Inheritance Tax (IHT) is a tax that needs to be taken seriously by any individual with assets in excess of £325,000. Taking some basic steps can mean that your family may be able to avoid the worst ravages of an IHT bill after you die.

Significant steps can be taken in lifetime to pass on assets but it is not always possible to achieve this and so planning a tax efficient Will should be seen as a major part of the tax planning agenda. This briefing focuses on the need to make a Will and how to make it as tax efficient as possible.

Why bother with a Will?

A Will is a very personal document in which the person writing it (known as the ‘testator’) sets out how their estate should be distributed after their death. Where an individual dies without leaving a Will the rules relating to intestacy come into play. These rules are set out in law and provide a formula by which the estate is to be divided. Different rules apply in the different countries which make up the United Kingdom.

One particular point which runs through all the sets of rules is that under intestacy, provision is made for a spouse and for children. There is no provision for an unmarried partner which could cause significant problems for the surviving partner in such situations.

There may not be major financial matters to deal with in a Will but it is important to express direction about particular assets, to identify care issues for minor children and to express wishes about a funeral.

If you have assets in another country outside the UK you should take advice on writing a Will in that country to deal with those specific assets. Legal problems could arise for your survivors if you do not.

Transfers between spouses

It is quite understandable that when one spouse dies they will want to ensure that their surviving spouse is financially provided for. The IHT rules recognise this and include a very important provision which allows transfers between spouses (including registered civil partners) to be exempt from IHT.

This exemption has been reinforced by legislation which allows the IHT nil rate band (NRB) to be transferred between spouses as well. Currently, the first £325,000 of any estate is taxable to IHT at 0% and it used to be the case that where assets were transferred between spouses on the first death, the couple were only able to use one NRB against their joint estate. This anomaly has been corrected by what is referred to as the ‘transferable nil rate band’.

It works like this. When the first spouse dies they can leave all their estate to their surviving spouse. That will be an exempt transfer. When the survivor dies, their estate can claim the benefit of any NRB not used at the time of the death of the first spouse. The unused percentage is added to the NRB of the survivor.

Example

George died in January 2008. He had total assets of £750,000 which he left to his widow Sheila. That transfer was exempt and so none of George’s NRB was used. Sheila dies in 2012 leaving a total estate of £900,000. The IHT bill will be just £100,000 (£900,000 – £650,000) x 40%. Under the old rules the IHT bill would have been £230,000 (£900,000- £325,000 x 40%).

If George had left £100,000 of his estate to his children it would be necessary to work out what percentage of his NRB was unused. In January 2008 the IHT NRB was £300,000 and so the unused percentage is (£300,000 – 100,000)/300,000 = 66.6%. On Sheila’s death the NRB available to her would be increased by that same percentage and would be 66.6% x £325,000 plus her own NRB of £325,000 = £541,450.

The rules apply to any couple irrespective of when the first spouse died. HMRC will want some documentary evidence to back up the claim. This will include copies of the death certificate of the first spouse, the marriage or civil registration certificate of the couple and details of the probate on the first death. It is important to have this information available as HMRC will not process claims without it.

Where a surviving spouse remarries it is possible that their estate in theory could have the benefit of NRBs from two deceased spouses. The legislation does not allow the collection of NRBs! The maximum additional allowance is 100% of the current NRB.

Should we automatically use the transferable NRB?

There is no doubt that the transferable NRB has simplified IHT planning for many married couples and registered civil partners. If the combined estate of the couple is below twice the current NRB and is not likely to grow significantly then the transferable nil rate band is the simplest route to take.

There are however two situations in which an alternative approach may be more desirable.

• The first is where there are assets which may qualify for one of the special reliefs for business or agricultural property.

• The second is where assets in the first estate are likely to grow significantly in value.

Dealing with business assets

Some assets such as shares in a private trading company and agricultural property are eligible important reliefs which can significantly reduce the IHT bill. Business Property Relief (BPR) can be up to 100% of the value of the business assets concerned and a similar percentage can apply for Agricultural Property Relief (APR). The precise conditions for these reliefs are complex and we can provide advice on your particular situation.

Very importantly, these reliefs are only available in situations which generate a chargeable transfer for IHT purposes and so they will not be used in situations where the qualifying assets pass directly to the surviving spouse or registered civil partner. This means that it is possible that the relief may be lost if the survivor decides to sell the asset concerned. Cash proceeds derived from a qualifying asset are not eligible for the relief.

Consideration should therefore be given to transferring these assets into a discretionary trust on the first death to ensure that the relief is utilised. Any subsequent sale will then be in the trust (this may require some careful planning for capital gains tax (CGT) purposes). The potential savings can be very significant as the following example shows:

Example

Keith holds shares (current value £900,000) in an unquoted trading company. The shares qualify for 100% BPR. Other personal assets for IHT total £500,000. Under Keith’s Will all the assets pass to his widow Linda.

The IHT position on Keith’s death will be a nil liability and all his NRB remains intact.

After Keith’s death, Linda sells the shares for £900,000. She dies with the cash and other assets still in her estate. The NRB at the time of her death is £350,000. The IHT position on her death will be: 

Value of estate                                        £1,400,000
Less 2 x NRB                                             (£700,000)
Taxable                                                     £700,000
IHT payable                                               £280,000

If Keith had through his Will put the shares into a discretionary trust the situation on his death would have been: 

Value of shares                                          £900,000
Less 100% BPR                                        (£900,000)
Taxable                                                            £nil
IHT payable                                                      £nil

His NRB would not have been used as the balance of his assets passed directly to Linda. On her death the IHT position would be: 

Value of estate                                        £500,000
Less 2 x NRB                                          (£700,000)
Taxable                                                          £nil
IHT payable                                                    £nil

The value of the shares net of CGT would be in the trust and a saving of £280,000 would have been made on the IHT bill.

Dealing with growth assets

The transferable NRB is fine where the assets passing on the first death grow at a rate no greater than the rate of growth in the NRB. A greater tax bill can arise if the growth in the value of the assets outstrips the NRB. This is currently of particular interest as the NRB has been frozen until April 2015 at £325,000.

The alternative is to redirect the asset away from the direct ownership of the surviving spouse on the first death. If the surviving spouse is not going to need the asset (or the income it generates) then a transfer to other family members of an amount up to the NRB on the first death will work. If the surviving spouse does need some access to the asset then the vehicle of a trust would be a better solution.

The trust in this case must be a discretionary trust where all decisions as to the distribution of capital and income are left to the trustees. The surviving spouse can be one of the trustees. A discretionary trust is treated as ‘relevant property’ for IHT purposes which means that the value of the assets in the trust cannot be added to other assets that a trust beneficiary may own. This means that if the assets in the trust grow significantly between the first death and the death of the surviving spouse all of that growth will not be chargeable to tax when the survivor dies. It should be pointed out that there are IHT charges which can arise within a discretionary trust but these should be significantly less than the equivalent charge if the asset remains in an individual’s estate.

Example

Ian has a property in his estate which is currently used only to generate rental income. Its current value is £325,000 but if the local development plan is adopted, the site will be in a key area and could be worth £750,000. Ian’s other assets are £500,000. Ian dies in 2012 when the NRB is £325,000.

He leaves all his estate to his widow Joy. The development plans proceed as they hoped and the property is sold for £750,000 (CGT would be due but is ignored for the purpose of this example). Joy dies in early 2016 with the cash from the sale of the property and the other assets inherited from her husband.

Her IHT position will be (NRB assumed to be £350,000 in 2016):

Value of estate                                                                              £1,250,000
Less 2 x NRB                                                                                   (£700,000)
Taxable                                                                                           £550,000
IHT payable                                                                                     £220,000

If Ian had put the property into a discretionary trust the position on his death would have been: 

Value of estate                                                                               £325,000
Less NRB                                                                                      (£325,000)
Taxable                                                                                                 £nil
IHT payable                                                                                           £nil

On Joy’s death the IHT position will be: 

Value of estate                                                                             £500,000
Less own NRB (no transferable NRB as all used on Ian’s death)           (£350,000)
Taxable                                                                                       £150,000
IHT payable                                                                                   £60,000

The proceeds from the sale of the rental property held in the trust are not included in Joy’s estate and the IHT saving on her death is £160,000.

Passing on to a surviving spouse

There is a further issue of concern for some families. This is where it is desired that the ultimate recipients of the assets are other family members but at the same time ensuring that the surviving spouse benefits during their lifetime. This can be a particular factor where there are children of the marriage and it is possible that the surviving spouse could remarry. If all the assets are transferred directly to the survivor on the first death, then on the death of the survivor it is possible that some of those assets could pass to beneficiaries other than the children of the first marriage.

This position can be avoided by transferring the assets into another type of trust on the first death which gives an interest in the income of the estate to the surviving spouse for their life. On the death of the second spouse, the trust then passes the capital to specific beneficiaries (i.e. the children). The first transfer is still subject to the spouse exemption and in this situation (unlike the discretionary trust described earlier) the value of the assets in the trust are taxable on the death on the second spouse. In IHT terms there is no tax saving under this route but the fulfilment of a personal wish to direct assets ultimately for the benefit of the children can be achieved.

To sum up

Ensure that you keep your Will updated so that it reflects your personal wishes in terms of who you would like to benefit. This is particularly important if you and your partner are not married.

IHT planning should always be done on a personal basis because every estate and every family situation is unique. Taking advantage of the planning opportunities can make a huge difference to the value of your estate which eventually passes down to your children. We would be happy to talk with you about how these opportunities might be used in your situation.

Disclaimer - for information of users - This briefing is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this briefing can be accepted by the authors or the firm.

Winter 2011

Penalties for late construction industry scheme (CIS) contractor monthly returns changed in October 2011.

The good news is that, in many cases, the new penalties may be lower than the previous position. In particular, for new CIS contractors there will be an upper limit to some of the penalties charged. This upper limit will apply when new contractors first send a monthly return if that return, and any other monthly returns that are sent at the same time, are late.

Although the new penalties do not 'officially' start until October 2011, HMRC has published guidance explaining how the rules may apply early at the taxpayer’s request (www.hmrc.gov.uk/cis/penalties-late-returns.htm). Any contractor who has been or is charged penalties for filing a monthly return late before October 2011 may ask HMRC to:

• work out how much the penalties would be under the new rules; and 
• if this is less than the amount already charged, agree that the penalties should be reduced to the lesser amount.

Rules up to October 2011
A late submission of a contractor monthly return currently incurs a penalty of £100 for each of up to 12 consecutive months that the return is not submitted by its due date. The due date is the 19th of the month, so for example, the monthly return from 6 July to 5 August is due on 19 August.

 

After 12 monthly penalties have been charged, if the return is still outstanding, a final penalty in the range of £300 to £3,000 is charged depending on how many other final penalties have been charged over the previous 12 month period.

When the returns are eventually submitted, the initial penalties of £100 are increased where the returns show entries for more than 50 subcontractors.

New rules from October 2011
The new penalty system started in October 2011. The first return to attract a penalty is the return due for the month starting 6 October and ending 5 November 2011.

Penalties will be charged as follows:

• Initial failure to meet the due date of the 19th of the month – a penalty of £100. 
• Return still outstanding two months after the due date – a further penalty of £200.
• Return still outstanding six months after due date – a ‘tax geared’ penalty becomes due. This penalty is the greater of 5% of any deductions shown on the outstanding return and £300. 
• Return still outstanding 12 months after the due date – a second ‘tax geared’ penalty becomes due.
  Contractors new to CIS

Under the new rules, if a contractor has not sent any previous returns and is filing the first returns late, there will be an upper limit of £3,000 on the total fixed penalties (£100 and £200) that may accrue.
This upper limit does not apply to any ‘tax geared’ penalty except that, where it applies, it removes the £300 minimum penalty that would otherwise be charged where the tax geared penalty is less than £300.

This briefing focuses on VAT matters of relevance to the smaller business. A primary aim is to highlight common risk areas as a better understanding can contribute to a reduction of errors and help to minimise penalties. Another key ingredient in achieving that aim is good record keeping, otherwise there is an increased risk that the VAT return could be prepared on the basis of incomplete or incorrect information. This aspect is not considered further here but useful guidance can be found in www.hmrc.gov.uk/factsheet/record-keeping.pdf

Input VAT matters

Only registered traders can reclaim VAT on purchases providing the expense is incurred for business purposes and there is a valid VAT invoice for the purchase. Only VAT registered businesses can issue valid VAT invoices. VAT cannot be reclaimed on any goods or services purchased from a business that is not VAT registered. Proforma invoices should not be used as a basis for input tax recovery as this can accidentally lead to a duplicate VAT recovery claim.

Most types of supply on which VAT recovery is sought must be supported by a valid VAT invoice. This generally needs to be addressed to the trader claiming the input tax. A very limited list of supplies do not require a VAT invoice to be held to support a claim, providing the total expenditure for each taxable supply is £25 or less (VAT inclusive). The most practical examples of these are car park charges and certain toll charges.

The following common items however never attract input VAT and so no VAT is reclaimable - stamps, train, air and bus tickets, on street car parking meters and office grocery purchases like tea, coffee and milk!

Business purpose

This is often an area of contention between taxpayers and HMRC as VAT is not automatically recoverable simply because it has been incurred by a VAT registered person. In assessing whether the use to which goods or services are put amounts to business use (for the purpose of establishing the right to deduct input tax), consideration must be given as to whether the expenditure relates directly to the function and operation of the business or merely provides an incidental benefit to it.

Private and non-business use

In many businesses, personal and business finances can be closely linked and input tax may be claimed incorrectly on expenditure which is partly or wholly for private or non-business purposes.
Typical examples of where claims are likely to be made but which do not satisfy the ‘purpose of the business’ test include:

• expenditure related to domestic accommodation
• pursuit of personal interests such as sporting and leisure orientated activities
• expenditure for the personal benefit of company directors/proprietors and
• expenditure in connection with non-business activities.

Where expenditure has a mixed business and private purpose, the related VAT should generally be apportioned and only the business element claimed. Special rules apply to recover input tax claimed on assets and stock (commonly referred to in VAT as goods) when goods initially intended for business use are then put to an alternative use.

Example: Three laptops are initially bought for the business and input VAT of £360 in total is reclaimed. One is then gifted by the business owner to his son so VAT will have to be accounted for to HMRC of £120 (1/3 x £360)

Business entertainment

VAT is not reclaimable on many forms of business entertainment but VAT on employee entertainment is recoverable. The definition of business entertainment is broadly interpreted to mean hospitality of any kind which therefore includes the following example situations:

• travel expenses incurred by non employees but reimbursed by the business, such as self employed workers and consultants
• hospitality elements of trade shows and public relations events.

Business gifts

A VAT supply takes place whenever goods change hands, so in theory any goods given away result in an amount of VAT due. The rule on business gifts is that no output tax will be due, provided that the VAT exclusive cost of the gifts made does not exceed £50 within any 12 month period to the same person.

Where the limit is exceeded, output tax is due on the full amount. If a trader is giving away bought-in goods, HMRC will usually accept that he can disallow the tax when he buys the goods, which may be more convenient than having to pay output tax every time he gives one away.

Routine commercial transactions which might be affected include such things as long service awards, Christmas gifts and prizes or incentives for sales staff.

Cars and motoring expenses

Input tax errors often occur in relation to the purchase or lease of cars and to motoring expenses in general. Some key issues are:

• Input VAT is generally not recoverable on the purchase of a motor car because it is not usually exclusively for business use. This prohibition does not apply to commercial vehicles and vans, provided there is some business use.
• Where a car is leased rather than purchased, 50% of the VAT on the leasing charge is not claimed for the same reason.
• Where a business supplies fuel or mileage allowances for cars, adjustments need to be made to ensure that only the business element of VAT is recovered. There are a number of different methods which can be used, so do get in touch if this is relevant to you.

Output VAT issues

Bad debts

Selling on credit in the current economic climate may carry increased risk. Even where credit control procedures are strong there will inevitably be bad debts. As a supplier, output VAT must normally be accounted for when the sale is initially made, even if the debt is never paid, so there is a risk of being doubly out of pocket.

VAT regulations do not permit the issue of a credit note to cancel output tax simply because the customer will not pay! Instead, where a customer does not pay, a claim to recover the VAT on the sale as bad debt relief can be made six months after the due date for payment of the invoice.

Example: A trader supplies and invoices goods on 19 October 2010 for payment by 18 November 2010 (ie a normal 30 day credit period). The earliest opportunity for relief if the debt is not settled would be 18 May 2011. The relief would be included in the return into which this date fell, depending on the return cycle of the business.

The taxpayer can only claim relief for the output tax originally charged and paid over to HMRC, no matter whether the rate of VAT has subsequently changed. In the above example the standard VAT rate charged would have been 17.5% (not the current 20%) so a claim can be made for only 17.5%. The claim is entered as additional input VAT - treating the uncollected VAT as an additional business expense - rather than by reducing output VAT on sales.

The customer

A customer is automatically required to repay any input VAT claimed on a debt remaining unpaid six months after the date of the supply (or the date on which payment is due if later). Mistakes in this area are so common that visiting HMRC officers have developed a programme enabling them to review Sage accounting packages and to list purchase ledger balances over 6 months old for disallowance.

Preventing the problem?

Small businesses may be able to register under the Cash Accounting Scheme, which means you will only have to account for VAT when payment is actually received. The scheme is considered in more detail later in this briefing.

Special schemes for the smaller business

Several special schemes relate to smaller businesses. These are mainly aimed at reducing the compliance burden.

The Flat Rate Scheme (FRS). FRS is an attempt to simplify VAT accounting for the small or growing business. This optional scheme provides currently registered traders with an alternative mechanism for accounting for VAT, and offers an additional incentive for new registrations. The scheme enables eligible businesses to calculate their VAT payment as a flat percentage of total turnover. The percentage to be used depends on the type of business activity carried on. If the business is newly registered for VAT and also decides to operate this scheme then a further 1% flat rate reduction applies in that first year of registration. The scheme is generally open to small businesses whose annual taxable turnover excluding VAT does not exceed £150,000. Traders must now leave the scheme when their taxable turnover (including VAT) exceeds £230,000. This calculation must be made annually on the anniversary of the trader joining the scheme. 

Annual Accounting Scheme. The Annual Accounting Scheme is also generally aimed at the smaller business. It can either be combined with FRS (described above) or used by a business which uses standard VAT accounting. The scheme allows the business to complete just one VAT return each year, instead of the usual four. However, it retains a smooth cash flow position as instalment payments of the expected VAT liability are made on account, so that the business is not faced with a large VAT bill at the end of the year. A choice of three (quarterly) or nine (monthly) instalments can be made towards the end of year VAT liability. These must be paid by direct debit, standing order or other electronic means. A business with a taxable turnover up to £1.35 million can apply for entry into this scheme.

Cash Accounting Scheme

Another popular small business scheme is the Cash Accounting Scheme. Under standard VAT accounting, VAT is payable on sales whether or not the customer has paid and can lead to a need to claim bad debt relief (as detailed earlier). Under this scheme VAT does not need to be paid over until the customer has paid. If the customer does not pay then the VAT is not payable. This clearly has cash flow benefits for traders which sell on credit. A business can enter this scheme provided the estimated VAT taxable turnover for the next VAT year is not more than £1.35 million. It can continue to use the scheme until the VAT taxable turnover exceeds £1.6 million. Where your business is registered under the Cash Accounting Scheme, do remember that this also means that VAT cannot be claimed on purchases and other inputs until you have actually made the payment, rather than the standard method of accounting for the reclaim when you receive the invoice. 

We can advise you if this scheme would be suitable for your business.

HMRC has responded to a Freedom of Information request and confirmed the following:

• The new Business Records Checks (BRC) annual target is 20,000 visits, a 30,000 reduction from the original objective of 50,000, as outlined in the BRC Consultation Paper.
• The 20,000 annual target has been reduced on a pro rata basis for this tax year. 12,000 BRC visits are due to be conducted before March 2012.
• The 30 staff who carried out the original ‘Test and Learn’ BRC visits between April and July from Edinburgh, Irvine, Liverpool, Manchester, Portsmouth, Sheffield, Stockport and Sunderland tax offices are going to be assisted by a further 90 staff. More tax offices are going to be involved. The additional 90 staff are being drafted on to the BRC Team between September and November 2011.

In addition to this second round of BRC visits which have already begun, HMRC is also revisiting businesses deemed to have been keeping inadequate records during the first ‘Test and Learn’ exercise. The follow up letters state the intention is ‘to check that the appropriate improvements have been made.’

There is no official clarification from HMRC yet as to whether fines will be levied for poor record keeping during the second round of BRC visits, although HMRC has previously said that businesses visited during the ‘Test and Learn’ phase would not receive fines unless in the most significant circumstances.

HM Revenue and Customs (HMRC) has announced plans to make online value-added tax (VAT) filing, payment and registration mandatory in the coming year.

From April, 2010, online filing of VAT returns and electronic payment became compulsory for all newly established businesses (regardless of turnover) and all existing businesses with a turnover of over £100,000. The decision to mandate the remaining businesses to do so was confirmed in the March Budget. In addition, in 2012, HMRC intends to introduce an enhanced and streamlined online service for VAT registration and deregistration.

"VAT: consultation on the next steps for moving VAT online" opened on August 8. It includes proposed legislation and seeks views on how to ensure and enhance assistance for those having difficulty moving online. Under the current rules, businesses with a turnover of less than GBP100,000 can still choose how to file their VAT returns. Under the plans, it will become a legal requirement to file these online, irrespective of the size of the business in question. According to the consultation document, online filing provides speed, security and convenience for customers and efficiency benefits for HMRC.

The consultation also states that HMRC's experience so far shows that those early mandated customers have demonstrated good compliance, with few practical problems encountered and a faster than expected take-up noted. In addition, of the 750,000 existing businesses left out of the initial phase in the scheme, 400,000 have thus far chosen to move to online filing.

“Once in force, the new rules will require online filing for all accounting periods starting on or after April 1, 2012, with any VAT due to be paid electronically from the same date. HMRC will write to the businesses affected in February next year, explaining the changes and their impact. In addition, HMRC is to offer a period of grace to those experiencing difficulty in moving online, and will not penalise those who fail to do so within the first year”.

An online registration, variation and deregistration service is also intended to become available from October, 2012. This, HMRC says, will make matters easier on both sides, and drive down costs.

If you need more information or would like to talk the implications through for your business please contact us.