary Wharf, Essex and Manchester waiting for your call.