The Implication of Income Tax Charge on Estate Planning
by Janine Byrne
Overview
Pre-Budget Report of December 2003 the Chancellor Gordon Brown announced
proposals to levy an Income Tax charge from 6th April 2005 in those circumstances
where the transferor of an asset retains and interest or continues to benefit
from that asset. In the instance of real property, the 'benefit' envisaged
is the transferor continuing to reside in the property he/she has allegedly
given away.
How the Charge Applies
The Government refer to such assets as 'pre-owned assets' and, broadly speaking,
its intention is to tax the 'annual value' of such assets as a benefit-in-kind
on the former owner still enjoying the use of the asset. The annual value
on which the charge is based will be the open-market rental for a property
or a fixed percentage of the capital value of most other assets to which
the new charge applies. Any amounts which the transferor pays for the use
of the asset - rent for example - will be deducted from the annual value
in arriving at the taxable benefit. The charge will also apply if a person
provides the funds to purchase an asset which they go on to enjoy the benefit
of after 5th April 2005.
Rationale Behind the Charge
The charge is intended to counter many Inheritance Tax planning schemes,
but unfortunately, it will also impact many innocent and unintended victims.
Thankfully, the legislation has included some exceptions to the application
of the charge. The charge will not apply if;
The asset was gifted before 8th March 1986
The asset is owned by the transferor's spouse
The asset is, in fact, still caught by the 'Gifts with Reservation' rules
and as such Inheritance Tax applies instead (hence, the Income Tax charge
will not be levied on top).
The asset was sold at an arm's length price for cash (even if to a connected
party).
The transferor of the asset had themselves inherited it and their ownership
had ceased as a result of a Deed of Variation affecting that
inheritance.
The transferor's continued enjoyment of the asset is merely incidental or
has arisen only as a result of an unforeseen change in family
circumstances.
The annual taxable benefit (after deducting any contributions by the transferor,
where necessary) does not exceed £2,500.
The Inland Revenue have also confirmed that the charge will not apply in
most cases where a taxpayer has funded life insurance policies held on trust.
Finally, there is also an 'Opt Out' option whereby the transferor can opt
not to pay the charge provided the asset is included back into their estate
and therefore consequently being subject to Inheritance Tax.
The Implications of the Charge
Most of the Inheritance Tax Planning techniques usually involve a widow or
widower having continued enjoyment of their former spouse's share of the
property and thus it would appear on first inspection that in the majority
of cases the charge would not apply as the transferor themselves would not
be around to continue to enjoy or benefit from the
property.
However, a problem seems to arise where a couple own their property as joint
tenants prior to commencing their tax planning strategy and subsequently
changing their ownership title to tenants in common. Where the widow or widower
formerly owned the property as joint tenants they had a share in ownership
of the whole property. This means that the new Income Tax charge could
conceivably apply to their continued occupation of the property after their
spouse's death.
A possible consequence of this for the future might mean that instead of
acquiring property as joint tenants which has been the general rule, the
wise policy would be to own the property as tenants in common instead. But
how many people are aware of this distinction? Will legal advisors be prepared
to explain the tax implications of acquiring property with the different
legal titles?
Conclusion
How far will the new charge impact on current Inheritance Tax Planning schemes?
As yet, it is too soon to tell, as the rules have not been fully fleshed
out and as yet, it is too soon to say with any certainty what will happen
and which schemes will be affected.
But it seem fair to argue that the current Labour Government is doing its
utmost to tax its citizens at every possible turn. Inheritance Tax avoidance
schemes - indeed any tax avoidance scheme -are not unlawful. Planning for
the future does not mean that people are engaging in tax evasion - which
IS unlawful. But the policies being employed leave an uncomfortable impression
of an angry parent chastising their child simply for being astute and planning
for the future!
Needless to say, the whole approach leaves a somewhat bitter taste in one's
mouth.
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