The government introduced the General Anti-Abuse Rule (GAAR) as part of its approach to managing tax avoidance and HMRC recently published guidelines as to how it would operate with respect to a whole range of taxes, including inheritance tax.
The GAAR is intended to provide HMRC with the powers to restrict tax arrangements that are deemed to be abusive and, therefore, unacceptable. When does a tax arrangement become abusive? HMRC has to apply a double reasonableness test. It must show that the tax arrangement “cannot reasonably be regarded as a reasonable course of action”, taking into account whether contrived or abnormal steps are involved, legislative shortcomings are exploited and if the arrangement is consistent with the principles and policy objectives on which the legislation is based.
There is a further safeguard in that HMRC must ask an independent advisory panel to decide if the arrangement is reasonable or not before it can apply the GAAR. If the tax arrangement is held to be “abusive”, the GAAR will operate by making a “just and reasonable” tax adjustment to reverse the abusive tax advantage.
How does the GAAR impact inheritance tax planning? The positive news is that the guidelines make it clear that arrangements such as discounted gift schemes, loan trusts and protection policies written in trust are not being targeted. HMRC does not consider such schemes to be abusive.
Under a discounted gift scheme, a capital investment bond can be made subject to a discretionary trust, where the right to income is held for the absolute benefit of the settler, with the remaining part of the investment held as a discretionary trust for the family. There is an immediate reduction in the potential inheritance tax liability based on the level of discount, with the prospect of the entire gift into trust being outside the estate after seven years.
A loan trust can be established with an interest-free loan which is made to the trustees. This is repayable on demand, so the settlor doesn’t lose control of the capital. Loan repayment can be requested of the trustees and any investment growth is deemed to be outside the investor’s taxable estate and, therefore, free of inheritance tax.
Perhaps one of the most effective solutions to meet a potential inheritance tax liability is to take out an appropriate life assurance policy written under trust. In the case of a husband and wife, this would be written under a last survivor basis, with the proceeds paid on second death to the beneficiaries, hopefully to meet any potential IHT liability.
Legitimate methods of mitigating inheritance tax bills should form part of any discussions regarding inheritance tax planning.
• Paul Galloway is a financial planning consultant at Edinburgh Risk Management