Nil rate band is not a zero risk option in complex Inheritance Tax landscape
Inheritance Tax is very emotive. Nobody likes paying it, particularly on savings put aside from hard-earned income, which has already been taxed. Any additional tax-free allowances are to be welcomed '“ usually!
The latest Inheritance Tax (IHT) allowance, to be introduced from 6 April 2017, will be known as the Residence Nil Rate Band (RNRB). Initially it will provide an additional tax free allowance of £100,000 and by 2020, the RNRB, when combined with the normal Inheritance Tax nil rate band (currently £325,000), will total £1 million for a married couple. Unfortunately, despite repeated claims by Government that it is trying to simplify the tax legislation, RNRB is potentially discriminatory and unfair.
To fully qualify, a couple must own a house valued at over £200,000, rising to £350,000 by April 2020. The house must be left to specific, restricted beneficiaries – the taxpayers' descendants, stepchildren, adopted children, a child for whom the taxpayer was a Guardian, spouses of any of these plus descendants and the taxpayers' own spouse/civil partner. If the taxpayer doesn’t own a house, the RNRB is not given and if the taxpayer owns a house but doesn’t leave the house, or a share of it, to any of the defined beneficiaries, it is not available.
In addition, if the house has a mortgage secured over it and its value, after debts, is less than the RNRB, the RNRB is restricted to the net value. This might have unfortunate results for a taxpayer who has taken out an Equity Release Loan because it is the value of the debt at the time of death which is deductible, not the initial amount borrowed.
The Government listened to requests to extend the RNRB to cover taxpayers downsizing to a lower value house or selling their house to move into a nursing home. The downsizing provisions are complex and in some circumstances can mean the RNRB is restricted, with the danger that it is client and fact-specific, plus the potential danger of penalties being charged if miscalculated.
Also, the Relief is withdrawn if a taxpayer’s estate exceeds £2m. To most, this is a significant, but it can be exceeded where a couple leave their estates to each other. In this situation, the RNRB is gradually withdrawn at a rate of £1 for every £2 in excess of £2m. Care will, therefore, have to be taken to avoid any “bunching” of estates and the loss of the RNRB, which could mean an additional £80,000-£140,000 of Inheritance Tax is paid.
With careful planning and correctly drafted wills, that tax will be able to be saved. This is the crux of the problem with the RNRB. Wills will now have to be drafted to take account of its complexities, which might be different for each taxpayer. The complexities are compounded when dealing with second families and, initially, after the introduction of the RNRB, wills won’t have been drafted in anticipation of the relief being claimed, so there will be an increase in the use of Deeds of Variation to make sure estates benefit from the RNRB.
Wills will need more complicated drafting to take account of the client’s situations as it is possible the RNRB could be lost because of bunching or because the surviving spouse already has the ability to claim two RNRBs (their own plus an inherited one) and cannot use a third. Again, Deeds of Variation will be useful but to qualify for the RNRB, the house or a share of a house must be left outright to the specified class of beneficiaries.
While welcome in reducing IHT, the RNRB brings unwelcome complications but, no doubt, opportunities.
John McArthur is a Partner, Gillespie Macandrew