I have a case in which the deceased left a will with a legacy of the nil rate band to his two daughters in equal shares. The definition of the legacy set out in the will is ‘such sum as is equal to the upper limit of the nil per cent rate band in force at my death, etc’ and refers to the IHTA 1984, with a deduction for any chargeable lifetime transfers. The residue passes to his widow. He made no chargeable lifetime transfers and so the full nil rate band is available. Among the assets were shares in some family enterprises that are clearly trading companies and seemingly tick all the boxes to claim business property relief from inheritance tax at 100%.
My concern is whether IHTA 1984, s 39A applies. My understanding is that, due to the way the legacy is defined, the daughters will receive no more than £325,000.
However, I am wondering whether the business property relief applies to part of the pecuniary legacy, meaning that part of the deceased’s nil rate band has not been used and so will eventually be transferable to the widow’s estate.
If that is so, I am guessing HMRC will not look at this until her death because no tax is due on the estate. But perhaps accurate records should be made now ready for that time. Further, I am minded to suggest a deed of variation to redirect the business property relief assets into a discretionary trust with the widow and daughters as beneficiaries, although presumably they will all be settlors for the purposes of income tax and capital gains tax?
In order for s.39A IHTA 1984 to apply, the following must take effect in the Will:
- The deceased must make one or more specific gifts which do not qualify for Business Property Relief(BPR)/Agricultural Property Relief(APR) and
- The residue includes assets which qualify for BPR/APR
If both of these conditions are met, then s.39A will apply. The effect of s.39A is that the BPR/APR is spread between the residue and the specific gifts.
If the assets qualifying for BPR/APR are given by way of specific gifts, then the BPR/APR is offset against that particular gift and the s.39A spreading provisions would not apply.
It should also be noted that the legal definition of ‘specific gift’ under a Will differs for tax purposes. s.42 IHTA 1984 defines specific gift as ‘any gift other than a gift of residue or of a share in residue’.
It would therefore follow that the legacy set out in the Will ‘such sum as is equal to the upper limit of the nil per cent rate band in force at my death, etc.’ qualifies as a specific gift for tax purposes.
Assuming the BPR shares qualify for relief and all of these shares are held in the residue of the estate, some of that relief will be offset against the nil rate band legacy. This will not be an issue for the residue as any BPR that’s not available in the residue will be covered by the spousal exemption instead.
As some of the relief will be offset against the nil rate band legacy, there will be an unused transferrable nil rate band allowance available on the death of the surviving spouse. A note of this should be made for your records in the event a query is raised in the future.
The surviving spouse can enter into a deed of variation within 2 years of death and transfer the shares to a discretionary trust for the benefit of the surviving spouse and her children. If an election is made under s.142 IHTA 1984 in the deed of variation, the transfer will be read back to the Will and will be treated as though it was made by the deceased. It would therefore follow that for IHT purposes, the deceased will be considered as the settlor of the trust and therefore the gift with reservation of benefit rules would not apply.
In the absence of this election, the surviving spouse is deemed to have settled the trust and would be a settlor of the trust. Retaining a benefit in this case would create a settlor interested trust and the gift with reservation of benefit rules would apply.
Regardless of the s.142 election, the surviving spouse will be considered as the settlor for income tax and capital gains tax purposes.
The effect of this is the spouse will be taxable on the income from the trust on an arising basis. A tax credit will be available on any tax paid by the trust.
For capital gains tax purposes, although she would be settlor of the trust, the trust will liable for any CGT liability arising within the trust.
If the surviving spouse was to go down the trust route, she may wish to exclude herself from benefit, this way the income will not be assessable on her.
The surviving spouse may also wish to make an election under s.62 TCGA 1992 under the deed of variation. This will treat the transfer as though it was made by the deceased and the trust would acquire the shares at open market value as at the date of death. Without this election, the surviving spouse is treated as making a disposal at market value for CGT purposes. This election may be useful if the value of the shares from date of death to date of transfer to trust exceed her annual exempt allowance.
Unless the children are adding value to the trust, they would not be considered as settlors of the trust.
Another option would be to enter into a deed of variation making the appropriate elections outlined above and re-direct the BPR shares to the children outright in addition to the nil rate band legacy. This will utilise the deceased nil rate band, the BPR and the spousal exemption without triggering s.39A.
If the deceased has drafted a Will where the residue is wholly exempt and has made tax free legacies, the personal representatives should consider whether single grossing applies as well as s.39A. In this case, as the chargeable estate would be below the available nil rate band allowance, single grossing is irrelevant.