Friday, October 26, 2007

One way to avoid paying inheritance tax


‘Double dipping’or How to pass investment assets down through the generations tax-free.

One of the starkest contrasts in the whole of taxation is between the treatment of predominantly trading businesses on the one hand and all other types of asset on the other, for inheritance-tax (IHT) purposes. While most forms of trading-business assets are 100% relieved from IHT, other assets are liable to tax at a rate of 40%, subject to the £300,000 threshold.

Double dipping is a way of effectively getting 100% relief on pure investment assets, and the best way to illustrate it is with an example.Mrs Widow has just lost her husband, and he has left her all the shares in Trading Limited, which are worth £1 million, and £1 million cash. There’s no tax on his death, of course, because all bequests to a surviving spouse are IHT-exempt. But both Mrs Widow and her son, who is actually running the business of the company and stands to inherit everything, can see that this has done nothing but postpone the problem. On his mother’s subsequent death, her taxable estate will consist of £1 million cash (the shares being 100% relieved) that will, at current rates, give rise to tax of nearly £300,000.

So, having consulted a tax specialist, he goes in for a double dipping scheme as follows.First, the will of the late Mr Widow is varied to leave the shares in the trading company direct to the son.

There is still no IHT even on the varied will because the shares in Trading Limited are 100% relievable.After a decent interval, though, Mrs Widow approaches her son with a view to buying the shares in the company for their full £1 million value.The son makes no capital gain on selling the shares to his mother, because he is treated as having acquired them at their full £1 million value.So the situation now is that Mrs Widow has £1 million worth of the shares in Trading Limited and her son has £1 million cash.

On her subsequent death, assuming nothing has changed, she leaves the shares in Trading Limited back to her son and her estate value is precisely nil, because of 100% relief on the shares.Hence, the same shares have effectively passed down from generation one to generation two twice, picking up business-property relief both times, and the net effect is that the £1 million cash is also passed down tax-free. Mrs Widow doesn’t even need to survive seven years, because the transaction she entered into with her son was at arm’s length and not a gift.Neat, if you know how!

Courtesy of The Schmidt Report

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