INHERITANCE TAX PLANNING: SOME COMMON MISTAKES

  
Inheritance tax (IHT) takes a meaty chunk out of all but the smallest estates these days; so it’s best to make sure you’re not increasing your liability as a result of misunderstanding the way the rules work. Here are some common mistakes:

1. Give away your home

This may be the commonest IHT-planning mistake of all. An old couple, or the survivor of them, gives away their house during their life to the children. They have some, usually vague and unformulated, idea that this will save ‘death duties’. Unfortunately, this isn’t the case at all, if the donor continues to live in the house. This is a ‘gift with reservation of benefit’, and the house continues to be treated as being in the old person’s estate for IHT purposes.

In fact, the person who does this has made the tax situation worse. Unless the children are still living at home, the property is no longer eligible for main residence exemption from capital gains tax (CGT).

2. The dwindling trade

It’s quite a common scenario, in practice, for a formerly trading company to wind down its trade and instead concentrate on investing its past profits, for example in investment property. The shareholders of such a company have a window of opportunity that often closes without their realising it. This is the point at which the company ceases to be mainly a trading one and becomes mainly an investment one. Once the investment element of the company’s activities crosses the 50% mark (however you measure that), it may be too late for the shareholder to give shares away, for example into trust, without being subject to CGT and/or IHT.

3. Conventional ‘wisdom’

It’s a very typical scenario, within a family, for the oldest generation to pass on any trading business they have to the younger generation, and, as they retire, to live on their investments – often, for example, the property from which the business runs and that is registered in the name of the older generation.

Actually, though, passing on the business assets and keeping the investment assets is precisely the wrong way round! The older generation should, rather than follow this conventional ‘wisdom’, concentrate their wealth within the trading assets (for example shares in a trading company) and derive their income, as much as possible, from this source. This is because the trading business is eligible for 100% business property relief from IHT, whereas the investment assets are fully chargeable at the 40% rate.

4. The limitations of agricultural property relief

  
It’s easy for a person, like a farmer, whose estate largely consists of agricultural land and buildings, to assume that that estate will be 100% relievable from IHT. This is, of course, the case in the ‘normal’ situation. However, one little rule, which is sometimes forgotten, is that agricultural property relief – which is at a rate of 100% for all agricultural assets – only applies to the ‘agricultural value’. If any of the land or buildings, say, have acquired development value, the excess of the development value over the agricultural value is taxable. This can sometimes be got round by treating the developable property as a trading business in itself.

5. Hang on to the majority

If you have the majority of the shares in an investment company (this isn’t a problem with a trading company), your estate will be taxable on a much higher value per share than if you (together with your spouse) have a minority interest.

This is seen at its most extreme in the following examples. An old man has 51% of the shares of a property investment company, with the other 49% owned by his children and grandchildren. On his death, the Revenue argues that his taxable estate should include 51% of the full current market value of all of the assets of the investment company, that is a full pro rata value. If, at least seven years prior to his death, he had given away as little as 2% of the shares, this would have made a huge difference because 49% is not a controlling holding, and therefore the pro rata value would have been heavily discounted (depending on a number of factors). Giving away a very small shareholding like this minimises the CGT problems that arise when you give away shares in an investment company.