John Harrison and Company - Charter Accounts

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.

Spring 2012

Are you NESTing?

In the current economic climate and with people living longer the Government is keen to ensure that we all have some pension provision. Measures have been introduced that place duties on employers to automatically enrol employees into a work based pension scheme. Employers can either make use of the National Employment Savings Trust (NEST) or they can set up a new or use an existing qualifying pension scheme if they prefer. Under the Pensions Act 2008 employers must ‘auto-enrol’ eligible jobholders into a pension scheme.

When?

The start date varies depending on the size of the employer and their PAYE reference number. Recently, the Government has announced a change to the timetable for introduction. The earliest start date of October 2012 remains but this will only impact on the largest employers. Medium sized employers (50-249 employees) will now be allocated start dates between 1 April 2014 and 1 April 2015. Small employers will be allocated start dates between 1 June 2015 and 1 April 2017. The Pensions Regulator will write to all employers around six to twelve months before their ‘staging date’ (start date) so that they know when to automatically enrol their eligible jobholders. There will be a further reminder issued three months prior to the start date.

What are the costs involved?

The minimum contribution level is still set to be 8% of ‘qualifying earnings’ but not until October 2018 of which the employer minimum contribution is 3%. Where the employer pays at this minimum level the following breakdown applies:

Minimum contribution 8%
Employee pays 4%
Tax relief 1%
Employer pays 3%

Until October 2018 the minimum contribution levels are set to be:

• October 2012 to September 2017 – minimum overall of 2% with 1% minimum from the employer
• October 2017 to September 2018 – minimum overall of 5% with 2% minimum from the employer.

Where an employer contributes more than the minimum level then an employee may be able to reduce their contributions. In any case employees, but not the employer, will be able to opt out of the scheme if they so wish.

Qualifying earnings

Minimum level contributions are based on qualifying earnings. Qualifying earnings consist of basic salary, commissions, bonuses, overtime and statutory pay entitlement such as Statutory Sick Pay. However, only qualifying earnings between a lower and an upper limit to be known as the ‘qualifying earnings band’ will be taken into account. The most recent consultation proposals suggest that:

• the lower limit will be aligned with the National Insurance Contributions (NIC) Class 1 lower earnings limit which is set at £5,564 for 2012/13 and
• the upper limit will be linked to the rise in average annual earnings using the earnings value in the Pensions Act 2008 as the base. This would currently mean a cap for 2012/13 of around £39,853.

So who is an eligible jobholder?

Eligible jobholders are those who:

• are aged between 22 and State Pension age
• are working or ordinarily working in the UK
• have qualifying earnings payable by the employer above the earnings trigger for automatic enrolment (currently proposed to be £8,105 for 2012/13).

Employers may enrol other employees outside these criteria in a pension scheme but they are not obliged to do so.
Employers will need to put procedures in place to identify eligible jobholders on a timely basis. For example, they must be able to identify when younger employees reach 22 and where lower paid employees breach the qualifying earnings trigger for automatic enrolment.

NEST

The Government is making available a simple low cost pension scheme known as NEST. This scheme is designed to offer a low cost solution so that employers can comply with the legislation. The scheme is aimed primarily at lower paid employees. NEST offers some benefits but has its limitations:

• Low charges. A 1.8% charge is to apply on funds going in and a 0.3% charge annually on the value of the NEST fund.

• Maximum contributions. The maximum amount of contributions which may be made by or in respect of a scheme member is limited. The 2012/13 limit (including tax relief) is set to be £4,400. There are rules to deal with the situation where excess contributions are received into a NEST fund.

• Fund investment choice. The fund choices are currently limited to five plus the default NEST Retirement Date Fund. The current choices include Lower Growth, Higher Risk, Sharia, Ethical and Pre-retirement Funds.

• Portable. Employees who change jobs will be able to take their NEST with them when they change jobs.

Checklist

1 When is your auto-enrolment (staging) date?
2 Do your existing pension arrangements qualify?
3 Have you budgeted for the extra costs?
4 How will you communicate with employees?
5 What scheme or schemes do you intend to use?

The introduction of auto-enrolment will involve more costs for the majority of employers. If you would like more details of auto-enrolment or want help setting up a scheme or liaising with employees please do get in touch.

Employing Pensioners?

The State Pension age (SPa) is the earliest age you can draw your State Pension. It is also the date from which employees no longer have to pay Class 1 NIC. With people working longer it is important that employers are aware of the date and the implications. In particular, employers’ NIC continues to be payable even when SPa is reached and always at the main rate of 13.8%.

So do you know your own or your employees SPa? Well, under current rules:

Who? Born SPa
Men Before 6 December 1953 65
Women Before 6 April 1950 60
Women 6 April 1950 to 5 December 1953 Between 60 and 65
Both 6 December 1953 to 5 October 1954 Between 65 and 68
Both 6 October 1954 to 5 April 1968* 66*
Both 6 April 1968 onwards* Increasing from 66 to 67 and then to 68*

*However, the Government announced towards the end of 2011 that the increase from 66 to 67 will be bought forward from 2034 to 2026. For those born on or after 6 April 1960 but before 6 April 1961, a SPa between 66 and 67 will be set. People born on or after 6 April 1961 will have a SPa of 67 or higher. This proposed change is not expected to be finalised until the end of 2012 or beginning of 2013. We will keep you updated on developments but meanwhile it is important to check the latest position.

Targeted increase in the personal allowance

The personal allowance increases to £8,105 for 2012/13 from the current £7,475. However, the point at which individuals start to pay the higher rate of tax of 40% will decrease from £35,000 to £34,370. The overall effect being that a higher rate taxpayer will only receive the same tax savings as a basic rate taxpayer.

Pay up and file on time - or face a penalty shoot out

HMRC have received some bad press and lost several tribunal cases regarding penalties issued for late filing of end of year PAYE returns. However, getting penalties reduced or waived cannot be relied upon so it is important to ensure the returns are submitted on time. The ‘week’s grace’ which used to allow time for postal delays was removed in 2011 so do not expect any leeway. The following example illustrates how the penalties can soon mount up!

Example: Tardy and Co only has two employees and fails to submit the P35 and P14s to HMRC by the due date of 19 May 2012. The returns are eventually filed on 30 September 2012 (over 4 months late). The penalty is £100 for each month or part month late and is therefore £500! Penalties as well as interest arise when PAYE liabilities are paid late. The first late payment is ignored but subsequent late payments incur a penalty. The penalties are:

• 1% for up to three late payments
• 2% for defaults four to six
• 3% for defaults seven to nine, and
• 4% for ten or more defaults.

Example: Dave After pays his business’ PAYE payments each month one day late. The average amount due is £2,500 per month. After the end of the tax year the business receives a penalty notice for £1,100 (11 x £2,500 x 4% as the first late payment is ignored).

The future of PAYE - Real Time Information (RTI)

RTI represents a radical change to the way and time frame under which information is reported to HMRC in respect of employee pay and deductions. Under the proposals:

• information will be submitted to HMRC each payday detailing net pay and the computations behind the net payment for each employee
• when the employer pays the deductions over to HMRC on a monthly basis the employer will also provide further details including such items as any adjustments required for Statutory Maternity Pay or previous errors
• once RTI is fully up and running, the end of year form P35 will no longer be required as HMRC will have received all the information throughout the tax year.

From April 2012, volunteer employers and software developers will start a pilot of RTI with HMRC. Subject to a successful completion of the pilot, the largest employers will be required to start using the RTI system from April 2013. However, it is envisaged that all employers will be using the scheme from October 2013. HMRC are therefore urging employers to ensure that their employee information is up to date before the introduction of RTI.

Coding out ‘debts’ - up to £3,000

From April 2012 HMRC will be able to collect debts up to the value of £3,000 by amending the tax code of individuals in PAYE employment or receiving a UK pension. HMRC are able to use this method to recover both income tax debts and tax credit overpayments from April 2012.

The coding notice adjustment will be described as an ‘Outstanding debt’ with a note to say whether this relates to a tax underpayment or a tax credits overpayment or both. Tax codes will not be changed in-year to recover these debts or overpayments as they will be included in the code issued for the start of a tax year.

Employees who are to have their debts recovered in this way should have been advised by HMRC of the procedure to be adopted. HMRC should have previously written to these individuals at least once asking for payment. A further letter will advise them that their debts or overpayments may be collected by a tax code adjustment from April 2012 and they should then be given a final chance to either pay in full or to contact HMRC to discuss other payment options.

Where employees believe that repaying the debt this way will cause financial hardship then they should visit the Business Link website which offers guidance on how to set up a voluntary arrangement to repay the debt over three years.

Employment law round up

Although there are few changes from April 2012, there are several issues which are the subject of consultation:

Unfair dismissal - the qualifying period for unfair dismissal increases from one to two years from 6 April 2012.

Consultation - on up-front fees for employees wishing to take their case to an Employment Tribunal. This consultation closes in March 2012 and proposes the introduction of fees, generally payable by the party bringing the claim. We will update you on future developments.

Consultation - on introducing compensated no fault dismissal for micro firms up to ten employees.

Call for evidence - on the consultation rules for collective redundancies.

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.
Spring 2012