Writing for Taxation magazine’s Readers’ Forum, BKL private client tax specialist Terry Jordan answers a fellow professional’s query involving gifts between two sisters, the inheritance tax nil rate band (IHT NRB) and nursing home fees.
The tax query
‘My client has now retired but she was a successful businesswoman who has built up a comfortable level of wealth and has significant amounts of pension and investment income. She has never married and has no children. Her will leaves her estate (after a few charitable bequests) to her sister, who is married and has children of her own. She had already started making regular gifts to her sister out of surplus income to reduce her eventual inheritance tax liability.
Unfortunately, my client is now having health problems and will need to move into a nursing home. She can’t afford to pay the fees and keep making the same level of gifts to her sister. Rather than sell the house, she is thinking of renting it out. That would raise some funds but not enough to fund all of the nursing home fees. So she has suggested that she could borrow against the value of her house and pay the balance of the fees out of those funds. This would enable her to keep making gifts to her sister. On her death the house would be sold to repay any outstanding borrowings and the balance of her estate would pass to her sister. Because she has no direct descendants the resident nil-rate band, or the downsizing relief, would not be available. The leakage to her estate from the interest payments on the loan would be less than the IHT due if she simply sold the house and retained the proceeds in cash.
Is this a viable solution or would HMRC say that she was making the nursing home payments out of income and any money paid to her sister would be a payment of capital?’ Query 20,428 – Worried.
Terry Jordan’s reply: It would be better to leave the estate on discretionary trusts for the sister.
‘Worried’s client has been making regular gifts out of surplus income to her sister who is married with children. We are not told for how long this has been going on but provided there is a demonstrable pattern of giving over four or more years or, following Bennett v CIR [1995] STC 54, the commitment to give regularly can be evidenced those gifts should be exempt from inheritance tax under IHTA 1984, s 21. Some clients are completing what is now page 8 of HMRC’s form IHT 403 as they go along to identify the scope for such gifts. (I have read in the press following the Budget that the exemption is a ‘loophole’; in my opinion it is no such thing: IHT is a charge on capital not income.)
It is settled that for the exemption to apply the gifts must be made from surplus income after the donor has met her outgoings without the need to resort to capital. The proposed borrowing against the client’s house would be capital in nature and so the exemption would cease to apply and future gifts to the sister more than the £3,000 annual exemption would be potentially exempt transfers (PETs) with a seven-year tail.
On death, the only consanguinity relief from IHT in the UK is afforded to spouses/civil partners. In my article ‘Sisters are doin’ it for themselves’, (Taxation, 22 September 2022) I considered the Lord Lexden OBE’s private members’ bill that would have afforded relief to co-habiting siblings over the age of 30 receiving gifts or inheritances. Even if enacted, that would not have helped Worried’s client as she does not live with her sister.
We are told that the client will leave her estate to her sister. That will lead to aggregation of wealth in the sister’s hands and a better solution would be to leave the estate on discretionary trusts for the sister and her nephews and nieces. Although such a trust would rank for ten-year charges the maximum rate is currently 6% as compared with 40% on the death of an individual. Under current rules, the sister could create a discretionary trust within two years of the death by a variation within s 142 without falling foul of the gifts with reservation of benefit rules but she would then be the income tax settlor and liable regardless of who received the income going forward.’
The full article was published in Taxation magazine (issue 4961) and is available to subscribers here on the Taxation website.
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