New Tax Ruling Highlights Need for Well Crafted Wills; ANALYSIS Inheritance Tax? Don't Panic, Urges Midlands-Based Estate Planning and Inheritance Tax Consultant Rob Teasdale

Article excerpt

Byline: Rob Teasdale

There has been considerable press coverage recently over a ruling involving inheritance tax (IHT) and the family home.

The impression you may have got from some of these articles is that the decision somehow was not expected; however let us look a little deeper.

The ruling by a Special Commissioner of Tax denied relief from IHT on a straightforward strategy that has been used by thousands of families over the years, where the value of the home is split between husband and wife.

This strategy, sometimes known as a "tenants in common" scheme, is designed to protect a couple's estate and their children from paying IHT upon the death of the second spouse.

The scheme is very simple with the home being owned by husband and wife as "tenants in common" (as opposed to being owned as joint tenants).

This enables each share of the property to be dealt with separately and not pass automatically to the surviving spouse on death.

On the first death, the deceased's share is put into a discretionary trust for the benefit of the surviving spouse.

The trustees then assign that share of the home to the survivor in return for an IOU (the debt).

This debt is then set against the estate of the surviving spouse when he/she dies, effectively reducing the IHT liability. This was the strategy used by Dr Patrick Phizackerley and his wife Mary who were the couple in the test case before the Special Commissioner, Dr John Avery Jones.

In their case, a half share of the house valued at pounds 150,000 on Mrs Phizackerley's death in April 2000 was put into a discretionary trust (in the form of an IOU) for the benefit of her husband and children.

This was expected to remove the pounds 150,000 from the couple's estate for IHT purposes because it would not pass directly to Dr Phizackerley and be included in his estate.

At this point no problems were foreseen.

However, if further consideration had been given to the existing rules at the time then the outcome would have been very different; John Avery Jones would not have denied relief and the pounds 150,000 would have escaped IHT.

The Special Commissioner stated that Mrs Phizackerley did not contribute financially towards the cost of purchasing the home as she had not worked. Because of this, the strategy designed to pass part of the value of the property out of Mrs Phizackerley's estate was deemed invalid and the pounds 150,000 remained in the estate.

This had the knock-on effect of a larger IHT bill, pounds 60,000 more, when Dr Phizackerley died in July 2002.

This case fell foul of a long standing anti-avoidance rule which prohibits this type of "circular" arrangement.

The reality is that Dr Phizackerley gave the money to his wife and when she died a value was left in her estate which he then borrowed as a loan; in other words the money effectively travelled full circle.

So, what could Dr and Mrs Phizackerley have done to ensure that their scheme worked?

In this case, had the trust simply allowed Dr Phizackerley to remain living in the property while making the children beneficiaries, then the "circular" rule would not have applied. …