Wealth questions: Avoiding inheritance tax

I would like to make a substantial lifetime gift to my children in the hope that I live for seven years and so avoid inheritance tax on the transfer. Is there a way of also ensuring that my daughter’s husband does not become entitled to a large (and undeserved) share of the transferred amount in the fairly likely event of their getting divorced? Could both objectives be achieved by making a transfer to a foreign trust, of which my daughter would be a beneficiary and which would not be subject to the jurisdiction of a UK court?

Patrick Hamlin, counsel at Withers, the law firm, says that if you make a substantial lifetime gift, your estate will face inheritance tax (IHT) at 40 per cent unless you survive for seven years.

This liability would be offset by your nil-rate band (currently £325,000) and tapering relief which means if you survive for at least three years after the gift is made, the amount of tax payable is reduced by 20 per cent each year. There is also an annual exemption for gifts of £3,000.

You do not say what assets you intend to give but special exemptions are available for agricultural and business property. You might want to consider a seven-year term life insurance policy to cover any tax liability.

Your concern about what might happen should your daughter get divorced is understandable. The Matrimonial Causes Act 1973 gives courts a very broad discretion to transfer assets from one party to the other. Although we normally think in terms of the wife receiving assets from the husband at divorce, if the husband is the weaker party financially, a court may make an “ancillary relief order” in his favour.

Since the leading House of Lords case White v White (2001), equality has been the yardstick in financial provision on divorce, so that a 50/50 split is usually the starting point – certainly in high-value divorces. It is possible that a court might regard the gift from you to your daughter as something external to the marriage and so outside the “marital pot” available for distribution.

However, if a court considered that your son-in-law’s financial needs could only be met by having recourse to this property, then your gift may not be immune from his claims on a divorce.

I doubt whether putting the gift in a trust (whether English or foreign) would help very much. There is also a significant downside for people who set up a trust when they are UK-domiciled (which I am assuming you are).

If you were to put this gift into almost any kind of trust, you would trigger an immediate charge to inheritance tax of 20 per cent of the value of the gift in excess of your available nil-rate band, assuming no other reliefs were available. If the gift is below £325,000, there would be no tax payable, provided the full nil-rate band is still available.

Any tax paid would not be refundable even if you survived for seven years. If you did not survive, HM Revenue & Customs would seek to tax the gift at 40 per cent (subject to deduction of the 20 per cent already paid, plus any tapering relief that might be available). In addition, an English court has very broad powers at divorce to vary trusts, including foreign trusts. Although a defence might be available on the basis that such a settlement is not “nuptial” – that is, unrelated to the marriage – it cannot be certain that the gift would be excluded from the marital pot.

Whether orders by English family courts requiring foreign trustees to transfer property to a divorcing spouse can be enforced in that foreign jurisdiction is a hot topic at the moment.

The Royal Court in Jersey has been prepared to enforce such orders in a number of recent cases, and other offshore jurisdictions may follow this lead.

In short, I think you have to balance the desire to save inheritance tax against the possibility that transferring significant assets to your daughter may carry the risk of claims by your son-in-law on a divorce.

A possible middle way would be to make a series of gifts over the next year or two rather than risk the entire sum you have in mind all at once.

The advice in this column is specific to the facts surrounding the questions posed. Neither the FT nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.