Date of issue: 11th June 2007

LANDMARK IHT RULING COULD AFFECT 500,000 FAMILIES

If you are relying on a Nil-Rate Band Discretionary Will Trust to save your beneficiaries Inheritance Tax (IHT), you could be among the estimated 500,000 families who may now face a large tax bill following the decision in a recent case in the Inland Revenue's favour.

Shona Cutler, partner and taxation specialist at independent Chartered Accountants Clement Keys has warned that the decision may have far reaching consequences.

"This case creates a situation where one rule applies on divorce but the opposite applies for IHT," says Mrs Cutler.

"It has become common practice for a married couple and people in civil partnerships to own their homes as tenants in common, and when one of them dies their share can go to the survivor free of Inheritance Tax by using a Nil Rate Band Discretionary Trust and creating a debt."

"Wills that include Nil-Rate Band Discretionary Trusts are made so that on the first death assets valued up to £300,000 - the current nil-rate IHT threshold - can be transferred into a trust for the benefit of the children and surviving spouse , saving the family up to £120,000 of IHT. The surviving spouse can take ownership of the house in return for giving the Trust an IOU. On death the Trust calls in the loan which is then deducted from the value of the estate."

This recent case has cast doubt on these schemes. The Special Commissioners ruled that because the husband, Dr Phizackerley had been the sole earner and had gifted a half share of their home to his wife, the debt in favour of her Trust following her death from Dr Phizackerley was not an allowable deduction in Dr Phizackerley's Estate for Inheritance Tax purposes.

If, however, Dr Phizackerley had died first the debt due to the Discretionary Will Trust by Mrs Phizackerley would have been an allowable deduction from her Estate for Inheritance Tax purposes.

The taxpayers representatives argued that the 'gift' of a half share of the house should not affect the subsequent Inheritance Tax charges but the Inland Revenue rejected the argument.

There is now concern that Nil-Rate Band Discretionary Trusts may not give relief for spouses who do not contribute financially to the marriage. This can be seen to be at odds with the decisions in recent divorce cases.

Mrs Cutler advises families who have Nil-Rate Band Discretionary Trusts created on the death of a spouse to review the Trusts and seek professional advice to ensure that they are not affected by this case.

"What this case shows is just how important it is to seek expert advice when making a Will, and when setting up trusts in order to secure the advantages of efficient tax planning," says Mrs Cutler.